----- Forwarded by Brian Spector/Enron Communications on 01/03/01 08:58 AM 
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	Davis Thames
	12/28/00 10:26 PM
		 
		 To: Cynthia Harkness/Enron Communications@Enron Communications, Evan 
Betzer/Enron Communications@Enron Communications, Brian Spector/Enron 
Communications@Enron Communications
		 cc: 
		 Subject: The Wall Street Journal Interactive Edition


December 28, 2000
Review & Outlook
California Messes Up
What a lovely mess in California. Wholesale electricity prices are zooming, 
power reserve margins are shrinking, the state's two biggest utilities are on 
the verge of bankruptcy and its Governor has just gone, hat in hand, to visit 
Alan Greenspan, as though he could somehow make all of this awfulness go 
away. California has created an unusual problem for editorial writers. Too 
much blame! We are dizzy trying to decide how to allocate it. But here's our 
best guess:
The stars. An unfortunate misalignment of the planets has zoomed prices 
nationwide for an important raw material in electricity -- natural gas. And 
in California, which depends on natural gas, higher prices have been 
aggravated by an inadequate supply of electricity generation (more on this 
later) and insatiable demand. Demand for electric power has been increasing 
at almost triple the national rate of increase of 2% to 3% a year.
***

Unplugged 

But the magic moment happened when the planets governing prices collided with 
the need to shut down 25% of generation capacity a few weeks ago. This past 
summer has been rough on electric power generation. Some of the plant 
shut-downs were for maintenance and repair, some because plants had reached 
their air-pollution limits for the year. In the past, California would just 
gulp down some power from neighboring states in the Northwest. However, the 
planetary influences in the Northwest have not been auspicious either. A 
drought has left hydropower plants with less generating capacity; and colder 
weather, earlier than usual, has swelled demand.
The regulators. Four years ago, California regulators took their first -- and 
so far, only -- step toward the deregulation of electric power. (Note: They 
did not deregulate electric power, they vaguely made a pass at it.) Hence, 
the wholesale price is relatively free to reflect market conditions in 
generation, but the retail price to consumers remains frozen. That isn't 
deregulation; it's California's popular Santa Claus theory of economics.
Thus, when wholesale prices started to rise sharply in June, utilities were 
forced to buy higher priced power without being able to pass the increase 
along to consumers. The mismatch has resulted in a multibillion-dollar 
shortfall that has Southern California Edison saying it cannot pay its power 
bills due January 4. "Consumer advocates" seem to think the utilities have 
stashed money somewhere. Nonetheless, credit-rating agencies, looking at the 
current runaway debt situation for both Pacific Gas & Electric and Southern 
California Edison, have downgraded their ratings, making it more expensive 
for them to borrow.
These very same regulators then made a muddle when they tried to rush to the 
rescue. First, when the price of power rose, state regulators slashed the 
price cap on wholesale prices to $250 from $750 per megawatt-hour. This of 
course caused those who generate power to sell it to states without price 
caps. So the regulators dropped the cap completely only to watch prices shoot 
up to an amazing $1,400 per megawatt-hour. Then the state regulators called 
in the Feds. The Federal Energy Regulatory Commission ordered more price caps 
and the Secretary of Energy, Bill Richardson, ordered 75 Western wholesalers 
to continue selling to California utilities, despite the fact that they may 
not be able to pay their bills.
The utilities. They not only agreed to the original, bogus deregulation 
scheme, but they supported it. The scheme itself is a masterpiece of 
short-term thinking.
At the time, energy prices were low, so having a plump fixed rate must have 
looked mighty appealing. So the utilities cheerfully signed off on an 
arrangement that provided them with fixed rates to consumers and mandated 
that they buy power -- whose price was not fixed -- from a central exchange; 
moreover, the scheme dictated that they could buy no longer than one day 
ahead of need. No longer-term or side contracts permitted. In other words, 
the utilities agreed to buy in a volatile commodity market without the tools 
allowing them to hedge.
Nor have the utilities shown much interest in investing in metering that 
gives consumers a peek at what they are paying for electricity. Thus 
consumers not only have no incentive to conserve, but have no idea of how 
much their own use of electricity costs.
Consumers. Of course having no incentive to conserve -- (Why?! Our rates are 
fixed!) -- they haven't. Indeed, what happened in San Diego this summer 
provides a scary look into the consumer mind-set. San Diego Gas & Electric, 
the state's third largest investor-owned utility, ended its rate freeze in 
mid-1999. Rates dropped and everything seemed hunky-dory until last summer 
when the price of power skyrocketed. As their electric bills went up, 
consumers did, in fact, start conserving on their energy use. But they also 
went berserk and demanded rates be frozen again. The state's Santa Claus 
legislature accommodated.
The great state of California itself. If this were happening in any state 
other than California, we'd be covered in sympathy. California, however, is 
an advanced example of the peril of Nimby. It has the toughest environment 
regulations. It has some of the toughest plant siting and permitting 
procedures. In fact, things are made so tough in California that no new 
substantial power generation has been added in the state in almost 15 years. 
(Thus causing Nimby to be replaced by Banana -- build absolutely nothing 
anywhere near anyone.)
The great state of California, which now imports 20% of its power, has just 
assumed that states in the Northwest and Southwest would continue to supply 
its needs. Too bad if those neighboring states need that power for 
themselves; California just gets the Feds to order them to keep sending power 
anyway.
***
Although blame has many receivers, in this case there is only one lesson to 
be drawn: You can't have your cake and eat it, too. California ought to 
recognize there are trade-offs. Either it deregulates electric power 
completely and is prepared to take the occasional bad consequences of high 
prices with the more frequent good consequences of lower prices or it 
continues to shield users from price volatility and suffers from inadequate 
supplies of power. Either it indulges its hyperaesthetic environmentalism or 
it builds the necessary power generation.
The coming weeks will be interesting. The federal order requiring Western 
wholesalers to sell to California will expire; the California Public Utility 
Commission will decide on whether to lift rates for consumers, the federal 
courts will decide whether to accept FERC's price caps, the bills for power 
for the two largest utilities will come due, and Standard & Poor's will 
decide whether to lower the utilities' credit ratings into junk bond 
territory. Optimists see the opportunity for some sort of resolution; we're 
betting on seeing a wider opportunity to assign blame.
URL for this Article:
http://interactive.wsj.com/archive/retrieve.cgi?id=SB977956529393612258.djm


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