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----- Forwarded by Chip Schneider/NA/Enron on 02/05/2001 04:57 PM -----

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	02/05/2001 04:37 PM
		 
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		 Subject: California's Desperate Attempts to Avoid a Rate Increase - CERA 
Alert


Title: California's Desperate Attempts to Avoid a Rate Increase
URL: http://www20.cera.com/eprofile?u=35&m=2241


California,s Desperate Attempts to Avoid a Rate Increase

On February 1, 2001, the California Assembly approved and the California 
governor signed a new law intended to secure power supplies for California. 
The 
legislature has been meeting since early January in a &special extraordinary 
session8 to address the power market crisis in the state, and the new law 
represents their first significant piece of legislation. The bill, AB 1, 
establishes a new mechanism for purchasing power for the state,s businesses 
and 
consumers. Whether the mechanism works will depend chiefly on whether the 
limited revenue source used to pay for the power*collected by the state,s 
investor-owned utilities (IOUs) under current retail rates*will cover 
wholesale 
power market costs incurred by the state. The law reflects the obsession by 
California lawmakers with avoiding a rate increase rather than focusing on 
the 
underlying flaws in California,s market structure. 

AB 1 ushers in several important changes to the California market structure. 
It 
also contains several key provisions that capture the political mood in the 
state. Highlights of the bill include

* Power buying authority transferred. The responsibility for purchasing power 
for the customers of California,s IOUs has been transferred to the California 
Department of Water Resources (CDWR). The California utilities will continue 
to 
operate and schedule their remaining generating facilities and contracts. The 
difference between the utilities, total load and the sum of their resources 
(referred to as the utilities, &net short8 amount) will be supplied by CDWR, 
an 
amount of energy that varies between 5,000 and 25,000 megawatts (MW), 
depending 
on the time of year, time of day, and utility plant availability. The 
utilities 
most recently performed this function themselves, buying energy from the 
California Power Exchange (PX). However, CDWR has been buying electricity on 
behalf of the IOUs since mid-January, when the near-bankruptcy of Southern 
California Edison (SCE) and Pacific Gas & Electric (PG&E) threatened to 
disrupt 
supplies to their customers. CDWR is a state agency that manages water 
reservoirs and transportation systems in the state. CDWR uses an enormous 
amount of electricity to transport water across California and provides 
critical load-shedding capability to the independent system operator (ISO). 
In 
addition, CDWR,s reservoirs generate power. The CDWR is thus well integrated 
in 
the state,s electric grid but in the past has not executed large, complicated 
energy purchase arrangements to supply the customers of California,s 
utilities. 

* Portfolio of transactions. The intent of AB 1 is to allow CDWR to execute a 
portfolio of contracts to stabilize the cost of power for the utilities and 
their customers. CDWR has until January 2, 2003, to execute contracts. CDWR 
will take title to power and is thereby not just acting as a clearinghouse. 
It 
has issued a request for bids and seeks a variety of terms, including 
monthly, 
annual, two-year, three-year, and longer. CDWR may also enter into options. 
Thus, although CDWR,s role is intended to be temporary, the contracts that it 
executes could extend many years.

* Power for munis. CDWR may purchase power on behalf of some California 
municipal utilities at the municipal utilities, election.

* New payment scheme. CDWR will be entitled to a portion of existing utility 
rates to pay for the cost of purchased power, interest on bonds, and 
administrative expenses. This payment stream will be equal to the difference 
between the generation component currently embedded in utility retail rates 
(averaging about $0.07 per kilowatt-hour &#91;kWh&#93;) and the utilities, 
costs to run 
their own generation plants, costs of bilateral and qualifying facility 
contracts, and the costs of ancillary services. The CDWR share of retail 
rates 
is referred to as the California Purchase Adjustment (CPA). It is not clear 
whether the CPA will cover wholesale power market costs. Current prices for 
multiyear power contracts may lie above the CPA. In addition, if investors 
believe that the CPA is inadequate to cover costs, the entire program may be 
abandoned. 

* New bonds. Bonds will be issued to secure power. The total amount of bonds 
issued may not exceed four times the CPA. The state will transfer $500 
million 
from the general fund to jump-start the program, which begins immediately. 
This 
seed money and all bond proceeds must be recovered by CDWR from the 
California 
utilities, customers (and municipal utilities if they opt in).

* New residential rate freeze. The California Public Utilities Commission 
(CPUC) is prohibited from increasing residential customer rates until it has 
completed paying all outstanding obligations. This locks in the recent 9 
percent residential rate increase indefinitely. Governor Gray Davis thus 
keeps 
his pledge not to increase rates further.

* Retail competition. To help secure a stable payment stream for the new 
bonds, 
AB 1 enables the CPUC to prohibit the utilities, retail customers from 
choosing 
an alternative electricity provider until CDWR,s obligations are paid. 
Although 
the CPUC has yet to act on this, the action would effectively halt the 
competitive retail markets in the state for the duration of the CDWR program. 

* Taxpayer protection. AB 1 directs that the new bonds clearly state &&#91;
n&#93;either 
the faith and credit nor the taxing power of the State of California is 
pledged 
to the payment of the principal of or interest on this bond.8 Thus, the bonds 
are secured only by the payment stream from utility rates.

*No assets affected. The CDWR is granted neither ownership nor control of 
utility assets.

Ironically, the authority now granted CDWR is what California utilities had 
essentially requested last summer when they sought to stabilize electricity 
prices by executing a portfolio of transactions. The utilities were never 
provided sufficient authority to execute term contracts. In addition, the 
utilities have more experience to perform this function than CDWR. 

Rather than aligning retail rates with wholesale electricity prices, 
California 
has sidestepped the issue by simply transferring the electricity purchasing 
function. SCE and PG&E are still left to contend with uncollected costs from 
past energy purchases, although they will no longer incur costs associated 
with 
buying power in the current wholesale market while charging frozen retail 
rates. The utility liquidity crisis has not been resolved. 

It is not clear whether the law,s prohibition on rate increases for 
residential 
customers can be achieved. The law is silent on rate increases for commercial 
and industrial customers, providing a potential path for recovering 
higher-than-
expected costs. Alternatively, CDWR could conceivably find contracts of 
sufficient duration and low enough price that the rate pledge is met. These 
contracts would lock in today,s retail rates for a long period of time. 

AB 1 is just one of the steps that state officials hope will restore the 
power 
system in California to a more stable footing. Key tasks remain.

* California,s wholesale market structure, which helped cause the supply 
crisis 
by ensuring that it was not profitable or possible to build generation in 
California, remains unchanged. The term contracts CDWR is likely to sign will 
provide a mechanism for mainly existing generators to lay off risk but will 
not 
be sufficient to encourage the build of sufficient new facilities. In 
addition, 
California,s siting and permitting process remains largely unchanged.

* The state must still address the need to expedite the development of new 
power plants.

* AB 1 does not provide for the recovery of uncollected past wholesale energy 
costs of California,s utilities. The state has been negotiating a deal with 
the 
utilities that may involve the transfer of generation or transmission assets 
to 
the state. However, the utilities have achieved recent court victories that 
may 
pave the way to a court-directed recovery of these costs. Recent audits 
indicate that SCE and PG&E recovered their stranded costs early in 2000, 
which 
should have triggered an end to their respective rate freezes. A legal 
showdown 
between the utilities and the state on this issue may be inevitable.

**end**

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