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September 25, 2001 


FERC and California ISO Move Closer to Decision on Refund Issue 



By Will McNamara
Director, Electric Industry Analysis 


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[News item from Reuters] U.S. regulators met with California state energy officials on Sept. 24 as part of ongoing mediation efforts to determine potential refunds in the Western power market, a spokeswoman for the Federal Energy Regulatory Commission (FERC) said. Separately, a House of Representatives panel signaled a possible probe into alleged price manipulation by two government-controlled California bodies that buy power for the state, according to a memo obtained by Reuters. FERC will facilitate meetings with the California Independent System Operator (ISO), the California Department of Water Resources-the state's main power buyer-seven private energy firms, and the state's investor-owned utilities. FERC is concerned that "reliability is being compromised" on the California power grid, Andrea Wolfman, a lawyer in FERC's enforcement office, wrote in a letter dated Sept. 17 obtained by Reuters. 

Analysis: In one of the lingering issues of the California energy crisis that has yet to be resolved, FERC, California officials and representatives from out-of-state power generators seem only incrementally closer to reaching a consensus on the refund issue, which has been under debate for most of this year. Two months ago, with California and power generators already locked in a stalemate over the state's demand for $8.9 billion in wholesale electricity refunds, FERC Administrative Law Judge Curtis Wagner halted negotiations on July 9 and declared that he would draft a refund plan. At that time, Judge Wagner made it clear that, while he had not calculated the amount, refunds would be returned to California and that the vast majority of the methodology presented by the California delegation would be adopted in his recommendation. Nevertheless, the issue still remains unresolved and now faces a new wrinkle: alleged market manipulation on the part of the California ISO and Department of Water Resources, the two state agencies with the biggest hand in wholesale transactions in California. 

It is also important to note at the onset that Judge Wagner disclosed on July 9 that power generators had offered a settlement of $716 million, which California officials flatly refused. Of that amount, reportedly $510 million was offered by the five biggest generators-Duke, Dynegy, Mirant, Reliant, and Williams. California's rejection of the offer signaled the end of the negotiations. In any case, the general message from Judge Wagner was one of support for the generators and a belief that any possible refunds would fall closer to a $1-billion level rather than $9 billion. Nevertheless, now that Judge Wagner has made his recommendations to FERC, he has apparently stepped out of these negotiations. 

In addition to the California ISO and the three California IOUs (Pacific Gas & Electric Co., Southern California Edison and San Diego Gas & Electric), the seven out-of-state energy companies that are participating in the negotiations on refunds are: Calpine (NYSE: CPN), Duke Energy (DUK), Dynegy (DYN), Enron (ENE), Reliant (REI), Mirant (MIR), and Williams (WMB). All of these companies are subject to potential refunds and as a result have seen their stocks fluctuate on the basis of positive or negative projections. In a nutshell, negotiations among the various parties stalled due to quantitative dispute over the amount of money that is owed to California. Gov. Gray Davis won't budge regarding his claim that generators owe the state nearly $9 billion. Most of the generators have consented to paying some amount of refund, but claim that the figure should be no more than $1 billion as a whole, adding that any amount above this figure would be unjustified. The wide range between the two amounts is what caused the negotiations to hit a brick wall and caused Judge Wagner to assume responsibility for a final recommendation to FERC. The stakes in this decision are huge, as Judge Wagner's refund plan (and FERC's subsequent ruling based on its own conclusions) will undoubtedly set a precedent for how wholesale power is bought and sold in U.S. markets that are subsequently deregulated. 

The other point of contention for the out-of-state generators is that the California ISO has reportedly not yet provided any detailed breakdown of data related to energy consumption by the California IOUs. With what they deem as insufficient data in hand, the generating companies are reticent to make any further refunds related to what they may or may not owe the state. Also at issue is whether or not previous refund demands made by the state of California included transactions that were manually completed or transactions that were in the process of being filled, the omissions of which could have artificially inflated the actual refund amount. Further, the generators maintain that their prices only reflected market conditions and that they are still owed billions from the state of California. 

In fairness, the actual dollar amount that the state of California may have been overcharged remains ambiguous because, up to this point, power generators have also refused to provide data showing their actual cost of producing power, as this represents competitive information. Rather, all of the parties involved in the negotiations have made presentations to Judge Wagner, and naturally have made the best case to support their various positions. This could all change if the dispute makes its way to a full-blown federal trial, as power generators (and state officials, for that matter) might be forced to turn over proprietary operational data. 

Moreover, out-of-state power generators have long been accused of price manipulation by Gov. Davis. Now, however, the new claims are being leveled against the California ISO and the Department of Water Resources. As a reminder, the California ISO manages the state's power grid with a mission to ensure that the grid is safe and reliable and that there is a competitive market for electricity in California. The Department of Water Resources assumed the unprecedented role of California's main power purchaser in January 2001 when the creditworthy status of the three IOUs became questionable. Specifically (according to the Reuters report), FERC is concerned that "reliability is being compromised" on the California power grid by the scheduling and dispatch procedures of the California ISO. 

In addition, the buying practices of the Department of Water Resources have also been brought into question. The accusation waged against the two agencies is essentially that the Department of Water Resources has spent an exorbitant amount of money for power through long-term contracts that it established when electricity prices soared from an average of $30/MWh to over $1,000/MWh earlier this year. Prices have now fallen to about $50/MWh due to cooler weather trends and reduced demand. FERC's concern, according to the memo obtained by Reuters, is that the California ISO is now purchasing surplus power from the Department of Water Resources at high prices to protect Gov. Davis from embarrassment related to the high price that the state is still paying for power. These accusations may fall under the investigation of the U.S. House Committee on Government Reform, but at least in this interim period are another sticking point for FERC in the refund negotiations. 

However, from my perspective, these new accusations against the California ISO and Department of Water Resources do represent an entirely separate issue from the refund-from-generators issue. Apart from everything else, the timeframe for which the refunds are being assessed is limited to October 2000 through May 2001. This time period may or may not overlap with any alleged market manipulation on the part of the two California state agencies. In any case, this issue will likely be sorted out through legislative intervention and will probably be kept separate from the refund issue. 

Although much of this case still remains in contention, some key factors are fairly undisputed. For instance, FERC has established that it is only seeking to establish a ruling based on three key areas: refunds of overcharges, long-term power contracts, and debts owed to generators by California utilities. Also, as noted, it is clear that the time period for which power generators may ultimately have to issue refunds is October 2000 through May 2001. Any overcharging that might have occurred outside of this timeframe is beyond the scope of this investigation and would not be included in any refunds made by the generators. It is also important to note that, according to a report issued by the California Energy Commission, other companies such as Destec and NRG also participate as non-utility generators in the California market and are presumably also under investigation. However, both of these companies have partnerships with Dynegy, which may have had the more active role in determining wholesale prices in the state. In addition, FERC has previously stated that it would be using its new price methodology as a basis to determine any potential refunds. The price control methodology, issued in June 2001, set an initial price ceiling of $107.9/MWh for wholesale power sales, which is considerably lower than the average price screen put into place by FERC's original order. Power generators will not be permitted to sell above the mitigated prices in the Western markets. 

Regarding the refund dispute, Gov. Davis maintains that the $8.9 billion in refunds, a figure that was calculated by the California ISO, is an accurate amount and one that is non-negotiable. Davis acknowledges that the figure includes potential overcharges from government-run operations such as the Los Angeles Department of Water and Power (LADWP) and BC Hydro, which FERC does not regulate. If the municipal utilities are not included in the equation, California officials allege that the power generators listed above collectively owe the state around $6 billion. Yet, when considering other Western states besides California that may also seek refunds from the power generators, the potential refund claimed by the states could reach as high as $15 billion. Records provided to Judge Wagner by California officials indicate that in January 2001, the first month in which the Department of Water Resources started to serve as the state's power purchaser, California spent about $332 per megawatt-hour for power on the wholesale spot market. 

Typically, the contracts already signed by the governor are in place for 10 years and were based on higher-than-cost-to-service rates. Some reports have indicated that the long-term contracts make the state liable for $43 billion in power payments over the next decade. At the time the contracts were signed, Davis felt pressure to ensure that California had a reliable supply of power, but he reportedly has been criticized for locking the state into expensive, long-term agreements and is eager to renegotiate them. While Davis is flexible on the various forms that the refunds could take, he has said, "they have to net out close to $8.9 billion." However, some of the power generators that established contracts with the state say re-negotiation is not possible as they have already locked themselves into deals with natural-gas suppliers. 


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