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November 29, 2001



California Develops Plan 
to Renegotiate Long-Term 
Power Contracts as State 
Faces Energy Surplus 



By Will McNamara
Director, Electric Industry Analysis





[News item from the Los Angeles Times] After months of defending the $43 billion worth of long-term electricity contracts he helped negotiate on behalf of the state, S. David Freeman suggested for the first time this week that the contracts be renegotiated, perhaps through the California Power and Conservation Financing Authority, a new public power agency he now chairs. "There seems to be pretty general agreement that these contracts need to be renegotiated," said Freeman, noting that critics of the contracts include Gov. Gray Davis, the president of the California Public Utilities Commission and the leader of the State Senate. Freeman said he is still proud of his work negotiating the contracts with companies Davis labeled at the time as gougers and pirates, but California's energy picture has vastly changed since January. 

Analysis: Oh, yeah, the California energy crisis ? remember that? For some, it may seem like ancient history that California suffered through an ill-fated experiment with electric deregulation that led to some devastating consequences, especially considering the Enron saga that now occupies headlines in the energy industry. Nevertheless, it should not be forgotten that, even though rolling blackouts in the state are no longer an imminent threat, some fundamental problems that defined the California energy crisis continue to plague the state. As one of the main resolution steps that were taken to repair the dysfunctional market, the state of California stepped into a very involved role as power purchaser on behalf of the state's three IOUs (Pacific Gas & Electric Co., Southern California Edison and San Diego Gas & Electric Co.), which due to credit problems were unable to secure power on their own. In an ironic twist indicating that California's problems are far from over, the stabilization of the state's markets are now in essence causing a new set of challenges and casting light on what appear to be questionable choices made by the state at the height of the crisis. 

At issue presently are some 54 long-term contracts that the state of California, through its Department of Water Resources, signed with power generators such as Calpine (NYSE: CPN), Duke (NYSE: DUK), Mirant (NYSE: MIR), and Williams (NYSE: WMB) to name a few back in early 2001, a time at which wholesale power prices were still running at very high levels. One of the primary benefits of the contracts was that they reduced the state's reliance on the volatile spot market, where prices had soared as high as $500/MWh. As a whole the contracts are worth about $43 billion and have a lifespan of 10 years or more. Some might argue that Gov. Davis, who led the effort for the state to assume the role of power purchaser, felt pressure to sign the contracts at that time, due to the uncertainty surrounding the financial solvency of Pacific Gas & Electric and SCE in particular. However, critics argue that the contracts locked the state into wholesale power costs when prices were the highest. 

Much of the details of the contracts signed by the state are proprietary, but there are some interesting details that can be gleaned. First, a good number of the contracts lock the state in to buying power at various times, including those of low demand (such as the morning). This leaves the state with a surplus of power that it does not need, which it in turn has been forced to sell at a loss. We also know that, as a general observation, the state bought power under the long-term contracts at an average price of $75/MWh. That same power reportedly will sell for only $16/MWh in 2002. 

As noted, Freeman, who previously managed the municipal utility known as the Los Angeles Department of Water and Power, recently assumed the management post of the new California Power and Conservation Financing Authority at the request of Gov. Davis. The agency was charged with quelling the extreme situation that California faced over the last year, including soaring power prices and blackouts. Looking beyond the immediate problems that have subsided, Freeman's new plan calls for a way to renegotiate the existing contracts and increase generation supply in the state at the same time. 

Let me try to put Freeman's plan into a nutshell. As a state agency, the Power Authority could sell up to $4 billion in revenue bonds, which would be guaranteed by energy sales, to lease, build or buy power plants. Consequently, the state, which can borrow money at below-market rates, is in a position to build new plants more cheaply than private companies could. As a carrot to entice the renegotiation of the long-term contracts, the state could offer generating companies a financial incentive to build new power plants in the state. In other words, the state would carry the investment for the costs of the new plants, alleviating pressure on the private companies to provide a 20-percent return to their shareholders. Note that most of the generating companies involved in long-term contracts with California are committed to building new power plants anyway. Some reports I've seen indicate that 70 percent of the 54 contracts that the state has signed include clauses that require the generating companies to build new power plants in the state. However, under normal circumstances, the expense of building the new plants would be financed by the generating companies and could cost hundreds of millions of dollars. Thus, in return for the financial incentive, the same generating companies would agree to renegotiate the terms of their long-term contracts with the state of California, presumably based on current market conditions. Note that the renegotiation could include cutting the prices in the contracts, or providing the state with more flexibility on the timing and quantity of electricity that must be purchased. 

The word from California is that most state officials think this plan has some legs. Nevertheless, word of the plan comes on the heels of claims that California is presently suffering from an energy glut (unused electricity) that may end up costing ratepayers as much as $3.9 billion over the next decade. The reason for the surplus power is that Californians have increased conservation efforts, which brought demand down, a condition that was maintained by comparatively moderate weather trends. The end result is that the state apparently bought far more power than it needed to meet the needs of the customers served by the three IOUs, and the state unfortunately cannot sell the excess power elsewhere and gain a profit. For instance, according to a report by the Department of Water Resources, in one three-month, low-usage period expected in the spring of 2002, 57 percent of the power for which the state has contracted will have to be sold at a loss of close to 80 cents on the dollar, ultimately costing utility customers as much as $193 million. The same report indicates that the power surplus in the state will reach its peak in 2004 and then gradually decline through 2010. 

Consequently, despite the financial advantages of Freeman's plan, the logistics of getting new power plants approved in the state in light of the apparent energy glut may be an impediment to the renegotiation strategy. In addition, some of the companies involved in the contracts with the state already own a large amount of generation capacity in California and may not be easily convinced to build new plants right away. For instance, Calpine Corp., which is one of the companies that has signed a long-term deal with the state of California, responded to the plan as saying that it "wouldn't be anything that Calpine would use." The company reportedly has finished three new power plants since June 2001 and would not be enticed by the financing incentive that the state is orchestrating. Further, the state's desire to renegotiate terms of the contracts is not a new concept. Ever since wholesale prices began to drop earlier this year, the renegotiation debate has been a fixture of state legislative and regulatory proceedings. However, since the onset of the talks, a good number of the generating companies have maintained that re-negotiation would not be possible as they had already locked themselves into deals with natural-gas suppliers. 

Thus, one concern is that the apparent energy glut in California will discourage further development of new generation and renewable energy sources, at least in the near term, which could set the state up for another dangerous boom-and-bust cycle down the road. In addition, those companies that already have long-term contracts with the state (such as Calpine) may not be enticed by the financing incentive, and those companies that don't have long-term contracts with the state will have no incentive at all to build new plants in California. All of this could create a situation in which California has too much power over the next few years and then will find itself in another shortage situation 10 or more years down the line. 

Freeman is apparently also pushing the state to once again make an attempt to take over some of Pacific Gas & Electric Co.'s physical assets. Instead of its transmission lines, however, the state now is examining its opportunity to buy the hydroelectric generation network (including dams and powerhouses) owned by the state's largest electric utility. Note that under its restructuring plan that has been submitted for regulatory approval, Pacific Gas & Electric Co. would split from its parent, PG&E Corp., and transfer generating and electric and gas transmission assets to form three new companies, which would fall under the jurisdiction of the Federal Energy Regulatory Commission (FERC). State regulators do not like this plan, and thus are seeking a way to retain control over the generating and transmission assets of Pacific Gas & Electric Co. Putting the hydroelectric assets under the State Power Authority would keep the assets under state control. 

Moreover, even though California is rethinking certain choices it made almost a year ago that directly entrenched the state government in the energy market, state officials still seem to want to gain control over fundamental parts of the state's energy infrastructure. Remember that Gov. Davis spent much of the last year attempting unsuccessfully to negotiate deals with SCE and SDG&E for the purchase of the utilities' transmission networks. Pacific Gas & Electric Co. never was interested in selling its transmission assets, which it believed the state's offer grossly undervalued. One of the main reasons that these attempts by the governor were unsuccessful was concern by state legislators who argued that the state was ill equipped to assume operation of the complex transmission networks. Nevertheless, in addition to renegotiating the long-term contracts, the state is still pursuing at least the hydroelectric generation assets of Pacific Gas & Electric. 


An archive list of previous IssueAlert articles is available at
www.scientech.com <http://secure.scientech.com/issuealert/> 


  _____  

We encourage our readers to contact us with their comments. We look forward to hearing from you. Nancy Spring  <mailto:nspring@scientech.com>

Reach thousands of utility analysts and decision makers every day. Your company can schedule a sponsorship of IssueAlert by contacting Jane Pelz  <mailto:jpelz@scientech.com>at 505.244.7650. Advertising opportunities are also available on our Website. 

  _____  

Our staff is comprised of leading energy experts with diverse backgrounds in utility generation, transmission and distribution, retail markets, new technologies, I/T, renewable energy, regulatory affairs, community relations and international issues. Contact consulting@scientech.com <http://consulting@scientech.com> or call Nancy Spring at 505.244.7613. 

  _____  

SCIENTECH is pleased to provide you with your free, daily IssueAlert. Let us know if we can help you with in-depth analyses or any other SCIENTECH information products. If you would like to refer colleagues to receive our free, daily IssueAlert articles, please register directly on our site at secure.scientech.com/issuealert <http://secure.scientech.com/issuealert/>. 

If you no longer wish to receive this daily e-mail, and you are currently a registered subscriber to IssueAlert via SCIENTECH's website, please visit <http://secure.scientech.com/account/> to unsubscribe. Otherwise, please send an e-mail to IssueAlert <mailto:IssueAlert@scientech.com>, with "Delete IA Subscription" in the subject line. 

  _____  

SCIENTECH's IssueAlert(SM) articles are compiled based on the independent analysis of SCIENTECH consultants. The opinions expressed in SCIENTECH's IssueAlerts are not intended to predict financial performance of companies discussed, or to be the basis for investment decisions of any kind. SCIENTECH's sole purpose in publishing its IssueAlert articles is to offer an independent perspective regarding the key events occurring in the energy industry, based on its long-standing reputation as an expert on energy issues. 



Copyright 2001. SCIENTECH, Inc. All rights reserved.
  <http://secure.scientech.com/images/spacer.gif>	
  <http://secure.scientech.com/_IA_TEST/Corner_BL.jpg>		  <http://secure.scientech.com/_IA_TEST/Corner_BR.jpg>	

November 29, 2001



California Develops Plan 
to Renegotiate Long-Term 
Power Contracts as State 
Faces Energy Surplus 



By Will McNamara
Director, Electric Industry Analysis





[News item from the Los Angeles Times] After months of defending the $43 billion worth of long-term electricity contracts he helped negotiate on behalf of the state, S. David Freeman suggested for the first time this week that the contracts be renegotiated, perhaps through the California Power and Conservation Financing Authority, a new public power agency he now chairs. "There seems to be pretty general agreement that these contracts need to be renegotiated," said Freeman, noting that critics of the contracts include Gov. Gray Davis, the president of the California Public Utilities Commission and the leader of the State Senate. Freeman said he is still proud of his work negotiating the contracts with companies Davis labeled at the time as gougers and pirates, but California's energy picture has vastly changed since January. 

Analysis: Oh, yeah, the California energy crisis ... remember that? For some, it may seem like ancient history that California suffered through an ill-fated experiment with electric deregulation that led to some devastating consequences, especially considering the Enron saga that now occupies headlines in the energy industry. Nevertheless, it should not be forgotten that, even though rolling blackouts in the state are no longer an imminent threat, some fundamental problems that defined the California energy crisis continue to plague the state. As one of the main resolution steps that were taken to repair the dysfunctional market, the state of California stepped into a very involved role as power purchaser on behalf of the state's three IOUs (Pacific Gas & Electric Co., Southern California Edison and San Diego Gas & Electric Co.), which due to credit problems were unable to secure power on their own. In an ironic twist indicating that California's problems are far from over, the stabilization of the state's markets are now in essence causing a new set of challenges and casting light on what appear to be questionable choices made by the state at the height of the crisis. 

At issue presently are some 54 long-term contracts that the state of California, through its Department of Water Resources, signed with power generators such as Calpine (NYSE: CPN), Duke (NYSE: DUK), Mirant (NYSE: MIR), and Williams (NYSE: WMB) back in early 2001, at a time at which wholesale power prices were still running at very high levels. One of the primary benefits of the contracts was that it reduced the state's reliance on the volatile spot market, where prices had soared as high as $500/MWh. As a whole the contracts are worth about $43 billion and have a lifespan of 10 years or more. Some might argue that Gov. Davis, who led the effort for the state to assume the role of power purchaser, felt pressure to sign the contracts at that time, due to the uncertainty surrounding the financial solvency of Pacific Gas & Electric and SCE in particular. However, critics argue that the contracts locked the state into wholesale power costs when prices were the highest. 

Much of the details of the contracts signed by the state are proprietary, but there are some interesting details that can be gleaned. First, a good number of the contracts lock the state in to buying power at various times, including those of low demand (such as the morning). This leaves the state with a surplus of power that it does not need, which it in turn has been forced to sell at a loss. We also know that, as a general observation, the state bought power under the long-term contracts at an average price of $75/MWh. That same power reportedly will sell for only $16/MWh in 2002. 

As noted, Freeman, who previously managed the municipal utility known as the Los Angeles Department of Water and Power, recently assumed the management post of the new California Power and Conservation Financing Authority at the request of Gov. Davis. The agency was charged with quelling the extreme situation that California faced over the last year, including soaring power prices and blackouts. Looking beyond the immediate problems that have subsided, Freeman's new plan calls for a way to renegotiate the existing contracts and increase generation supply in the state at the same time. 

Let me try to put Freeman's plan into a nutshell. As a state agency, the Power Authority could sell up to $4 billion in revenue bonds, which would be guaranteed by energy sales, to lease, build or buy power plants. Consequently, the state, which can borrow money at below-market rates, is in a position to build new plants more cheaply than private companies could. As a carrot to entice the renegotiation of the long-term contracts, the state could offer generating companies a financial incentive to build new power plants in the state. In other words, the state would carry the investment for the costs of the new plants, alleviating pressure on the private companies to provide a 20-percent return to their shareholders. Note that most of the generating companies involved in long-term contracts with California are committed to building new power plants anyway. Some reports I've seen indicate that 70 percent of the 54 contracts that the state has signed include clauses that require the generating companies to build new power plants in the state. However, under normal circumstances, the expense of building the new plants would be financed by the generating companies and could cost hundreds of millions of dollars. Thus, in return for the financial incentive, the same generating companies would agree to renegotiate the terms of their long-term contracts with the state of California, presumably based on current market conditions. Note that the renegotiation could include cutting the prices in the contracts, or providing the state with more flexibility on the timing and quantity of electricity that must be purchased. 

The word from California is that most state officials think this plan has some legs. Nevertheless, word of the plan comes on the heels of claims that California is presently suffering from an energy glut (unused electricity) that may end up costing ratepayers as much as $3.9 billion over the next decade. The reason for the surplus power is that Californians have increased conservation efforts, which brought demand down, a condition that was maintained by comparatively moderate weather trends. The end result is that the state apparently bought far more power than it needed to meet the needs of the customers served by the three IOUs, and the state unfortunately cannot sell the excess power elsewhere and gain a profit. For instance, according to a report by the Department of Water Resources, in one three-month, low-usage period expected in the spring of 2002, 57 percent of the power for which the state has contracted will have to be sold at a loss of close to 80 cents on the dollar, ultimately costing utility customers as much as $193 million. The same report indicates that the power surplus in the state will reach its peak in 2004 and then gradually decline through 2010. 

Consequently, despite the financial advantages of Freeman's plan, the logistics of getting new power plants approved in the state in light of the apparent energy glut may be an impediment to the renegotiation strategy. In addition, some of the companies involved in the contracts with the state already own a large amount of generation capacity in the state and may not be easily convinced to build new plants right away. For instance, Calpine Corp., which is one of the companies that has signed a long-term deal with the state of California, responded to the plan as saying that it "wouldn't be anything that Calpine would use." The company reportedly has finished three new power plants since June 2001 and would not be enticed by the financing incentive that the state is orchestrating. Further, the state's desire to renegotiate terms of the contracts is not a new concept. Ever since wholesale prices began to drop earlier this year, the renegotiation debate has been a fixture of state legislative and regulatory proceedings. However, since the onset of the talks, a good number of the generating companies have maintained that re-negotiation would not be possible as they had already locked themselves into deals with natural-gas suppliers. 

Thus, one concern is that the apparent energy glut in California will discourage further development of new generation and renewable energy sources, at least in the near term, which could set the state up for another dangerous boom-and-bust cycle down the road. In addition, those companies that already have long-term contracts with the state (such as Calpine) may not be enticed by the financing incentive, and those companies that don't have long-term contracts with the state will have no incentive at all to build new plants in the state. All of this could create a situation in which California has too much power over the next few years and then will find itself in another shortage situation 10 or more years down the line. 

Freeman is apparently also pushing the state to once again make an attempt to take over some of Pacific Gas & Electric Co.'s physical assets. Instead of its transmission lines, however, the state now is examining its opportunity to buy the hydroelectric generation network (including dams and powerhouses) owned by the state's largest electric utility. Note that under its restructuring plan that has been submitted for regulatory approval, Pacific Gas & Electric Co. would split from its parent, PG&E Corp., and transfer generating and electric and gas transmission assets to form three new companies, which would fall under the jurisdiction of the Federal Energy Regulatory Commission (FERC). State regulators do not like this plan, and thus are seeking a way to retain control over the generating and transmission assets of Pacific Gas & Electric Co. Putting the hydroelectric assets under the State Power Authority would keep the assets under state control. 

Moreover, even though California is rethinking certain choices it made almost a year ago that directly entrenched the state government in the energy market, state officials still seem to want to gain control over fundamental parts of the state's energy infrastructure. Remember that Gov. Davis spent much of the last year attempting unsuccessfully to negotiate deals with SCE and SDG&E for the purchase of the utilities' transmission networks. Pacific Gas & Electric Co. never was interested in selling its transmission assets, which it believed the state's offer grossly undervalued. One of the main reasons that these attempts by the governor were unsuccessful was concern by state legislators who argued the state was ill equipped to assume operation of the complex transmission networks. Nevertheless, in addition to renegotiating the long-term contracts, the state is still pursuing at least the hydroelectric generation assets of Pacific Gas & Electric. 


An archive list of previous IssueAlert articles is available at
www.scientech.com <http://secure.scientech.com/issuealert/> 


  _____  

We encourage our readers to contact us with their comments. We look forward to hearing from you. Nancy Spring  <mailto:nspring@scientech.com>

Reach thousands of utility analysts and decision makers every day. Your company can schedule a sponsorship of IssueAlert by contacting Jane Pelz  <mailto:jpelz@scientech.com>at 505.244.7650. Advertising opportunities are also available on our Website. 

  _____  

Our staff is comprised of leading energy experts with diverse backgrounds in utility generation, transmission and distribution, retail markets, new technologies, I/T, renewable energy, regulatory affairs, community relations and international issues. Contact consulting@scientech.com <http://consulting@scientech.com> or call Nancy Spring at 505.244.7613. 

  _____  

SCIENTECH is pleased to provide you with your free, daily IssueAlert. Let us know if we can help you with in-depth analyses or any other SCIENTECH information products. If you would like to refer colleagues to receive our free, daily IssueAlert articles, please register directly on our site at secure.scientech.com/issuealert <http://secure.scientech.com/issuealert/>. 

If you no longer wish to receive this daily e-mail, and you are currently a registered subscriber to IssueAlert via SCIENTECH's website, please visit <http://secure.scientech.com/account/> to unsubscribe. Otherwise, please send an e-mail to IssueAlert <mailto:IssueAlert@scientech.com>, with "Delete IA Subscription" in the subject line. 

  _____  

SCIENTECH's IssueAlert(SM) articles are compiled based on the independent analysis of SCIENTECH consultants. The opinions expressed in SCIENTECH's IssueAlerts are not intended to predict financial performance of companies discussed, or to be the basis for investment decisions of any kind. SCIENTECH's sole purpose in publishing its IssueAlert articles is to offer an independent perspective regarding the key events occurring in the energy industry, based on its long-standing reputation as an expert on energy issues. 



Copyright 2001. SCIENTECH, Inc. All rights reserved.
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