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December 18, 2000 SourceBook Weekly Issue titles are below
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Utilities and Bandwidth: The Past, or the Future?
http://www.consultrci.com/web/rciweb.nsf/Web+Pages/SBEntrance.html
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Alternative Energy IPOs: Hot Now, But for How Long?
http://www.consultrci.com/web/rciweb.nsf/Web+Pages/SBEntrance.html
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Real-Time Metering: Can It Make a Difference in the Competitive Bottom
Line?
http://www.consultrci.com/web/rciweb.nsf/Web+Pages/SBEntrance.html
***********************************************************************
Light Amid the Darkness: Pennsylvania Viewed as Most Successful Competitive
Market
http://www.consultrci.com/web/rciweb.nsf/Web+Pages/SBEntrance.html
***********************************************************************

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SCIENTECH IssueAlert, December 18, 2000
FERC Approves Contentious Order on California
By: Will McNamara, Director, Electric Industry Analysis
===============================================================

The Federal Energy Regulatory Commission (FERC) last Friday unanimously
approved a comprehensive order on ways to fix California's troubled 
marketplace.
Though some, including Commissioner Curt H,bert, hoped this order would
be the final word, FERC signaled that more work has to be done to reach
market consensus on several issues, including a new market structure for
the state.

ANALYSIS: Although some ongoing and larger issues remain, this order does
bring closure to FERC's proposed ruling from last month, which had outlined
several key remedies to repair what has roundly been called a flawed system
in California. FERC previously had determined that the dysfunctional market
structure in the state had caused "unjust and unreasonable rates" for 
utilities
that must purchase power on the wholesale market, and end-use customers
such as those in San Diego who no longer are protected by a rate freeze.
With a couple of important exceptions, the Commission essentially gave
a rubber stamp of approval to its proposed order that was issued on Nov.
1, after receiving input from participants throughout the energy industry.

As expected, FERC adopted its "soft" rate cap of $150/MWh. In real terms,
this means that bids above this amount cannot set the market clearing price
that is paid to other bidders for power on the wholesale market. The rate
cap is referred to as "soft" because sellers may bid above this level and
receive their bid if they are dispatched, but anything higher than $150/MWh
will not set the price that all other generators will receive. Any generator
setting a bid above $150/MWh must report their bid to the Commission, and
presumably fall under intense scrutiny.

FERC also officially adopted a policy that removes restrictions against
bilateral contracts in California and de-emphasizes spot-market activity.
Moving forward, buyers and sellers in the California market no longer
have to sell into and buy from the California PX. Instead, long-term contracts
may be established between power distribution utilities and power sellers.
Specifically, FERC set into place a $74/MWh "target price" for forward
contracts. This represented a new policy on the part of the Commission
that had not previously been outlined in its proposed order, and was the
source of a great deal of contention within FERC. Commissioner Linda Breathitt
offered that the $74/MWh target price could possibly set the "standard
for reasonableness." However, unlike the $150/MWh rate cap for transactions
on the open market, prices below the target price of $74/MWh will likely
be accepted without the same level of scrutiny from FERC. Higher prices
may be subject to review.

A month ago, FERC had proposed establishing independent (non-stakeholder)
boards for the California Independent System Operator (ISO) and the PX.
This turned out to be more easily said than done, and was one of the earlier
proposals from which FERC retreated in its final order. Essentially FERC
had wanted to replace existing members of the respective boards with new
members not associated with the energy industry. However, the word is out
that California Governor Gray Davis had put pressure on FERC to not adopt
this policy because the governor himself wants to be able to choose new
members for the boards that will be "more sensitive to the needs of California
consumers." In the end, FERC decided that a new governing structure for
both the ISO and PX would be put into place by April of next year, and
would be established with the cooperation of the governor and other state
officials. Until that time, the current board members will continue to
act in an advisory capacity.

Signaling that FERC's final order will by no means close the book on the
problems we are seeing in California, Southern California Edison (SCE)
immediately responded with "deep disappointment" to the Commission's order.
Specifically, SCE claims that the order will do nothing to protect California
consumers from the unjust and unreasonable wholesale electricity prices
that FERC already agreed were in existence in the state. SCE previously
had urged FERC to adopt cost-based pricing rules, meaning that each power
seller would be able to bid into the market at variable operating costs.
FERC had taken this cost-based approach with the initial operation of the
restructured PJM pool, which appears to be working rather well in that
area. However, FERC did not adopt this approach for California, and SCE
contends that since November the soft rate cap of $150/MWh has been in
place and rates have continued to skyrocket.

Reportedly, prices last week in California reached as high as $1,400/MWh,
compared to an average of $31/MWh, which SCE claims was the price that
it charged for power from its own plants during the month of December in
previous years. Thus, SCE contends that FERC has not fulfilled its regulatory
obligation to repair the system in California, and as a result a severe
operational crisis in the state now appears inevitable.

Again, as we saw with the proposed order, dissension ran high within the
FERC itself. Commissioner H,bert reportedly felt that the final order was
"too timid" and that it did not do enough to solve the problems in California.
FERC Chairman James Hoecker appeared to be open to region-wide rate caps,
which H,bert strongly opposed and said could never receive approval from
the Commission. H,bert's consistent position has been that FERC is 
over-extending
its reach to mitigate prices, something he believes the Commission is 
ill-equipped
to do. H,bert, who by the way is rumored to become the next FERC chair,
dislikes any kind of rate cap and prefers instead to let market participants
manage their own exposure to price risk.

As I had discussed when I outlined the proposed order back in November
(see IssueAlert from Nov. 2 on www.consultrci.com), I questioned whether
or not FERC could reach any long-term solutions to California's problems.
The lack of consensus regarding how to fix California's dysfunctional market*
not
only within the Commission, but throughout the industry as a whole*only
seems to be growing. FERC set out with the clear goal of bringing down
energy prices for consumers, but it is still questionable if this final
order can accomplish that objective. As SCE notes, the soft price cap has
done nothing to keep prices down in the state, and concerns about power
supply in California continue to increase. In fact, nearly every day during
this month the California ISO has issued a stage one or two emergency warning,
indicating that operating reserves of power in the state are falling to
alarming lows.

Consequently, although this order attempted to reach resolution, it still
seems like there is little chance that we will see the end of the debate
over California any time soon. Perhaps the best feature of this order is
the removal of the requirement that buyers must obtain their power through
the California PX. The three California investor-owned utilities (PG&E,
SCE and SDG&E) represent 80 percent of the buying market in the state.
Through establishing bilateral contracts, they will have a new way to 
negotiate
the prices they pay for power, which could ultimately bring some stabilization
to the market in the state.

However, if California is indeed headed for even worse problems than it
has faced thus far, it will quickly become apparent whether or not FERC's
order does anything to abate the crisis. Quite possibly, the next course
of action could be taking the California issues to federal court for 
resolution,
which*much like our recent presidential election*could mean months (or
years) of further negotiations.
===============================================================
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