----- Forwarded by Sarah Novosel/Corp/Enron on 12/29/2000 08:58 AM -----

	"Jackie Gallagher" <JGallagher@epsa.org>
	12/21/2000 05:01 PM
		 
		 To: <bhawkin@enron.com>, <bmerola@enron.com>, <christi.l.nicolay@enron.com>, 
<donna.fulton@enron.com>, <janelle.scheuer@enron.com>, 
<jeff_brown@enron.com>, <jhartso@enron.com>, <Mary.Hain@enron.com>, 
<sarah.novosel@enron.com>, <tom.hoatson@enron.com>
		 cc: 
		 Subject: Possible EPSA Response to FERC's December 15th Order


MEMORANDUM

TO: Regulatory Affairs Committee
       Power Marketers Working Group

FROM: Don Santa, Regulatory Affairs Committee Chair
             Joe Hartsoe, Power Marketing Working Group Chair
             Julie Simon, Vice President of Policy

DATE: December 21, 2000

RE: Possible EPSA Response to FERC's December 15th Order
      Directing Remedies for California Wholesale Electric
      Markets
      ? Conference Call Scheduled for Wednesday, January 3rd
        at 2:00 p.m. (EST)

On December 15th, FERC issued an Order Directing Remedies for California 
Wholesale Electric Markets.  The Order retains many features of the 
Commission's November 1st order outlining proposed remedies for the 
California markets.  However, there are several aspects of this Order which 
vary from the earlier proposal.  EPSA has previously forwarded FERC's press 
release outlining the major features of the Order, along with a brief memo 
highlighting the $74 benchmark for finding forward contracts prudent and the 
January 2nd filing requirement for forward contract offers.

We need to consider whether EPSA should seek rehearing or clarification of 
any aspect of this Order.  Filings would be due at FERC no later than January 
15th.  Based on a review of the order, there are limited issues on which EPSA 
might seek rehearing, included the continued finding that the rates in 
California were unjust and unreasonable and the removal of opportunity costs 
as a basis for justifying prices above the $150 benchmark.  We will discuss 
these issues on our next weekly conference call, which is scheduled for 
Wednesday, January 3rd at 2:00 p.m. (EST).  If you have additional issues you 
want EPSA to raise, please forward them to Julie Simon at 202-789-7200 or at 
jsimon@epsa.org before the call.  To access the call, dial 1-800-937-6563 and 
ask for the Julie Simon/EPSA Call.

December 15th Order

Finding that the "electric power situation in California has worsened since 
the November 1 order was issued," the December 15th Order retained many of 
the proposals contained in its November 1st order, as well as new remedial 
measures.  Briefly summarized, the order includes the following measures:

? Elimination of the requirement that California utilities buy and sell power 
through the Power Exchange (PX).  This modification to the California market 
structure returns the 25,000 MWs of generation owned by the IOUs to the rate 
jurisdiction of the California PUC.  FERC also urges the California PUC to 
release the IOUs from their obligation to purchase from the PX.  The PX's 
current rate schedules are terminated as of April 30, 2001.  This new ability 
of the IOUs to self-schedule is intended to be the primary mitigation 
measures to dampen prices in California.

? A benchmark price for wholesale bilateral contracts, set at $74/MWh for 
five-year, round-the-clock arrangements.  The Commission hopes that 
establishing a level at which purchases can be deemed prudent will encourage 
the California PUC to do likewise.  The $74 benchmark was derived from the 
pre-restructuring, average embedded cost of generation in California. To 
corroborate the benchmark, and make adjustments as necessary, the Commission 
directed all sellers with market-based rate authority to report, no later 
than January 2, 2001, on a confidential basis, round-the-clock long-term 
products in annual increments between two and five years which they are 
willing to offer in California.  These informational reports should include 
price, terms and conditions, and amounts.  This information can also be 
reported on a non-confidential basis.

? Addition of a penalty for scheduling imbalances of more than five percent 
in the real-time energy market.

? Market monitoring and price mitigation for the residual real-time market, 
including modifications to the single price auction that preclude bids over 
$150/MWh from setting the market clearing price.  The November 1st Order had 
proposed this remedy for a two-year period, which has been shortened to four 
months in this Order.  The Commission will convene a technical conference, no 
later than January 25th, to develop a "comprehensive and systematic 
monitoring and mitigation program which incorporates thresholds and screens 
and specific mitigation measures if those thresholds and screens are 
breached."  A proposed plan is due by March 1, 2001 so that it can be in 
place by May 1, 2001.   An important modification to the November 1st 
proposal, suggested by EPSA, is that the review period for sales over $150 
will be limited to 60 days.

? Imposed a reporting requirement on the ISO and PX and jurisdictional 
sellers on sales over the $150/MWh "breakpoint."

? Elimination of the stakeholder boards of the ISO in favor of independent 
boards.  The directive for replacing ISO board has been modified to requiring 
the current governing board to relinquish decision-making power and operating 
control to the ISO management on January 29, 2001, although the governing 
board can continue to function as an advisory board.  The issue will be 
addressed and resolved in the context of the anticipated January 15th RTO 
filing.

? Requiring the ISO and the three IOUs to develop and file generation 
interconnection procedures.

Much of the Order is focused on eliminating the PX mandatory buy-sell 
requirement and incenting more forward contracting, with the goal of 
shrinking the real-time market to the extent possible.  The Commission stated:

We cannot emphasize enough that the California Commission must act decisively 
and immediately to eliminate the requirement for the IOUs to buy the balance 
of their load from PX.  This is the most serious flaw in the market design 
created by AB1890 and the California Commission's implementing orders.  
Continued delay in making this fundamental change places all other aspects of 
our remedial plan at risk, and prolongs the dysfunction of this market.  In 
addition it is critical that the California Commission move quickly to 
provide the IOUs with approval of their forward purchases.  The specter of 
after-the-fact disallowance for transactions other than PX purchases has 
certainly chilled the decision-making process and continues to subject 
California's ratepayers to the volatility of spot prices.  California is in a 
state of economic emergency, and there is little chance that the IOUs will 
rise to the task if they are not afforded certainty.

The Commission went on:

Some parties to this proceeding argue that the prices in the forward markets 
will be affected by last summer's spiraling spot prices and should therefore 
be deemed unreasonable.  We do not agree.  Sellers will certainly be aware 
that supplies of power are tight and that the IOUs are now aggressively 
seeking to avoid the exposure of the spot markets.  Under these 
circumstances, . . . , we will be vigilant in monitoring the possible 
exercise of market power.  However, suppliers also benefit from the stable 
revenue stream of forward markets and have every bit as much incentive to 
avoid the volatility of spot markets as do purchasers.  Moreover, suppliers 
will bargain knowing that the spot market's size will be greatly reduced and 
that next summer's spot prices will therefore not be fueled by frenzied 
buyers whose over-reliance on last minute purchases have forced them to bid 
up the prices to obtain needed supply.

On the issue of the $150 "breakpoint," the Commission pointed out that it is 
intended to be a "safety net" for a vastly reduced spot market.  The 
Commission emphasized that "by design and definition, spot markets must be 
allowed to reflect the price swings which capture their temporal nature."  
Since spot market prices are subject to dramatic drops in times of surplus, 
and increases in times of shortage, "those who remain in the spot market for 
buying their residual load or selling their residual supply should be there 
in full recognition of the effects on price of last minute sales and 
purchases."

In discussing plans for careful market monitoring and review of sales over 
the breakpoint, the Commission announced plans to look at outage rates for 
the seller's resources, failure to bid unsold megawatts into the real-time 
market, and variations in bidding patterns.  The order recognizes that 
sellers may bid above their marginal costs in times of scarcity, but does not 
expressly include the concept of opportunity costs, which were included in 
the November 1st Order.  On an issue that EPSA raised, the Commission 
concluded that the review of as-bid transactions will close within 60 days 
after the report is filed with FERC.  Unless notified by the Commission or 
its staff, transactions will be considered final and not subject to 
mitigation or other refund liability after the 60-day period.

In response to requests to revise or clarify the finding in the November 1st 
order that the flawed market rules in California "have caused, and continue 
to have the potential to cause, unjust and unreasonable rates for short-term 
energy," the Commission clarified that the November 1st order "did not find 
that all rates, at all times, were unjust and unreasonable in these spot 
markets."  The Commission points out that:

We have been faced in this case with the difficult question of what makes a 
market-based rate unjust and unreasonable.  There is no precise legal 
formulation for setting a just and reasonable rate and no precise bright line 
for when a rate becomes unjust and unreasonable. Under long-standing Supreme 
Court case law, rates must fall within a zone of reasonableness where the 
rates are neither so low as to be "less than compensatory" nor so high as to 
be "excessive" to consumers.  While high prices in and of themselves do not 
make a rate unjust and unreasonable (because, for instance, underlying 
production prices may be high), if over time rates do not behave as expected 
in a competitive market, the Commission must step in to correct the situation.

The Commission goes on to conclude that it has no evidence of specific abuses 
of market power.  However, other circumstances, such as over reliance of spot 
markets and a supply and demand imbalance, can lead to rates being excessive 
relative to the benchmark of producer costs or competitive market prices and 
a finding that prices are not just and reasonable.  In other words, even in 
the absence of market power abuses, prices are not necessarily just and 
reasonable.

Possible Area for Comment

Overall, the December 15th Order is consistent with the comments filed by 
EPSA in response to the November 1st Order.  The Order largely strikes a 
reasonable balance between principles and political practicality, with the 
Commission bending very little in response to intense political pressure from 
California.  Specifically, the Order does not find abuse of market power, 
order refunds, or impose California or regional price caps.  However, there 
are two issues that remain troubling:

1. The Commission reiterates its earlier conclusion that rates were not just 
and reasonable under certain circumstances in California.  While we argued 
strenuously against this conclusion in our November 22nd comments and the 
Commission "clarified" its early findings in this Order, the implications of 
this conclusion continue to have significant adverse political 
ramifications.  Without merely repeating our early arguments, we should 
consider taking another run at this issue.

2. The November 1st Order expressly provided for opportunity cost as a 
justification for prices above the $150 breakpoint.  The reference to 
opportunity costs has been deleted from this Order, apparently based on a 
belief that opportunity costs don't exist in real-time.  If we can make a 
credible case that sellers can sell out of California into other Western 
markets in a real-time or next-hour market, we may want to ask the Commission 
to reconsider allowing opportunity costs as a justification for prices over 
the $150 breakpoint.