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Sent: Monday, February 05, 2001 4:38 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**

Follow above URL for full report.

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