The attached article appeared in today's San Diego Union. I now have the 
official transcript from the Senate hearing of May 18 if you need that. If 
you are scheduling a conf call for tomorrow, can you do it after 12 your time 
as I am flying to San Francisco and will then be in the Brobeck offices. 
Thanks

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Date: Wed, 06 Jun 2001 08:53:28 -0700
From: "Cindy Frederick" <cfred@pkns.com>
To: "Michael Kirby" <mlk@pkns.com>
Subject: IS TRADING AN INSIDER'S GAME?
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IS TRADING AN INSIDER'S GAME?
Buying, selling of electricity is a growth business, but some say deck is 
stacked against consumers


By Craig D. Rose
STAFF WRITER

June 6, 2001



While Californians decry deregulation's failure to deliver a competitive 
market, electricity wholesalers have quietly developed a vast and rapidly 
growing business of buying and selling power among themselves.

The deals take place on high-tech trading floors in Houston and elsewhere 
around the country, as well as on Internet-based trading systems.

Some experts say this electricity trading is a key mechanism for raising 
consumer power prices, yet it's largely unregulated.

"Electricity trading is like buying stock -- when you have ability to change 
the stock price," said Frank Wolak, a Stanford University economics professor 
and member of the state grid operator's market surveillance group.

Energy companies say the buying and selling of contracts to deliver power 
provides risk management, allowing plant owners to presell their electricity, 
lock in prices and avoid fluctuations. The rough and tumble of the free 
market, they add, is the most efficient means of allocating a resource like 
electricity.

But industry critics say trading is far from a competitive market paradigm. 
In their view, it's a means of communication -- a way for energy insiders to 
collude and raise prices under the guise of competition.

To be sure, the trading arms of major energy companies have emerged as stars 
in an industry where profit surges of 300 percent or 400 percent are not 
uncommon.

The transactions, shrouded in secrecy, can leave ownership of a critical 
commodity in unknown hands. Consider the case of power generated by AES 
Corp.'s California plants.

In 1998, AES made a bold move. Immediately after purchasing power plants that 
gave it control of 10 percent of the state's electric generating capacity, 
the company sold the output from its plants for the next 20 years to Williams 
Cos.

Williams did not sit on this treasure trove of electrons. The Tulsa, Okla., 
company soon sold 80 percent of what it bought.

It is difficult to say who owns that power now. Some might be owned by Sempra 
Trading, a sister company of SDG&E. Or some could be owned by Enron Corp., 
the nation's biggest electricity trader.

A spokeswoman for Williams conceded that Williams itself may have repurchased 
some of the electricity it sold earlier. But trading companies closely guard 
their positions.

This much can be said with certainty: Electricity that AES sold for less than 
5 cents per kilowatt-hour to Williams changed hands perhaps 10 times in the 
wholesale market and emerged at times in recent months with a price tag for 
consumers that was 300 percent higher.

Williams' trading profits increased by 523 percent in the first quarter this 
year.


Advance sales
All this buying and selling creates curious confluences.
In their attempt to deflect criticism over high prices, generating companies 
such as Duke Energy -- operator of the South Bay Power Plant in Chula and 
others in the state -- frequently note that they sell most of their 
electricity far in advance. But they acknowledge less often that their 
trading units may also be buying power, which could boost the company's 
electricity inventory.

Duke was the fourth biggest electricity trader last year and cited its 
trading activity as a prime contributor to its wholesale business profits, 
which soared 324 percent in the first quarter to $348 million.

It is a company's power traders who frequently direct plant operators to 
increase or decrease the generation of power in response to market conditions.

Energy companies have little option but to turn to trading for profits. One 
of the better kept secrets of electrical deregulation and its promise of 
competition is that there is remarkably little competition in the production 
side of the business.

For one thing, electricity is a commodity; power from one company is 
indistinguishable from that generated by others.

More important, nearly all modern plants generate power from turbines built 
by a handful of manufacturers. The result? Modern plants owned by different 
companies produce power at nearly identical cost.

"The cost of power produced by modern plants is all within a mil 
(one-thousandth of a dollar)," said Michael Peevey, an adviser to Gov. Gray 
Davis and former president of Southern California Edison.

So the extraction of profit in the electricity business relies much more on 
trading. Traders' profits rise when prices are volatile -- plunging, or even 
better, rising sharply.


Little regulation
But despite the obvious temptation to manipulate the market, the burgeoning 
electricity trading business has remained largely unregulated.
The Federal Energy Regulatory Commission does require quarterly filings from 
energy traders, but these often provide incomplete information, or at least 
little that has been of concern to FERC.

In fact, although the trading of electricity grew more than a hundredfold 
from 1996 to 2000, FERC has taken no major enforcement action against a 
trader. After the onset of the California crisis last year, FERC has acted 
once. That was against Williams, which agreed to pay $8 million without 
admitting guilt to resolve an allegation that it withheld supply to pump up 
prices.

FERC's record of enforcement in the area of power trading stands in contrast 
to a long list of enforcement actions within other markets taken by the 
Securities Exchange Commission and the Commodity Futures Trading Commission.

FERC has recently added staff to its market oversight operations. But William 
Massey, a FERC commissioner, says the agency's effort is still inadequate.

"Electricity can be flipped, stripped and chopped up," Massey said. "It's an 
extraordinarily complicated market.

"The sophisticated marketers and traders have simply moved past us. We're 
kind of horse and buggy in our approach and they're out there in rocket ships 
flying around ... The problem is that sophisticated traders don't necessarily 
produce reasonable prices. They produce profits."

Before deregulation, electricity trading was a low-key affair. Regulated 
utilities dealt power back and forth on a reciprocal basis to fill 
electricity shortfalls in their control areas. There was little trading for 
profit until the mid-1990s, after federal legislation and FERC rulings opened 
the market.

Major traders include large energy companies, sister companies of 
California's major utilities and Wall Street firms.


Market volatility
In many ways, the trading of power is similar to that of other commodities. 
But there are important differences. Because it cannot be stored and its use 
is so fundamental, the price of electricity is the most volatile of all.
When supplies are tight, a single supplier can rapidly raise prices to 
budget-busting levels, as evidenced by Duke Energy's recent admission that it 
charged California nearly $4,000 for a megawatt-hour of power, a quantity 
that probably sold hours earlier for one-tenth of that sum or less.

Wolak, the Stanford economist, and state Sen. Joseph Dunn, D-Garden Grove, 
who is investigating the state power market, say trading allows companies to 
collude under the guise of competition. Instead of wringing out lowest costs, 
the wholesale trading market serves to raise prices, they say.

"As I trade to you and you trade to me, we communicate to each other what 
price we would like to get," said Wolak. "It's not collusive. It's just 
communicating price."

Mark Palmer, a spokesman for Enron, the nation's biggest power trader, said 
California's problem is not the result of trading.

"It's a result of shortages," Palmer said.

Underscoring its emphasis on trading, Enron's new headquarters tower in 
downtown Houston rises from a six-story block of new trading floors, 
including expanded space for electricity trading.

Enron also pioneered trading in cyberspace and its Enron Online site claims 
to be the most active computer-based trading market.

The Houston company argues that consumers won't fully benefit from power 
trading and deregulation until they have greater choice in choosing their 
power supplier. And the company says FERC has not done enough to open access 
to transmission lines, which would allow traders to move power around the 
country. To that end, Enron has lobbied hard for President Bush's plan for a 
national electricity grid.

Palmer says the notion that the price of electricity rises each time it is 
traded is mistaken.

"The market is always looking for the real price of a commodity," Palmer said.

Dunn, the California state senator, says his investigation found a different 
function for trading. At a time when supply barely meets or falls short of 
demand, he noted, companies with electricity to sell have to worry only about 
how high to set their price.

"The trader is a pawn in the generator's game to drive up prices," said Dunn. 
"Trading develops a level of trust. You, my alleged competitor, will bid in 
the same patterns and I will respond not in a competitive pattern but in a 
complimentary pattern."

The state senator said his investigation found evidence that on several days, 
energy companies appeared to test their ability to drive prices up, without 
being undercut by competitors.

This ability to drive up prices without competitive consequence is a key test 
of market power, the technical term for manipulation or price fixing.

But Dunn also conceded that antitrust violations can be hard to prove in 
court. He suggested that even if the trading behavior falls short of 
antitrust violations, it remains anti-competitive and devastating for the 
California economy.

To Harry Trebing, a utility industry expert and professor emeritus at 
Michigan State University, wholesale electricity trading is reminiscent of 
what took place in the 1920s and early '30s. Back then, utility companies 
created complex networks of holding companies that traded stock among 
themselves, driving up prices in the process.

Undoing that scheme was a focus of President Franklin Roosevelt's 
administration. Congress ended up barring national power companies and 
tightening regulation of utilities, in an effort to counteract their tendency 
to create markets that work only for insiders.

"The broad goals of trading are the same," Trebing said.

"The goal is to maximize profits through raising prices."