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May 7, 2001

California Update: Duke Energy Proposes Settlement Deal 

By Will McNamara
Director, Electric Industry Analysis 

[IMAGE][IMAGE]Duke Energy (NYSE: DUK) approached Calif. Gov. Gray Davis with 
a secret deal, now made public, that offered monetary concessions if the 
state drops lawsuits and investigations into the company's alleged price 
gouging. Duke made the offer in a secret 17-page letter sent in April to Gov. 
Davis' office, which the governor confirmed on May 2. Davis' spokesman called 
the letter Duke's "wish list," which included having the state call off 
investigations of the North Carolina-based generator. Although Gov. Davis has 
acknowledged receipt of the proposal, he has not officially accepted or 
rejected the offer. 

Analysis: Duke's desire to make a settlement with the state of California 
stems from an ongoing investigation by FERC that began back in March. At that 
time, FERC put 13 California power sellers, including Duke, on notice that 
they must either make refunds for certain power sales or provide further 
justification for their prices. Duke is considered to be one of four 
companies (along with Dynegy, Reliant and Williams) that faces the biggest 
potential refunds to the state of California. In fact, Duke reportedly faces 
potential refunds of up to $20 million for the power that it has sold to 
California since the start of this year. 

We can fast forward from FERC's investigation to Duke's "good faith" 
settlement offer that now sits before Gov. Gray Davis. The plan sets out 
specific action steps for new generation, conservation programs, electric and 
gas infrastructure improvements, regional transmission frameworks, and 
environmental goals. In addition, Duke has offered an undisclosed settlement 
agreement, for which the California government would agree to cease all 
ongoing investigations of price manipulation by the company. Duke's 
"appropriate payment" is based on fair estimate of the company's alleged 
overcharges for power that it sold to the state.  

Yet, beyond the spin control surrounding this offer, Duke's proposal amounts 
to a mutual back-scratching agreement, with Duke clearly obtaining the 
largest benefit. Duke wants the state to drop all pending lawsuits that 
allege price gouging and tone down the negative public comments against Duke 
made by the governor and others. In return, Duke will refund to the state 
some of the money that it allegedly owes and will further assist in helping 
the state with its power supply needs. However, under the offer Duke will 
admit no wrongdoing. Rather, the company's proposal is being presented as an 
altruistic effort to assist in the resolution of California's flawed market. 
Neither Duke nor Gov. Davis has disclosed the monetary amount of Duke's 
settlement offer, but it is fairly safe to assume that it is only a fraction 
of the $20 million that the state wants. 

Other specifics within Duke's proposal that are important to note include the 
company's "commitment to work with the state to get 680 MW of additional 
peaking capacity ready for summer 2002." In addition, Duke has offered to 
enter into long-term contracts with the state on "reasonable terms" and also 
"attempt to secure other reasonably priced electricity for the state." 
Perhaps eliciting the greatest response within the industry is Duke's pledge 
to "share the financial pain" of California's troubled market with other 
market participants. 

Presently, Duke supplies about 5 percent of California's power needs, the 
majority of which is based on long-term contracts. This is a significant 
point because Duke has argued that its participation in the California market 
is not as entrenched in the volatile spot market, in contrast to many of the 
other power suppliers under FERC's investigation. The company also owns the 
Moss Landing plant, located south of San Jose, Calif., which it is upgrading 
with a $500 million investment. Duke has established that the plant should be 
able to provide approximately 30 percent of California's new generation in 
2002.  

While Duke downplays the role that California has played in its profits, the 
company's total wholesale profits soared 374 percent to $744 million for 
year-end 2000. For the year, Duke's California power plants generated 70 
percent more electricity than they did in 1999. In addition, in 2000 the 
plants provided 17 million megawatt hours of electricity to the state's power 
grid versus 9.5 million the previous year. 

Further, in January and February 2001, Duke charged more for power through 
"credit premiums," which were levied because of the risk of non-payment 
associated with California's financially struggling utilities. Duke claims 
that it is still owed about $100 million by the Department of Water 
Resources, California's power purchaser. 

Duke is not the only company forging settlement contracts with California. On 
May 2, Tulsa-based Williams Co. (also one of the top four companies 
reportedly owing the most to California) announced that it has agreed to pay 
$8 million to the California ISO to end FERC's investigation into whether the 
company's plants were kept offline to drive up prices. For several months, 
FERC has been investigating Williams regarding the company's alleged shutdown 
of two power generation units owned by AES, which reportedly allowed Williams 
to sell power from other units at higher prices. The stipulation and consent 
agreement reached between Williams and FERC identified no improprieties. In 
other words, Williams has made the payment but has admitted to no wrongdoing 
or price manipulation. A Williams spokesperson has said that the $8 million 
will be deducted from the $252 million that Williams is still owed for power 
sales to the California ISO and the California PX.  

Much like Duke, Williams has reported stellar profits over the last year. For 
year-end 2000, the company reported unaudited income from continuing 
operations of $873.2 million, or $1.95 per share on a diluted basis, versus 
$178 million, or 40 cents per share on a restated basis, for 1999. In 
addition, the company reported 1Q 2001 unaudited results that were more than 
double that of 1Q 2000-$378 million, or 78 cents per share, compared with a 
restated $139 million, or 31 cents per share.  

Moreover, the offers that Williams and Duke are forging with the state of 
California are probably only a small portion of what both companies have made 
from power sales to the state. However, one benefit of the deals is that they 
would keep the parties out of years of expensive litigation. Yet, at least as 
of this writing, Gov. Davis remains less than enthused about Duke's offer and 
has not eased off from his accusation that Duke (along with the other power 
generators) has "bilked millions of dollars from California consumers." In 
fact, although the governor has said that he is willing to continue 
negotiations with the various power generators, he has also vowed "not to 
call off the dogs" in the state and federal investigation of any price 
gouging. Toward that end, the state's lieutenant governor has initiated a 
class-action suit on behalf of California consumers against Duke and other 
power generators accused of price fixing. This legal claim follows similar 
suits initiated by the city of San Francisco and lawyers in San Diego. All of 
the suits basically claim the same thing, that Duke and four other power 
generators engaged in unlawful trading practices-such as shutting down 
plants-to drive up market prices in California.  

Duke, of course, maintains its innocence and says that the new lawsuit merely 
makes the same old claim that the company has repeatedly denied. 
Nevertheless, Duke has made a monetary offer to the state of California, 
which could be driven merely by the desire to avoid lengthy legal proceedings 
or by a concern that some wrongdoing on the company's part could eventually 
be determined. The stakes have also been raised with some California 
attorneys suggesting that any generators found to have engaged in price 
gouging should face civil and criminal penalties, which could include 
incarceration for any executive at the company who knowingly allowed the 
price manipulation to take place. Consequently, despite Duke's offer and any 
other proposals that subsequently come from power generators, it appears that 
litigation over the price gouging matter is unavoidable. 

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