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SCIENTECH IssueAlert, November 28, 2000
Duke Energy Offers Fixed-Priced Electricity Package for SDG&E
By: Will McNamara, Director, Electric Industry Analysis
===============================================================

Duke Energy, through its business unit Duke Energy North America (DENA),
has submitted an offer to manage San Diego Gas & Electric's (SDG&E) 3,300-MW
electricity load. The offer would establish a fixed price of 6 cents per
kilowatt-hour for wholesale power supply for the next five years, based
on market prices for electricity and natural gas as of Nov. 17, 2000. DENA's
proposal, which takes into account SDG&E's seasonal and hourly load 
requirements
and has a 3-percent annual adjustment for inflation, was included in comments
submitted to the Federal Energy Regulatory Commission (FERC) last week
in response to the commission's proposed remedies for California's electricity
market.

ANALYSIS: As has been well documented in this column and elsewhere, SDG&E
customers witnessed a staggering increase in the price of their electricity
last summer and into this fall, which resulted primarily from an ongoing
imbalance between supply and demand in the state of California. In addition,
other contributory factors have included the state's economic growth, lack
of new power plants over the last decade, unstable existing generation,
and the uncertainty of import prospects.

As SDG&E's rate freeze had been lifted last spring, customers of the utility
were exposed to retail electricity prices that often exceeded 18 cents
per kilowatt-hour, compared to the 6.5 cent per kilowatt hour maximum they
had become accustomed to under the rate freeze. The problem persists as
all three utilities in the state face high wholesale electricity prices.
However, SDG&E customers are as of yet the only ones in the state who bear
the brunt of the high prices as a rate freeze remains in effect for 
California's
other two IOUs, SCE and PG&E.

DENA is proposing to FERC that it be granted the right to provide power
for the totality of SDG&E's 3,300 MW electricity load. In return, DENA's
proposed fixed rate of 6 cents per kilowatt hour (plus annual 3-percent
increases) presumably will be much lower than the cost SDG&E customers
will continue to face without such a contract. DENA's proposal has been
made possible as a result of FERC's proposed order that was issued last
month, outlining a major overhaul of California's energy market. Since
competition began in the state in the spring of 1998, the three California
IOUs were required to buy their power from the state's Power Exchange.
FERC's order proposes to eliminate the requirement of buying from the PX,
which essentially permits the three IOUs to establish bilateral contracts
with energy suppliers. DENA has seized upon this opportunity to gain a
very lucrative contract, while at the same time attempting to protect SDG&E
customers from exorbitant electricity prices.

So, what is SDG&E's response to DENA's proposal? I spoke with Doug Kline,
spokesperson for the utility, yesterday afternoon. Kline pointed out that,
first of all, SDG&E has not yet received any offer from DENA and that "all
we've seen thus far is a press release." Kline suggested that it was a
public relations strategy on the part of DENA to first submit its proposal
to FERC and that, ultimately, SDG&E would be the one to accept DENA's offer.
In order to speak in detail on DENA's proposal, Kline said he would need
to see an actual contract, which has yet to materialize. Kline did disclose
that locking up long-term contracts for SDG&E customers, based on today's
high prices, would have to be seriously questioned by the utility, especially
considering that new generation will be coming online in California over
the next few years.

Beyond that, SDG&E is fielding other offers from energy suppliers, and
in fact has established long-term contracts with other providers, which
remain unidentified, for 50 percent of the power it buys on the wholesale
market. Back in September, the CPUC granted approval for SDG&E (as well
as SCE and PG&E) to purchase 50 percent of its power in forward markets,
with the other 50 percent still coming from the PX. For SDG&E, this amounts
to 1,900 MW of its total electricity load. Kline said that SDG&E would
need to compare DENA's offer with those received or accepted from other
energy suppliers to know if it represents a good deal for SDG&E customers.


At the same time, Sempra Energy*SDG&E's parent company*has made its own
proposal to FERC, urging the federal regulators to order refunds for SDG&E
customers and place a rate cap on wholesale rates, based on generators'
actual fees. Under FERC's proposed order, the commission suggested a "soft
rate cap" of $150/MWh. It's 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 generators will receive. Also, any generator setting
a bid above the soft rate cap must report their bid to the Commission,
and presumably fall under intense scrutiny.

This is not the first attempt that DENA has made to, as it says, "fix the
crisis" in California. In fact, back in August DENA offered California
Governor Gray Davis a deal in which the company would deliver 3,000 MW
of new supply to the state through the construction of generation facilities,
and provide all three IOUs with five-year, fixed-priced supply contracts.
Although Gov. Davis did not finalize a deal that would apply to all three
IOUs, SCE and PG&E proceeded with their own wholesale electricity contracts
with DENA. Both deals were sealed within the last month, although the specific
prices of the contracts are proprietary.

DENA has also proceeded with building new generation in the state. Just
two weeks ago, the company broke ground on a $525 million modernization
of its Moss Landing Power Plant in Monterey County. The modernization effort
is projected to add 1,060 MW of new capacity to site's current 1,500 MW
and create the state's largest power plant. DENA claims that, when completed,
the 2,560 MW that the plant will produce will generate enough wholesale
electricity to serve approximately 2.5 million households. In addition,
DENA has pending applications with the California Energy Commission to
modernize and expand two other power plants in California (Morro Bay and
South Bay power plants).

DENA's motivations are pretty understandable. The company may espouse good
intentions of helping California recover from its crisis but, realistically,
energy suppliers stand to make an awful lot of money from the state. I
started to notice the trend last month as 3Q earnings were reported. Virtually
every company that is active in California's wholesale market reported
a significant increase in earnings, reflective of the summer price volatility.
DENA was no exception. As a whole, Duke Energy reported record 3Q earnings
of $2.08 per share, a 73-percent increase over earnings per share of $1.20
for 3Q 1999. The company's North American Wholesale Energy*comprised of
DENA and Duke Energy Merchants*posted sharply higher gains with EBIT of
$231 million, a 175-percent increase over 3Q 1999. According to Duke Energy's
report, DENA achieved strong performance from its fleet of merchant power
plants and from natural gas and power trading activities.  DENA remains
on schedule to deliver approximately 3,200 megawatts of new merchant 
generation
(nationally) in time for summer 2001.

Moreover, it is as of yet unknown whether or not DENA's offer truly benefits
SDG&E and its customers. The proposal certainly benefits DENA, however,
especially if the company can lock in a contract that is based on current
high prices and includes annual increases. Securing SDG&E customers under
these factors would be a major coup for DENA in the California market,
but how it stacks up against SDG&E's other unnamed offers remains to be
seen.
==============================================================
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Sincerely,

Will McNamara
Director, Electric Industry Analysis
wmcnamara@scientech.com
===============================================================
Feedback regarding SCIENTECH's IssueAlert should be sent to 
wmcnamara@scientech.com
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