-Caveat Lector- http://www.capitolalert.com/voices/walters/walters.may20-01.html Davis Neglected Key Strategy In Power Crisis Regulators, utilities sought fixed contracts 6 months ago Patrick Hoge, Chronicle Staff Writer Sunday, February 4, 2001 �2001 San Francisco Chronicle URL: http://www.sfgate.com/cgi-bin/article.cgi?file=/chronicle/archive/2001/02/0 4 /MN184122.DTL Gov. Gray Davis was slow to respond to the economic realities of California's power crisis despite warning signals from legislators, regulators and utility executives stretching back to last summer. Indeed, documents and interviews with industry insiders, regulators and lawmakers show Davis may have contributed to the meltdown of the state's two largest electric utilities by neglecting a repeatedly suggested strategy for stabilizing wholesale prices. In addition, a top former federal regulator said he told the governor's advisers and state Public Utilities Commission officials as early as July that a key Davis proposal -- to lower wholesale price caps -- wasn't likely to solve the state's power problems. "The governor resorted to a log-rolling strategy to get us to do things that we understood at the outset were not going to be real solutions," said James Hoecker, an appointee of President Clinton's who stepped down in January as the chairman of the Federal Energy Regulatory Commission. "He (Davis) has done a remarkable amount of homework, but I also think that he needs to listen to other people who know more about the business," Hoecker said. Ironically, Davis and the Legislature are now trying to employ the same tactic that Pacific Gas and Electric Co. and Southern California Edison Co. executives urged over six months ago -- negotiate longer-term contracts with generators to guarantee supplies at fixed prices. Today, however, the state is buying the electricity because the utilities ran up about $12 billion in debt between May and January and are unable to get credit. HIGHER RATES FOR YEARS For Californians, it means the state is spending hundreds of millions of tax dollars to keep the lights on and the gas flowing -- and California will be locked into doing so for years at higher rates than were being charged for power this past summer. "The supreme irony is that the state is now entering into the same contracts that we were prohibited and discouraged from entering into," said Dan Richard, a senior vice president for PG&E. Davis spokesman Steve Maviglio said the governor "has been promoting long- term contracts since June," and he blamed Republican appointees on the PUC for any delay in securing them, although there is little evidence to support that. Regarding the utilities' precarious fiscal health, Maviglio said nobody knew how bad it was until early December when the Independent System Operator, which operates the state's transmission lines, "went behind everyone's back" and asked federal officials to eliminate a $250 per megawatt wholesale price cap and prices jumped to $1,500, Maviglio said. The ISO asked for the caps to be lifted because not enough bids were coming in to keep the transmission system running reliably. "No one knew the economic realities. Everyone had a different story about their financial condition. The utilities had been crying wolf for only a few weeks back then," Maviglio said. "That (lifting the cap) ran out the clock pretty quickly." As early as Aug. 2, the PUC and the state Electricity Oversight Board reported to the governor that the summer rate spikes sparking citizen outrage in San Diego -- and rolling blackouts that had hit the Bay Area -- were a "precursor of what lies ahead for California's economy over the next 30 months. " Davis has posted a time line on his Web site listing his actions to stem the energy crisis. Much of his effort went to quickening construction of new generating plants, increasing conservation, and demanding investigations of alleged price gouging by out-of-state electricity generators and refunds for San Diegans. A reconstruction of key events based on interviews and documents filed with state and federal agencies, however, shows the Democratic governor did relatively little to address the hemorrhaging of money by Edison and PG&E, other than seek conservation and call for federal price caps. DAVIS MADE BIG MISTAKE A number of state legislators -- Democrats and Republicans -- as well as university economists and Wall Street analysts now agree with Hoecker and utility executives that failing to address longer-term contracting was a big mistake on Davis' part. Although by the fall it may have been too late to stop the utilities from spiraling into debt, longer-term contracts might have slowed the rate of their losses and bought the state time to address longer-term supply issues, said Pablo Spiller, chair of the business and public policy group at the University of California at Berkeley's Haas School of Business. "I think the Public Utilities Commission had all the tools necessary to avoid this, at least to avoid the utilities' financial problems," said Spiller, one of two dozen academics who recently issued a manifesto calling upon Davis to bite the bullet and raise electricity rates. "I think the inaction is at the source of the trouble that we have right now." Assemblyman Rod Wright, D-Los Angeles, chairman of the Assembly special committee on energy, advocated longer-term contracts between utilities and generators in December. Asked recently why the utilities had not yet entered into bilateral contracts, Wright said, "The answer to that is really at the PUC and the governor's office," Wright said the PUC, which he believed took much of its direction from the governor, was "derelict to some degree for not doing something to prevent these companies from going bankrupt." Until Aug. 3, California's investor-owned utilities were barred as part of the state's deregulation effort from entering into contracts directly with power generators. The theory was that competition would increase if all sales and purchases went through primarily short-term "spot" markets run by the California Power Exchange, a now-defunct state-created organization through which generators sold electricity, and the Independent System Operator, also a state-created agency. CALIFORNIA IS EXCEPTION California is the only state that has imposed such a limitation on its utilities as part of deregulation, and the utilities have been trying for years to get more latitude. The issue was not critical until late May, when prices started rising for the first time above what the utilities are allowed to charge customers, and the utilities started losing hundreds of millions of dollars a month. Media and political attention focused on San Diego, where residents saw their electricity bills almost triple. But in the second week of June, a Southern California Edison representative met with Davis and several of his top aides and warned that San Diego's experience had serious implications for Edison and PG&E, whose customers were protected by retail rate freezes until 2002 at the latest. On July 21, Edison and PG&E filed emergency requests with the PUC seeking authority to sign longer-term contracts directly with generators to protect themselves from surging prices. Their cause appeared to be bolstered by the Aug. 2 report that Davis requested from the PUC and the Electricity Oversight Board, which clearly said the state's spot markets were exacerbating price spiking and that contracts between the utilities and power producers were needed. Sources say some state economists feared that signing five-year contracts at $50 per megawatt hour could harm the economy. The day after the report was released, the PUC voted to let the utilities sign bilateral contracts through Dec. 31, 2005, subject to a review of reasonableness. But the utilities now say that vote was meaningless because the commission's staff refused to preapprove contracts as reasonable after a 30- day review -- as the commission's order directed. Commission President Loretta Lynch strongly defended the PUC's actions, saying the commission gave the utilities what they wanted. The utilities could enter into bilateral contracts from Aug. 3 forward, and their attempts to claim otherwise are disingenuous, she said. In fact, the utilities signed some bilateral contracts in October, Lynch said. "From my perspective, they're looking for someone to blame for their own inaction . . . They didn't make enough contracts," said Lynch, suggesting the utilities were trying to avoid a review of whether their contracts were reasonable. "Frankly, regulated entities always want less review and the whole pie whenever they can get it," she said. 'CRIMINALLY SLOW' For whatever reason, the utilities, claiming they were afraid the PUC might retroactively order refunds, continued buying short-term supplies while prices skyrocketed to previously unimaginable levels. "They (Davis and the PUC) were criminally slow in responding, and they really put the utilities in a corner," said Gary Ackerman, a spokesman for the Western Power Trading Forum, an association of energy generators, some of whom Davis has accused of price gouging. The Legislature on Aug. 30 passed a resolution stating that electricity prices were threatening "the financial viability of the electrical corporations" and directing the PUC to issue a report by Sept. 21 on "the most effective mechanisms to protect consumers from price volatility." Assembly Republicans also urged Davis to call a special session on the electricity crisis. In what now seems a prescient speech, Assembly Republican leader Scott Baugh of Huntington Beach, who has since left office, predicted the crisis in San Diego would spread statewide. "Nobody wants to be in public office when the tsunami hits," Baugh said. "I challenge the Democrats to stay in session until we have a long-term strategy in place. Otherwise, we are all fooling ourselves and wasting time." Once the Legislature recessed, lawmakers largely forgot about the issue until after the November election. Current Assembly Republican leader Bill Campbell of Villa Park acknowledged he didn't realize until he returned to Sacramento in December that PG&E and Edison were losing so much money. During the Legislature's absence, warning signs began to mount. On Sept. 7, Fitch Investors securities rating service reported that if California's electricity prices remained as high as they had all summer, utility debt "may balloon to extraordinarily high levels . . ." On Sept. 14, Moody's Investors Service changed the outlook for PG&E and its parent corporation from stable to negative. Then, on Nov. 1, the Federal Energy Regulatory Commission again recommended that California reduce its reliance on spot markets. The advice came in a detailed draft order that rejected lower price caps. Yet today, the utilities claim that state regulators still have not told them how to sign longer-term bilateral contracts without risking hefty sanctions. In December, after numerous complaints from the utilities, the state PUC issued draft guidelines, but those are not final. By that time, generators were refusing to sell to California's utilities for fear they would never get paid. "The utilities recognized early on that there was a serious problem and they tried to address it," said Susan Abbott, managing director of the power group at Moody's Investor Service in New York City. "They went to the (state) commission and tried to solve the problem and couldn't do it. The fact is, they tried to work within channels and they didn't get anywhere." Asked about the PUC's inaction on bilateral contracts, Maviglio suggested the governor's hands were tied because the five-member PUC was dominated by Republican appointees. Davis appointed a third commissioner only in January, giving him a majority, Maviglio said. "We knew about the issue (of longer-term contracts). The governor had two votes out of five on the commission. If Republicans wanted it to happen, it could have happened," Maviglio said. The commission, however, unanimously approved allowing bilateral contracts, and the sponsor of the motion was Henry Duque, an appointee of Republican Gov. Pete Wilson. When it comes to implementing commission directives, the PUC's energy division reports directly to Lynch, a Davis appointee. Michael Kahn, a San Francisco lawyer and chairman of the Electricity Oversight Board, who has advised Davis throughout the crisis, also said the mood changed dramatically when the Federal Energy Regulatory Commission, which he said dramatically worsened the utilities' financial situation by lifting the state's $250 price cap on Dec. 8. Prices skyrocketed after the cap was lifted. "It wasn't until early December . . . that the utilities dramatically intensified their predictions of catastrophic consequences," Kahn said. "Prior to that, they were saying that they wanted the right to long-term contracts, but that for the foreseeable future things were under control." Yet from August to October, PG&E internal notes document meetings with various PUC staff members at which the regulators, displaying an alleged "lack of urgency," refused to give assurances that the utility's efforts to secure low prices were reasonable. In frustration, Les Gugliasi, PG&E's director of regulatory relations, wrote Lynch on Oct. 16 complaining that after nine weeks PUC staff had not produced guidelines. The same day, PG&E told federal regulators that it had cash flow shortfalls of "astounding" dimensions. PG&E went ahead and signed some bilateral contracts, but the company was unwilling to assume more risk without guidance from the PUC, Gugliasi said. Bob Foster, a senior vice president of Southern California Edison, said his company experienced similar roadblocks, and that complaints were made to the governor's staff about it. "The fact is, the PUC set up a 30-day review period and they didn't follow it," Foster said. Hoecker, the former FERC chairman, said Davis repeatedly demanded a federal cap of $100 per megawatt hour, although generators could not be expected to sell for that price because it would not cover their costs. Hoecker said the state's $750 price cap was lowered to $500 on July 1 and then lowered to $250 on Aug. 7 but it did not help California's plight and actually drove suppliers out of the market. Federal officials spent "a lot of time" trying to persuade California officials to encourage longer-term contracting, he said. "With the considerable supply and demand imbalance, having everyone operating in the spot market was just a recipe for astronomically high prices, " Hoecker said. ---- ROAD TO THE ENERGY CRISIS Here is a snapshot of the key events leading to the current energy crisis in California: -- May: Wholesale electricity prices begin an unprecedented rise. -- Mid-June: A Southern California Edison Co. official meets with Gov. Gray Davis and several of his top advisers and warns that electricity prices in San Diego could soon go sky high, and that his company could take on significant debt. -- June 14: 100,000 Bay Area residents experience rolling blackouts. -- June 15: Davis orders report on Bay Area outages from California Public Utilities Commission and Electricity Oversight Board. -- July 21: Pacific Gas and Electric Co. and Edison file emergency motions seeking authority and guidelines to sign long-term contracts with electricity suppliers. -- July 27: Davis calls on federal regulators to extend wholesale electricity price caps. -- Aug. 2: PUC and Electricity Oversight Board report to Davis about the Bay Area power outage and high San Diego electricity prices, calling the problems "a precursor of what lies ahead for California's economy over 30 months." It recommends allowing big utilities to sign long-term contracts. -- Aug. 3: The PUC allows PG&E and Edison to sign long-term contracts, subject to review of reasonableness. Both companies soon file proposed contracts, which they say the PUC has not acted on to date. -- Aug. 22: Assembly Republican leader Scott Baugh and his caucus write Davis requesting that he call a special session of the Legislature starting Sept. 1, to formulate a response to "the current energy crisis in San Diego threatening to overwhelm the rest of the state." -- Sept. 6: Davis signs AB 265, capping San Diego electricity prices for some users. -- Sept. 14: Moody's Investors Service changes the outlook for PG&E and its parent corporation to negative from stable. -- Oct. 16: PG&E files a document with the FERC stating that it has cash flow shortfalls of "astounding" dimensions. -- Nov. 1: FERC issues a proposed order rejecting Davis' call for a lower wholesale price cap. The highly detailed response recommends California encourage the utilities to enter into long-term contracts with generators. -- Nov. 9: Davis testifies by video to the FERC, chastising federal regulators for not imposing price caps. -- Nov. 14: Davis testifies in person at a FERC meeting in San Diego, again calling for price caps. -- Dec. 7: Independent System Operator issues Stage 3 alert because of a dwindling power supply and warns of rolling blackouts. -- Dec. 8: FERC lifts the $250 per megawatt-hour hard cap on wholesale prices at the request of the ISO. An outraged Davis calls for a congressional investigation. -- Dec. 13: Davis and legislative leaders meet in Washington, D.C., with Energy Secretary Bill Richardson, FERC Chairman James Hoecker and others. Davis argues for federal wholesale price caps. Richardson averts rolling blackouts by ordering 12 generating companies to sell power to PG&E and Edison. -- Dec. 13: PUC President Loretta Lynch announces the commission is reversing its stance and would consider raising retail electricity rates. -- Dec. 16: Davis calls a special session and reserves $1 billion in his 2001- 02 budget to deal with the power crisis. -- Jan. 3: The Legislature convenes in special session, four months and 12 days after Assembly Republicans first asked for it. -- Jan. 4: PUC announces three-month rate increase of 10 percent for PG&E and Edison customers. -- Jan. 17: Rolling blackouts ordered in California for the first time. Davis declares a state of emergency. -- Jan. 22: Davis announces an auction for long-term energy contracts, advocating the state now do what the utilities say they had been trying to do for years. -- Feb. 1: Legislature authorizes the state to enter long-term contracts to buy power and opens the door for future rate hikes. 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