Published Monday, Feb. 19, 2001, in the San Jose Mercury News

Stopgap fix won't keep power on

STATE STILL FACES DIFFICULT DECISIONS

As California's leaders scurry to rein in the immediate power crisis, the question of how the state's energy markets will work in the future remains unanswered.

BY CHRIS O'BRIEN Mercury News

Since legislators began tackling the power crisis six weeks ago, they have fundamentally changed the way the state's energy markets work. But they haven't even begun to grapple with the biggest issue they face: how these markets ought to work in the future.

The electricity system that has emerged over the past six weeks is a temporary patchwork of plans designed to prevent a full-scale meltdown. As stopgap measures go, the plans are radical: California has turned itself into the country's largest buyer of power. And on Friday, Gov. Gray Davis announced a multibillion-dollar plan to prop up the state's beleaguered utilities.

Davis has called the state's earlier efforts to deregulate its electricity system ``a colossal and dangerous failure.'' But the state's leaders still haven't decided whether they want to re-establish state control over the price and supply of electricity or simply correct the flaws in its 1996 deregulation law. That decision will lead them to a host of other, crucial questions.

Will the state continue to play its new, central role in buying power, or will it get out of the market, transferring the responsibility back to the utilities? Will consumers' electric rates be set by a state regulatory agency or by power generators and utilities? Will electricity regularly be bought under long-term contracts, a method that keeps rates stable but prevents consumers from reaping the benefits if wholesale power prices drop? Will consumers ever have a choice of power suppliers?

Legislators probably won't begin tackling the bigger picture until they are satisfied the immediate crisis has passed. Once that happens, experts say, Californians can expect a debate even more wrenching than the current one as utilities, power generators, consumer groups and politicians try to concoct a system that serves their constituents' interests and avoids the mistakes of the past.

``There needs to be a sense of urgency about developing a long-term solution,'' said Chuck Griffin, a spokesman for Mirant, an Atlanta-based energy company. ``Somebody needs to have a finger in the dike, and somebody needs to be rebuilding the dike.''

Stopgap system

The system created under deregulation was a mind-bending series of rules, accounting, trading schemes and new agencies designed to run the show. Observers say the system slapped together in recent weeks is even more complicated -- and, in some cases, incomprehensible.

At its heart is an existing state agency, the Department of Water Resources, that is doing two things: buying power every day and negotiating long-term energy contracts.

The department has already found plenty of critics for its method of buying power, through which it acquires about one-third of the electricity the state needs every day. By the end of February, the department will have spent $2 billion from the state's general fund.

Those transactions are secret because they are conducted through the Independent System Operator, the non-profit agency that runs the electricity grid. The ISO assumed much of this responsibility after the Power Exchange -- the energy trading market created under deregulation -- shut down last month.

Thanks to that secrecy, nobody knows just how much electricity the water agency is buying, or the cost. But one trend has become clear: The agency is not buying all the power the state needs, just power it can get that is sold under a certain price.

The remaining electricity is coming from power generators that are being forced to provide it under a controversial court order. At some point, they must be paid -- by either the utilities or the state -- but their patience is waning.

``We don't believe this was the intent of the legislation,'' said Joe Bob Perkins, chief operating officer for Reliant Energy's Wholesale Group.

State officials won't divulge how much power the water agency is buying or the cutoff price. But Steven Maviglio, a spokesman for Davis, said the legislation that was passed to authorize the energy purchases makes it clear the state would buy only power offered at ``reasonable'' prices.

That legislation also authorized the state to issue $10 billion in bonds to cover the cost of purchasing power. The money first will be used to cover what has already been spent by the state. The bonds won't be sold until May at the earliest, by which time the Department of Water Resources will have spent $4 billion on power at its current spending rate.

The remaining money will fund long-term energy contracts currently being negotiated by the water agency. The state hopes these contracts will lock in lower prices in the coming months and years.

Just how long this temporary system will hold together largely hinges on how much electricity is bought under these contracts and the price the state can get. The legislation authorizes the arrangement for three years.

So far, the signs aren't good. While the state is negotiating with several energy companies, it hasn't signed many contracts. Whatever power the state can't buy through contracts, it will have to buy on the open market. The more power it buys on the market, the higher the price is likely to be.

The rates paid by utilities customers will be used to pay back the bonds. These rates were raised about 9 percent in January and -- under the deregulation law -- could go up an additional 10 percent next year. The utilities will collect the money and use some of it to pay their own costs. The rest will be sent to the state.

If this leftover money isn't enough to cover the bond payments, the legislation requires the California Public Utilities Commission to step in and cut the utilities' costs or raise rates.

Long-term decision

Until the state finishes negotiating the long-term contracts, nobody can say how long this new system will last or how well it will work. That also means that nobody knows how much time the state has to design a more permanent solution to replace this temporary one.

Perkins, of Reliant, said this is a mistake. He said the state should have sought a comprehensive solution from the beginning, one that addresses long-term and short-term issues. Of course, the power generators' solution was more straightforward: Raise consumers' rates so the utilities would be solvent and the generators would get paid. Higher rates probably would also cause demand to decrease.

``Raising retail rates for the long term and the mid-term is for the good of all consumers in California,'' Perkins said.

Assemblyman Fred Keeley, a Santa Cruz Democrat, defended the work legislators have done so far.

``This has enormous consequences,'' Keeley said. ``We need to get this done. But we need to get this right. I understand they want to get paid. But I'm sure they don't want us to get this wrong.''

Over the coming weeks, the Legislature must grapple with the bailout proposed by Davis on Friday. Members must decide how much to pay the utilities for their transmission systems and whether that will provide enough money to reimburse generators. Once that final piece is in place, the state will have to begin the search for a permanent solution.

At the moment, nobody seems to have any idea what that solution might be.

``Right now, we have no clue,'' said Severin Borenstein, director of the University of California Energy Institute.

On a fundamental level, lawmakers must decide whether they want to return to some sort of deregulated system in which the market sets prices for consumers or whether to create a tightly regulated system in which the state sets prices.

By the time summer rolls around, the state will have cemented a major role in the energy market. It will be buying power, possibly owning the transmission grid, and -- under one plan circulating in the Legislature -- may be on its way to building power plants. But there still has been no decision as to whether this central role would be permanent or whether state leaders hope to find a way to return these functions to the utilities one day.

If they choose the latter course, they'll need to figure out how to keep the utilities going. Under the stopgap system, the utilities function primarily as billing and service companies, although they still generate a small portion of their power. It's unclear how profitable these reduced roles would be and whether the utilities would be in any condition down the road to take back some of their old duties.

In any type of system, it's likely that at least some power will be bought as it is needed, on the so-called spot market. But legislators will have to decide whether the majority of power will be bought this way -- as it was after deregulation -- or whether most power will be bought under long-term contracts at a set price. Like someone who's weighing a fixed-rate mortgage against an adjustable-rate mortgage, they'll have to balance the comfort of stability against the potential risks and rewards of paying market price.

For now, state officials say they want to take a deep breath and weigh all the options.

``Haste got us into this mess,'' Maviglio said. ``The governor wants to make sure that haste doesn't make this worse.''

http://www0.mercurycenter.com/premium/local/docs/powerfut19.htm

-- Martin Thompson (mthom1927@aol.com), February 19, 2001