California power deals may prove short-sighted Updated 5:02 PM ET March 7, 2001 By C. Bryson Hull HOUSTON (Reuters) - Long-term power contracts, hailed as the answer to California's electricity crisis, may end up costing the state top dollar for years to come -- to the glee of generating companies mostly based outside the state.

Gov. Gray Davis made long-term contracts the backbone of his plan to cut wildly inflated electricity prices, announcing 40 deals or agreements-in-principle with 20 generators Monday.

While prices are much lower initially than the current spot market level, in the longer term the deals look very good for generators, analysts said Wednesday.

"They're just extending the high prices for years," said analyst Jeff Dietert of investment house Simmons and Co. in Houston. "What they're doing is capturing an artificially low price in the early years of the contract, but it locks in an artificially high price in the out years."

The deals, most in the 10-year range, provide power at an average price of $69 per megawatt-hour (MWh), far below the current spot market price of roughly $300 per MWh.

But consider that in 1999, the last year of normal wholesale electricity prices in California, the average price paid for a megawatt-hour was $30.95, according to statistics from the California Energy Commission.

"We wouldn't have settled on those prices if we thought they were too high. We think it's an excellent deal," Davis spokesman Steve Maviglio said. "No one has a crystal ball, and it's irresponsible to say prices will be lower if no one knows what they'll be."

What is certain is that new power plants will be built in California, which will help ease the shortage of generating capacity that made a grossly imbalanced seller's market for generators and sent spot prices to stratospheric levels.

And once generating capacity increases, supplies will catch up and drive prices down.

"With new generation, the shortages will stop, and prices may return to something like normal, around $30 per MWh, and if you're paying $70-80 per MWh, you're going to be paying way too much," said Robert Grow, an energy analyst with the California Energy Commission.

A major analysis of the California crisis released last month by respected consultancy Cambridge Energy Research Associates cautioned that the supply-demand curve was too far to the seller's side to make long-term deals a good buy.

"The worst time to shift into a portfolio buying strategy concentrated on long-term contracts is when the market is in shortage," the report said.

"Therefore, California should only deliberately move in this direction over the next three years, rather than trying to contract for excessive long-term supplies now."

GENERATORS WIN

Though only time will tell if California loses on the deals, power wholesalers and marketers can already count themselves among the winners.

The idea of using long-term contracts to protect against price volatility is the key strategy in the burgeoning multi-billion dollar business of energy services, pioneered by Houston-based energy and trading powerhouse Enron Corp.

So it should be no surprise that generators and power marketers jumped at the chance to provide long-term deals once California agreed to back them with its strong credit rating and authorization to issue up to $10 billion in new bonds to pay for them, Dietert said.

"They're able to stabilize their earnings, they eliminate the risk of wondering who's going to pay and they are locking in prices that provide good rates of return on their assets over the term that they're entering into," he said.

The companies include, among others, Enron, Dynegy Inc. , and El Paso Corp., all based in Houston; Williams Cos., based in Tulsa, Oklahoma; Calpine Corp. , based in San Jose, California; and Sempra Energy , based in San Diego.

So far, none of the companies involved has released financial terms, but the contracts have the potential to be worth billions, given the amount authorized in bonds.

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-- Martin Thompson (mthom1927@aol.com), March 09, 2001