Posted at 9:27 p.m. PDT Saturday, May 5, 2001

Grid execs admit to bloated budget

Officials say rushing into business three years ago, vendors who played hardball contribute to extra cost

BY JOHN WOOLFOLK AND ERIC NALDER Mercury News

The non-profit agency that runs most of California's electric grid and sits at the hub of the state's collapsing power system spends far more than any other grid operator in the country on everything from telephones to salaries.

The agency, the California Independent System Operator, pays more than $30 million a year for a phone system that vastly exceeds its needs, gives its chief executive a salary of more than a half-million dollars and spent $15 million on an outdated computer system that needs to be replaced after just three years.

The ISO's spending has been largely overlooked in the uproar about rising power prices. But the agency spends about twice as much as other grid operators, a stark contrast to the promise that deregulation would deliver great savings through market efficiency.

``The cost of the ISO is, in my judgment, two to three times what it could be to do the same thing,'' said James H. Caldwell, an energy consultant who compared costs in a 1998 study for the agency. ``It's just all really, really gold-plated.''

ISO officials acknowledge the high spending but say state leaders forced them to put the organization together quickly three years ago at great cost. Policymakers were in a hurry to launch deregulation, believing it would lower what were among the nation's highest electricity rates.

``Compared with other ISOs, we're about twice as costly,'' said Philip Leiber, the ISO's treasurer and financial director. ``We spent more than they did to get up and running. Just like everything else, if you have to build something quick, you pay a premium.''

Among the ISO's expenses:

A six-year, $200 million contract for a custom fiber-optic phone system, costing about 10 times more than those at comparable agencies.

More employees and some of the highest salaries in the industry. The ISO pays its president and chief executive, Terry Winter, $550,000 a year, nearly twice what some of his peers earn and three times the California governor's salary.

An outdated $15 million computer system unable to perform needed tasks that may have contributed to sellers' ability to drive up prices. It is being replaced, for $9 million, by a more up-to-date customized system.

Prices inflate budget

State leaders expected that savings from low-market power prices would easily offset the ISO's high start-up costs. Now that out-of-control market prices are pushing California's electric bill to about $70 billion in 2001, 10 times the 1999 cost, ISO officials say their $225 million budget pales in comparison.

Three current and former ISO officials questioned why anyone would notice the high cost of phones, salaries and computers now that billions are being lost in the electricity market.

``Small potatoes,'' said Jeff Tranen, the agency's first CEO and now a consultant in New York.

``Lost in the noise level,'' said S. David Freeman, the trustee who oversaw the creation of the ISO.

``A hangnail,'' said ISO board member Mike Florio, who's also an attorney for The Utility Reform Network, a consumer group.

The ISO is supported by fees charged for delivering wholesale power over the grid, not by taxpayers. Those fees amount to a tenth of a cent per kilowatt-hour, or about 50 cents a month for an average household.

Critics, however, argue that the ISO's free spending betrays consumers.

``This is just more of the boondoggle of deregulation,'' said Harvey Rosenfield of the Foundation for Taxpayer and Consumer Rights. ``It's legalized graft.''

Few officials have ever questioned spending at the ISO, which is overseen by the state Electricity Oversight Board and the Federal Energy Regulatory Commission. Even regulators have had difficulty prying market information out of the ISO.

Some lawmakers did ask about the ISO's proposed $52 million headquarters. But the agency planned to proceed anyway, arguing it would be cheaper than paying rent. The project is on hold now because of market uncertainty.

The ISO's spending is shielded from the same line-item budget scrutiny a government agency receives because it is a private non-profit company. The ISO must release its tax returns, but it isn't subject to open meeting and public records laws.

Based in a sprawling office in Folsom with a space-age ``war room,'' the ISO sits, literally, at the heart of California's electricity system, controlling 85 percent of the state's transmission lines.

The organization manages the distribution of power, is expected to ensure reliability and buys electricity needed to make up last-minute shortfalls.

The ISO was conceived in 1996 and launched in 1998 to operate the power grid owned by the state's three big utilities, with the idea that it would free up the transmission lines from the monopolistic companies so that competition could flourish. State leaders wanted it up and running in less than a year and a half, and it missed that target by just three months.

Comparable organizations on the East Coast -- the PJM Interconnection serving mid-Atlantic states, and ISOs in New York and New England -- moved slowly toward a market system and relied more on existing utility infrastructure. That lowered costs.

California, by contrast, quickly built a new network from scratch, borrowing more than $300 million to cover start-up costs that were several times those at other grid agencies.

The ISO's phone system illustrates the size of its leaders' ambitions and the harsh reality that awaited them. When buying the system, the agency expected to communicate constantly with 2,000 ``scheduling coordinators,'' or representatives of generators, marketers and power-users, ISO president Winter said. They didn't want a system they would quickly outgrow. But today, only 53 schedulers are on the line, he said. That requires a big phone system, but nothing like this one, he said.

Winter said his agency tried several times to get out of the contract with MCI Worldcom, which manages the phone system, but couldn't because the terms were airtight. The ISO was able to reduce the annual price from $35 million to $30 million last year under an agreement to extend the deal to the end of 2003. A spokeswoman for MCI Worldcom said the company doesn't comment on client contracts.

Even for a private phone network, designed to handle the highest conceivable number of calls without a busy signal, the annual cost is staggering for an agency with just 475 employees.

The California government, with 225,000 employees, pays $250 million a year for a phone system serving 160 state agencies and 1,600 smaller governments, including cities, counties and school districts.

Created in a rush

Few current ISO employees were around when the agency negotiated the phone system. Freeman, the former head of the Los Angeles Department of Water and Power and Gov. Gray Davis' chief aide on energy issues, handled the deal as a trustee overseeing the ISO's formation.

``It was a near miracle,'' said the governor's energy czar. ``We did what would ordinarily be five years of work in a year and half.''

Those who remember the talks characterized MCI as a hard bargainer and said they had little choice in buying the system because no one else sold a comparable product at the time.

``The vendors really had us over a barrel,'' Florio said. ``All the vendors knew California had set this ambitious schedule for itself. It certainly could have been done cheaper if it had not been done so quickly.''

Other ISOs have pursued cheaper Internet-based systems. Their telecommunications bills are about $3 million to $4 million a year, Caldwell said.

``The industry more and more is migrating toward the Internet and a different type of system, but that really wasn't a proven technology in the fall of 1996,'' Florio said. ``If we had done it two years later, we probably would have had an Internet system, and eventually I think we'll migrate to that.''

Another bad decision

The computer system was another item bought in a hurry that turned out to be inadequate. It was ``off-the-shelf sort of stuff,'' ISO spokesman Patrick Dorinson said, and it was designed to control the grid and aid in the purchase of small amounts of power needed to keep the system running properly.

Three years after the agency opened its door, it is replacing the entire system. Problems arose from the start, due to poor planning. Unlike other states where markets and grid management are handled together, California set up a separate agency, the Power Exchange, as its principal energy marketplace. The two agencies ended up building different computer systems that couldn't communicate effectively.

``A lot of time had to be spent to get the two systems to talk to each other,'' Florio said.

Also, when prices spiked in 1998 and 1999, the ISO found that it couldn't adjust the system in ways that might prevent the problem from recurring. Federal regulators said in a January 1999 memo that California may have encouraged price spikes because it did not force power suppliers to submit their bids simultaneously. But ISO computers couldn't make the suggested switch to simultaneous auctions.

Computer system manufacturer ABB Group did not respond to a request for comment.

While the ISO was overpaying for its hardware, it also was paying top dollar for personnel. Winter's $550,000 salary and benefits eclipse the $310,000 paid to his counterpart at New England's ISO and the $165,000 paid to Gov. Davis. Winter, an electrical engineer, was formerly the division manager of San Diego Gas & Electric's power operations.

ISO officials say they have to fight with Silicon Valley and the energy industry for talent. Sempra Energy, parent of the San Diego utility where Winter once worked, pays chief executive Stephen Baum $2.9 million.

``It's conceivable there could be some savings there,'' Florio said. ``But it's a trade-off. If you don't pay competitive salaries, you don't get high-quality people. You don't want Homer Simpson running the grid.''

ISO officials say they're trying to control spending, even as it continues to rise. This year's budget is up 26 percent, a ``substantial increase,'' Winter noted.

``We do everything we can to attack our costs and get them lower,'' financial director Leiber said. ``It's an issue we pay a lot of attention to.''

-------------------------------------------------------------------------------- Contact John Woolfolk at jwoolfolk@sjmercury.com or (408) 278-3410.

http://www0.mercurycenter.com/local/center/iso050601.htm

-- Martin Thompson (mthom1927@aol.com), May 06, 2001