IssueAlert for May 21, 2001 California Update:

Governor Threatens Windfall Tax, Seizure of Reliant's Power Plants by Will McNamara Director, Electric Industry Analysis Calling Reliant Energy (NYSE: REI) “obstructionist” and charging that the company wants to bleed the state dry, California Gov. Gray Davis issued threats late last week to seize the Houston-based company's profits or its electric power plants. In an interview with the Los Angeles Times published on May 17, Davis warned that actions taken by Reliant and other independent generators this summer will determine whether he signs a windfall profits tax bill, commandeers the electricity produced by a plant or seizes the facility itself.

Analysis: There are two interesting elements to this new twist in the ongoing California energy saga. First, I have wondered for some time whether the state of California would proceed in issuing a windfall profit tax on the power generators that it claims to have gouged prices in the state. Along with state and federal lawsuits that are just becoming more and more complex and entangled, several months back the issue of California hitting power generators in their bank accounts with a legal tax on their profits was raised by state officials, but then seemed to be put on the backburner. Second, I also find it interesting that Gov. Davis is once again taking steps to expand the state government's role in owning and operating California's energy infrastructure. Up to this point, Davis has appointed the state Department of Water Resources as the primary buying agent for power, and has forged deals with at least one of the state's utilities to purchase transmission assets. The latest threats from the governor now indicate that he is also thinking through the option of taking ownership of the power plants in the state that are presently owned by private companies.

First, let me provide a little bit of background on this case. Reliant is one of 13 power companies that sell power to California which has been singled out by Gov. Davis (and FERC) for engaging in alleged price manipulation. Reliant owns about 3,800 MW of generation in California (less than 5 percent of the state's total of 54,000 MW), which is produced by five power plants that Reliant purchased from Southern California Edison. At last report, the governor claims that Reliant owes California approximately $337 million for what has been deemed as unjust and unreasonable power sales. One of the ongoing claims that Gov. Davis has made against Reliant and a few other generators is that the companies shut down their plants for unnecessary maintenance in order to inflate power prices. This is a claim that Reliant continues to deny, arguing that it has run its plants at the highest level since purchasing them four years ago.

Nevertheless, the war of words over the California energy crisis just becomes more intense and heated as the weeks go on. Along with a sideline exchange between California officials and members of the Bush administration, Gov. Davis continues to publicly assail the handful of power generators, which he has called “the biggest snakes on Planet Earth.” Out of this group, Reliant is now being singled out even further, although the governor has stated that the company is not unique in what he claims are attempts to bleed the state dry. Rather, Davis contends that Reliant has refused to cooperate with the state's measures to reach resolution and therefore is, in Davis' opinion, “uniquely obstructionist.”

In addition, Davis recently disclosed that the state paid Reliant $2,000/MWh to avert blackouts last week, which probably heightened the governor's ire against the company. Davis broke confidentiality agreements to publicly disclose the price for power that Reliant has charged, arguing that it is about five times the current spot price. Further, new reports indicate that California could face up to 260 hours of rolling blackouts this summer alone, which naturally is intensifying the pressure on the governor and others to find solutions. These factors, coupled with the fact that Reliant and other power generators have reported huge over-year increases in profits in the last two quarters, have made them easy targets on which to place blame.

It is important to note that Davis has issued his threat as a bargaining tool, indicating that power generators have control over his decision to implement his threats, based on their subsequent actions. Specifically, Davis says that the generators must ensure that their plants are up and running this summer in order to avoid any seizure of their plants that might take place. From a legal perspective, Davis appears confident that it is within the rights of the state to seize the plants from the private companies, but certainly any such action would be fiercely contested.

Regarding the windfall profit tax, back in February U.S. Representative Bob Filner of California introduced a bill (H.R. 443) to amend the Internal Revenue Code of 1986, allowing for a tax on wholesale electric energy sold in the Western Systems Coordinating Council (WSCC). [For more information on this, see the 2/16/01 IssueAlert.] A windfall tax has been used in the United Kingdom, and if passed in the United States would essentially allow California to retroactively recoup some of the large profits that have been made by the power generating companies in question. The tax is based on the concept that companies (such as the power generators) received an unexpectedly high return, or windfall return, that cannot be fully justified. In addition to the federal bill that is still moving its way through the House, Gov. Davis is now threatening that California would also adopt a similar windfall tax provision unless the power generators begin to comply with the state's demands.

As noted, the legalities of California seizing control of in-state power plants owned by out-of-state companies remains in question. However, Governor Davis already has extended his control over the state's energy market beyond what was originally envisioned at the commencement of deregulation in 1998. The same concerns about increasing California's liability that applied to Gov. Davis' decision to put the state into the role of power purchaser and transmission owner also apply to the potential ownership of power plants. Further, California has really just moved full circle along its deregulation path, with the state now assuming an arguably broader regulatory role than it had prior to 1998.

For its part, Reliant immediately responded to Davis' threats, arguing that any actions such as a windfall profit tax or seizing power plants would further deter new generation from being built in California, which would only exacerbate current problems. Instead, Reliant holds that Davis should be more focused on finding long-term solutions to his state's energy problems, such as investing what Reliant claims is a needed $15 billion in new transmission and generation investment over the next three years. In addition, Reliant continues to justify the high cost it has charged for power. As a general argument, Reliant says that the high cost has resulted from its being forced to generate more electricity to sell to the power-starved state.

Regarding the $2,000/MWh charge from last week, Reliant says that this was a strategic bid that the company issued, thinking the state would reject the bid and consequently force Reliant to shut down some of its peaker units. Further, Reliant argues that it invested $80 million in 2000 alone to upgrade plants to ensure that power would be available during peak times, implying that the returns it had made from power sales are a justified recovery for its investment.

Rumors have been flying that Davis' threats might cause Reliant to pull out of the California market altogether, but so far the company has not confirmed or denied these reports. It remains speculation at this point, but if Reliant (and others) initiate a mass exodus from California due to the governor's threats of a windfall profit tax and power plant seizure, this certainly would only compound the state's supply / demand imbalance. Moreover, neither Gov. Davis nor Reliant seems willing to budge at this point, as reputations and public support hang in the balance with every move. As the days go on and temperatures (literally and figuratively) increase, the stage is once again set for a showdown over California.

http://www.poweronline.com/content/news/article.asp?docid={995CBB33-4E02-11D5-A772-00D0B7694F32}

-- Martin Thompson (mthom1927@aol.com), May 21, 2001

Answers

Has Davis lost his mind?

-- Loner (loner@bigfoot.com), May 21, 2001.

It's hard to believe that any governor in his right mind would make so much noise about seizing power plants due to disputes over costs and charges. It's an out and out attempt to socialize private industry. The inevitable result would be that such a zany action would only drive other energy providers out of the California market, thus making the state's present plight only more perilous.

-- Wellesley (wellesley@freeport.net), May 21, 2001.

Yes, and throw a windfall profits tax into the stew, mix well, and you have a real first rate disaster waiting to happen.

Shades of the '70s and the windfall profits tax on 'big oil'. We sure got a lot of benefits from that, didn't we? A long, steady slide in oil prodction in the continental 48 that continues to this day, making us more dependent than ever on OPEC.

Will they ever learn?

-- Chance (fruitloops@hotmail.com), May 21, 2001.

What I can't understand is why all these public threats; wouldn't it be better to just seize these properties, quietly, without pre-announcement, if he's serious? What am I missing?

-- Nancy7 (nancy7@hotmail.com), May 21, 2001.

It seems to me that the legal ramifications of such actions would produce some of the fiercest legal battles in the history of American jurisprudence.

-- RogerT (rogerT@c-zone.net), May 21, 2001.

Davis is desperate. After his yelling, screeming fit--in public--against a Republican legislator a couple of months ago, I thought, at the time, that he was losing it.

But, then, if I had dived head first into day trading for electricity and lost nearly seven billion dollars over the past five months, I'd probably be losing it too.

-- Uncle Fred (dogboy45@bigfoot.com), May 21, 2001.

If you owned, or were the CEO of a large California company and Gray Nationalized, er, uh, Kaliforniaized the power plants, wouldn't you have some thoughts of "getting the hell out of Dodge"? I see no difference in this than those companies that go into foreign lands and then lose it all to that gov't. And what really gets me is that so many STILL want it all but want to give nothing in return. They want their lights on, but they don't want the power plants, etc and they are still actively fighting it. Same with ANWR. Have these enviromentalists figured out some way to drive their cars and to eat without fuel or food? Sure wish they would let the rest of us know how to do that! And of all the people driving SUVs, you can bet the farm that THEY are!! Taz

-- Taz (Tassie123@aol.com), May 22, 2001.