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Electricity Markets: Lessons Learned from California.
Subcommittee on Energy and Air Quality
Mr. Peter Esposito
Mr. Chairman, I appreciate this opportunity to appear before this subcommittee today. As you know, Dynegy is a major national generator and marketer of energy that is active in California. Dynegy owns or controls approximately 14,000 MW of generating capacity in the United States, of which 2,750 MW is in California. That's about 5% of the California market. Despite our relatively small presence in California, we have spent thousands of hours and hundreds of millions of dollars to provide California consumers and businesses with power. As a recent FERC staff investigation revealed, we have been running the generating plants we bought from the California utilities in 1998 and 1999 more heavily in the last year than in the last 3 years, and perhaps ever. These intermediate and peaking plants are 30 to 40 years old and inefficient, averaging a 12,000 heat rate when new technology achieves 7,000 heat rates. Because California's current needs are resulting in delayed maintenance, we are forced to run these plants until they break, then take whatever steps are necessary to bring the generating facilities back on-line as soon as possible, often at great additional expense. And despite growing financial risk, we have continued to produce power. Gov. Davis and California Legislature are now focused on constructively solving the problem. Dynegy is presently negotiating with the California Department of Water Resources on a long-term sale at prices substantially below current spot prices. Mr. Chairman and members of the subcommittee, Dynegy takes its mission to serve our customers very seriously. Recognizing that no one benefits if power is not reliable and consumers are shocked with staggering price increases is good public policy and good corporate policy. What Went Wrong In California. 1. Demand grew substantially without corresponding increases in supply. California has added virtually no generation during the last 10 years. Meanwhile, its demand increased substantially - 15% at peak, 33% in Silicon Valley - as a result of a booming internet-related economy. Notably, California is dependent upon importing power for about 25% of its peak load. While California's power appetite was growing, so too was that of its neighbors. Although California represents 42% of the summer peak in the West, California's neighbors have accounted for 85% of the West's peak load growth in the last 5 years. This left California's neighbors increasingly short of excess power to export to California. While this problem was brewing, a below average hydropower year further limited California's in-state production and its neighbors' export capabilities. On top of that, summer 2000 was the second hottest in 100 years. The end result was a reduction of approximately 12% in peak import capabilities last summer. Then add a significant increase in natural gas prices, the final ingredient in the recipe for what some refer to as a "Perfect Storm" - spot prices increased 5- to 10-fold in December and January and have doubled for long-term contracts for the natural gas that fuels more than 50% of California's generation - and you can see what got us here. Making matters worse, when surplus power could be found, it could not always be moved to market, because of transmission constraints. 2. California Over-relied on Spot and Real-Time Markets. No one wants to wait until the last minute to buy airline tickets at the highest price; yet this was the required operating mode for California's utilities and customers. And, because of other aspects of the legislation, San Diego Gas & Electric customers, who never had a realistic chance to enter into long-term, fixed price contracts, also paid those highest, last-minute prices 3. CA did not "deregulate" the market. California made a critical error by deregulating only the wholesale market, while maintaining rate caps on retail purchases. This kept out retail competition that could have given customers more price certainty when stranded cost collections were complete and price caps came off as they did in San Diego. Additionally, price caps also isolated consumers from real price signals that would have caused them to reduce consumption. In fact, when San Diegans briefly saw real-time prices last July, they reduced demand substantially. No one wants to increase retail rates, but when the price for the natural gas that fuels over 50 percent of California's peak demand is multiples of the price embedded in capped energy rates, no one should be surprised by the need for higher retail rates. Indeed, a retail rate increase of 10 to 30% -- in the context of a portfolio of long- and short-term forward contracts.--would likely solve the current financial crisis. Yet, rather than increase retail rates (as other Western states have done), California has chosen so far to create a financial train-wreck for its utilities in hopes of avoiding the obvious need for a rate increase. Other States Have Not And Will Not Make The Same Mistakes as California Texas: Unlike California, Texas started down the path towards deregulation in an environment where generation was being added, some 8,652 MW in the last five years, with 12,745 MW under construction for operation in 2002. Additionally, Texas is upgrading its transmission facilities, and has an expansive gas pipeline infrastructure. In implementing retail competition, Texas is developing a "price to beat" structure that encourages competition. While Texas has a mandated rate cut, there is a mechanism to adjust utility rates for increases in fuel costs, so Texans will see appropriate price signals. Pennsylvania: Pennsylvania is widely touted as a retail success story, and rightfully so. Like Texas' "price to beat," Pennsylvania's "shopping credit" encourages retail competition. Additionally, in neither of these markets is the utility forced to buy from spot and real-time markets. Illinois: Similarly, Illinois' retail choice program incorporated transition power purchase arrangements, where utilities who divested their generation assets entered into long-term transitional buy-back arrangements, rather than depending solely on the spot market for supplies. What Can The Federal Government Do? Congress Should Not Over-React To The California Power Price Crisis While natural gas prices are still twice what they were a year ago in much of the country, they are already self-correcting from the December and January highs. While no one is predicting the kind of price collapse that occurred in the early '80s, the market is feverishly responding: Price signals are inducing an all-out drilling effort, the Alaska gas pipeline has been resurrected, and El Paso alone has 6 LNG proposals in the works. Rather than being tempted to legislate price caps or to re-regulate, Congress should be cognizant that the FERC has already dealt with and seen the results of a variety of price caps in California and has settled on a $150 soft cap, one that can take into account rises in the price of gas and other inputs. In the Northeast, the FERC has a $1,000 safety net price cap in effect, one which is much less likely to deter the addition of new generation than the lower caps tried in California. And bear in mind that cost-based regulation and government tinkering are what resulted in $16.8 billion in so-called stranded costs that California utilities collected from their customers. Develop a well thought out national energy strategy and address the need for open access to power transmission lines, including: 1. addressing the need to increase supplies of natural gas and power, through access to public lands for drilling, and efficient siting of both power and gas transmission lines; (Remember, gas fuels over 90 percent of new generation in America; increasing supplies is the No. 1 thing that will reduce the cost of power in this country.) 2. encouraging fuel diversity, e.g., clean coal, and renewables; 3. promoting demand-side responses, e.g., incentives for conservation and efficiency research and development, tax credits for conservation and the like; 4. repealing PUHCA so that excessive costs can be removed from transmission and distribution assets and economies of scale realized. 5. affirming FERC's authority to require participation in regional transmission organizations and otherwise encouraging FERC to exercise all its authority to assure that new generation is interconnected as quickly and cost effectively as possible; and 6. giving FERC eminent domain authority when necessary to resolve interstate transmission siting problems. In the short-term, there is no silver bullet that will fix all California's ills. California must do its part by finalizing the long-term contracts currently being negotiated with Dynegy and others and by developing a mechanism to pay the outstanding balances over to power suppliers so that order can be restored to markets. One fact that policy makers in State and Federal government should be aware of is that Dynegy's plants in San Diego are facing a 60 percent reduction in emission limits, which equates to taking about 750 megawatts of capacity offline, further taxing hydroelectric and other assets all over the West. We have heard that others face the prospect of similar cutbacks in other areas of California. While we recognize that California agencies are addressing these issues and that the EPA is aware of them, there is uncertainty over when and if these issues will be resolved, uncertainty that cannot last much longer. We appreciate the invitation to join you today and I am pleased to be available to answer your questions.
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