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Electricity Markets: Lessons Learned from California.
Subcommittee on Energy and Air Quality
Mr. John Fielder
Good morning. I am John R. Fielder, Senior Vice President of Regulatory Policy and Affairs for Southern California Edison. I appreciate the opportunity to testify before you today on the problems which threaten not only California's electric system, but the economic well-being of the state and potentially the entire country. Eight months ago, my company was financially healthy. Our credit rating was A+ and our market capitalization was approximately $6.5 billion, based on a share price of $20. Today, our credit rating is deeply speculative grade or "junk." We have temporarily suspended payments for borrowed funds totaling $638 million. In addition, we also deferred making power purchase payments totaling approximately $730 million. Our stock price has dropped from a 52 week high of $28.50 to a low of $6.25, but has risen recently to approximately $12. We have eliminated common dividend payments to our shareholders for the first time in our 100-year history. Not by coincidence, California has endured 30 straight days of Stage 3 Emergency alerts, the most serious level leading to rolling blackouts. Southern California Edison has found itself in a precarious situation where we had to buy wholesale electricity at artificially high prices and resell at artificially low prices. As a result, we incurred $4.5 billion in undercollections as of the end of 2000. We initially financed this massive revenue shortfall by borrowing in unprecedented amounts. However, we have now exhausted our credit, and have limited cash reserves. As a result, we have suspended payment for power and some of our outstanding debts. We are implementing major cost reduction measures totaling nearly half a billion dollars annually, which will reduce our workforce by approximately 1850 positions and limit critical investments in the electric system. If sustained, these reductions in staff and operating budget will certainly jeopardize the reliability of our system and our ability to adequately serve our customers. These measures are not enough, however. With the widening gap between wholesale and retail prices, even the most drastic cutbacks we could possibly make would only generate enough cash to buy another few weeks' worth of wholesale electricity. Last January, in response to seller concerns about the creditworthiness of the state's major utilities, the California Department of Water Resources began buying power in the wholesale markets in an effort to avoid massive blackouts. Later that same month, California approved the issuance of $10 billion in bonds to finance future purchases of electricity. During this past year, California has seen wholesale electricity prices skyrocket. In 2000, California paid nearly $21 billion more for wholesale electricity than it paid the year before -- a nearly fourfold increase. In 1999, the bill for areas served by the Independent System Operator (ISO) was $7.4 billion; in 2000, it rose to $28 billion. As staggering as this increase is, it does not reflect the true cost of the electricity crisis to California. The high prices we have been paying have not ensured adequacy of supply. Power emergencies have become an everyday occurrence. There are several power plants under construction or in the permitting stages in California, but not nearly enough for the state to pull ahead of the current supply shortage -- not to mention the substantially higher demand anticipated next summer. Neither is there sufficient power to sustain the state's economic growth. Without dramatic action to accelerate the provision of new supply to the market, the problem has the potential of continuing for years. However, the problem is not entirely one of supply shortage. Ironically this winter, during a time of relatively low load, we experienced the well-publicized rotating blackouts in Northern California on January 17 and 18. In addition, both we and PG&E were forced to repeatedly curtail "interruptible" customers -- those who agreed during a supply crisis to a limited number of interruptions in exchange for lower rates. These customers include schools, small businesses and larger manufacturers. While the California Public Utilities Commission (CPUC) has decided to suspend the fines for this program and make it purely voluntary, this has increased the likelihood of rotating blackouts. The shortfall this winter has been caused both by problems in the California market structure, and worries about the creditworthiness of the California utilities. As a result, generators have decided to either not run their plants or send their supply elsewhere, creating artificial shortages and the constant threat of more rotating blackouts, even when there is no shortage of supply. How did we get here? What has gone wrong? No participant in this crisis is free of blame: Everyone can now see that the market structure adopted in California's electricity restructuring is terribly flawed, even though the intent was to introduce competition and ultimately lower prices for consumers. The Federal Energy Regulatory Commission (FERC) over-relied on competitive markets to control consumer prices, even in the face of overwhelming and incontrovertible evidence that California's market was dysfunctional, needed significant repair, and was producing prices that were "unjust and unreasonable". The CPUC either refused or significantly restricted our ability to purchase power in forward markets or outside the California Power Exchange. Through seven different filings made with the CPUC over the course of two years, my company has consistently asked for authority and more authority to enter into such contracts. Once the CPUC granted such authorization, they did so only reluctantly and imposed significant restrictions on our ability to do so. All of us, including the utilities, were not as insightful as we should have been about the way the market would work and the way demand and supply would get out of balance in the California economy. Generators and other suppliers took advantage of a situation that obviously gave them significant economic gains. Everyone involved, private companies and public agencies, undoubtedly believed they had good reasons for what they did. Predictably, there has been a lot of finger pointing and casting of blame. None of this fixes the problem, however; and the longer it goes on, the deeper the crisis becomes. What is needed now is strong and decisive leadership directed to solving the problem. What needs to be done? At the state level, California officials need to take a combination of actions including raising rates, finding ways to finance both the past and future utility undercollections, and other actions to reestablish the creditworthiness of California's utilities. This is critical, because the reality is that the electric grid requires substantial capital investment for modernization and expansion. Financially crippled utilities will not be in a position to make the required investment that is critical to the health of this vital infrastructure industry. Furthermore, increased rates similar to those implemented in neighboring states will send the appropriate price signals to consumers and encourage conservation. California officials, working in cooperation with federal regulators, need to implement market structure reforms, including reduced reliance on the spot market by encouraging long-term contracts. New methods of compensating peaking units, through bilateral contracts with buyers or the ISO, are needed so these plants can recover their costs without inflating the overall cost of generation. The state also needs to consider ways to streamline the siting of new plants. While there is much that California can and should do, there is also a clear need for immediate federal action. Under the Federal Power Act, only the federal government has authority over wholesale rates. Clearly something must be done about current wholesale rates. The FERC found the rates in the California market to be unjust and unreasonable on November 1, 2000, and prices have only gone up since then. The law unequivocally requires that FERC set just and reasonable rates; the courts have made clear that FERC may depart from cost-based pricing and permit market-based pricing only where it finds that the markets will restrain prices to just and reasonable levels. The FERC cannot continue to rely on an overly doctrinaire approach to competitive markets when the markets are not sufficiently competitive to control prices and ensure fair rates. We believe that the imposition of temporary cost-based price caps or load-differentiated price caps is fair to both consumers and sellers. Those sellers who truly have high costs will be allowed to recover those costs, including a reasonable return on their investment, but only when their high priced power is needed to keep the lights on. We recognize that price caps may be only a temporary solution. However, longer term solutions take time, and immediate relief is needed now. In conclusion, I would like to thank the Subcommittee and you, Chairman Barton, for holding this hearing. We are working hard in California to develop and implement long-term solutions to the problems in our wholesale electricity market. But we cannot do it alone. Active and attentive leadership is needed at the federal level to ensure that the promise of reliable and affordably priced electricity is available to all citizens of California and the West. Nothing short of the well-being of our citizens, our economy, and the future of competitive electricity markets are at stake.
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