<DOC> [108th Congress House Hearings] [From the U.S. Government Printing Office via GPO Access] [DOCID: f:87231.wais] CALIFORNIA ENERGY MARKETS: REFUNDS AND REFORM ======================================================================= HEARING before the SUBCOMMITTEE ON ENERGY POLICY, NATURAL RESOURCES AND REGULATORY AFFAIRS of the COMMITTEE ON GOVERNMENT REFORM HOUSE OF REPRESENTATIVES ONE HUNDRED EIGHTH CONGRESS FIRST SESSION __________ APRIL 8, 2003 __________ Serial No. 108-14 __________ Printed for the use of the Committee on Government Reform Available via the World Wide Web: http://www.gpo.gov/congress/house http://www.house.gov/reform U.S. GOVERNMENT PRINTING OFFICE WASHINGTON : 2003 87-231 PDF For Sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpr.gov Phone: toll free (866) 512-1800; (202) 512-1800 Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001 COMMITTEE ON GOVERNMENT REFORM TOM DAVIS, Virginia, Chairman DAN BURTON, Indiana HENRY A. WAXMAN, California CHRISTOPHER SHAYS, Connecticut TOM LANTOS, California ILEANA ROS-LEHTINEN, Florida MAJOR R. OWENS, New York JOHN M. McHUGH, New York EDOLPHUS TOWNS, New York JOHN L. MICA, Florida PAUL E. KANJORSKI, Pennsylvania MARK E. SOUDER, Indiana CAROLYN B. MALONEY, New York STEVEN C. LaTOURETTE, Ohio ELIJAH E. CUMMINGS, Maryland DOUG OSE, California DENNIS J. KUCINICH, Ohio RON LEWIS, Kentucky DANNY K. DAVIS, Illinois JO ANN DAVIS, Virginia JOHN F. TIERNEY, Massachusetts TODD RUSSELL PLATTS, Pennsylvania WM. LACY CLAY, Missouri CHRIS CANNON, Utah DIANE E. WATSON, California ADAM H. PUTNAM, Florida STEPHEN F. LYNCH, Massachusetts EDWARD L. SCHROCK, Virginia CHRIS VAN HOLLEN, Maryland JOHN J. DUNCAN, Jr., Tennessee LINDA T. SANCHEZ, California JOHN SULLIVAN, Oklahoma C.A. ``DUTCH'' RUPPERSBERGER, NATHAN DEAL, Georgia Maryland CANDICE S. MILLER, Michigan ELEANOR HOLMES NORTON, District of TIM MURPHY, Pennsylvania Columbia MICHAEL R. TURNER, Ohio JIM COOPER, Tennessee JOHN R. CARTER, Texas ------ WILLIAM J. JANKLOW, South Dakota BERNARD SANDERS, Vermont MARSHA BLACKBURN, Tennessee (Independent) Peter Sirh, Staff Director Melissa Wojciak, Deputy Staff Director Randy Kaplan, Senior Counsel/Parliamentarian Teresa Austin, Chief Clerk Philip M. Schiliro, Minority Staff Director Subcommittee on Energy Policy, Natural Resources and Regulatory Affairs DOUG OSE, California, Chairman WILLIAM J. JANKLOW, South Dakota JOHN F. TIERNEY, Massachusetts CHRISTOPHER SHAYS, Connecticut TOM LANTOS, California JOHN M. McHUGH, New York PAUL E. KANJORSKI, Pennsylvania CHRIS CANNON, Utah DENNIS J. KUCINICH, Ohio JOHN SULLIVAN, Oklahoma CHRIS VAN HOLLEN, Maryland NATHAN DEAL, Georgia JIM COOPER, Tennessee CANDICE S. MILLER, Michigan Ex Officio TOM DAVIS, Virginia HENRY A. WAXMAN, California Dan Skopec, Staff Director Melanie Tory, Clerk Paul Weinberger, Minority Counsel C O N T E N T S ---------- Page Hearing held on April 8, 2003.................................... 1 Statement of: Winter, Terry, president and chief executive officer, California Independent System Operator; Karen Tomcala, vice president, regulatory relations, Pacific Gas and Electric Co.; Gary Ackerman, executive director, Western Power Trading Forum; Jan Smutny-Jones, executive director, California Independent Energy Producers; and George Fraser, general manager, Northern California Power Agency.......... 50 Wood, Patrick, III, chairman, Federal Energy Regulatory Commission................................................. 6 Letters, statements, etc., submitted for the record by: Ackerman, Gary, executive director, Western Power Trading Forum, prepared statement of............................... 76 Fraser, George, general manager, Northern California Power Agency, prepared statement of.............................. 90 Ose, Hon. Doug, a Representative in Congress from the State of California, prepared statement of....................... 4 Smutny-Jones, Jan, executive director, California Independent Energy Producers, prepared statement of.................... 84 Tomcala, Karen, vice president, regulatory relations, Pacific Gas and Electric Co., prepared statement of................ 69 Waxman, Hon. Henry A., a Representative in Congress from the State of California, prepared statement of................. 31 Winter, Terry, president and chief executive officer, California Independent System Operator: Information concerning a review on LMP................... 51 Prepared statement of.................................... 58 Wood, Patrick, III, chairman, Federal Energy Regulatory Commission, prepared statement of.......................... 9 CALIFORNIA ENERGY MARKETS: REFUNDS AND REFORM ---------- TUESDAY, APRIL 8, 2003 House of Representatives, Subcommittee on Energy Policy, Natural Resources and Regulatory Affairs, Committee on Government Reform, Washington, DC. The committee met, pursuant to notice, at 2 p.m., in room 2157, Rayburn House Office Building, Hon. Doug Ose (chairman of the committee) presiding. Present: Representatives Ose, Sullivan, and Van Hollen. Staff present: Dan Skopec, staff director; Barbara Kahlow, deputy staff director; Melanie Tory, clerk; Yier Shi, press secretary; Paul Weinberger, minority counsel; Earley Green, minority chief clerk; and Christopher Davis; minority staff assistant. Mr. Ose. Good afternoon. Welcome to today's hearing of the Subcommittee of Energy Policy, Natural Resources and Regulatory Affairs. Today we are going to look at the California electricity markets' refunds and reform. We are going to discus two items. First, the actions taken by FERC on March 26th of this year regarding the California energy crisis, and second, the progress California has made in reforming its electricity market structure. As many of you know, on March 26th, FERC issued a report following its investigation of western energy markets. They concluded that an imbalance of supply and demand, coupled with a flawed market design, created conditions that led to market manipulation in California and other western markets. Consequently, FERC issued several show cause orders that will potentially result in prohibiting violating companies from selling electric power and natural gas at market-based rates. I support FERC's effort to punish those who have been found to manipulate the market. This sends a strong message to future would-be violators that if you break the rules, you not only will have to refund the money, but you also will not be able to participate in energy markets in the future. FERC also increased the amount of refunds due to California by taking into account the manipulation that occurred in natural gas markets. The Commission plans to continue to investigate specific acts of market manipulation and make a final ruling on refunds by the end of the summer. I encourage FERC to vigorously and promptly complete its investigation. California and its citizens deserve to get back every dollar that was overcharged during the energy crisis. It's been almost 3 years since the crisis erupted. It's time to refund the overcharges so Californians can get the relief they deserve. The second purpose of this hearing is to discuss efforts to reform California's electricity market. While politicians from all corners can argue about who owes what to whom, we must not lose focus of one important point; that is, a leading cause of the energy crisis of 2000 and 2001 was a fundamental lack of electricity supply and a seriously flawed market design. Almost 3 years later, California has failed to fix this problem and its electricity market still needs reformation. In February 2002, this subcommittee held a hearing to discuss the leading market reform proposal known as Market Design 2002. At that hearing, I made the following statement: ``In reality, California is not out of the woods yet, not by a long shot. As the witnesses at today's hearing will tell you, the fundamental factors that exacerbated the energy crisis are still with us today. California still lacks adequate energy supply. Our transmission system is old and overburdened, and most importantly, the structure of the electricity market is dysfunctional. The market suffers from inefficiencies in terms of pricing, transparency, transmission and settlement policies.'' To my great regret, this statement is almost as true today as it was then. Since last year's hearing, the California Independent System Operator has introduced Market Design 2002, which we are hereafter going to refer to as MD02. It's CAISO's comprehensive proposal to reform California's electricity market. I applaud the efforts of CAISO to recognize the market flaws in the current system and attempt to solve them. However, I remain concerned that the reform process is moving too slowly. Time delayed is money lost for Californians. Already, several implementation deadlines have been pushed back. I am particularly concerned about the delay in the resource adequacy standards that are central to any market reform. One of the key regulatory failures of California's restructuring was the California Public Utility Commission's refusal to provide utilities with the ability to enter long-term contracts under safe harbor provisions. Resource adequacy would return the obligation to serve customers to the utilities by requiring utilities to produce adequate levels of power to serve its customers, plus a certain reserve amount. Utilities could meet these standards by signing long-term contracts with generators, thereby providing financial certainty and incentive to build more energy supply in California. However, this key component has been pushed back to the final phase of MD02. The CAISO is currently awaiting a rulemaking by the CPUC before it proceeds. We have been waiting for that rulemaking since April 2002, when this subject first came up. Given the abysmal history of the CPUC regarding long-term contracts, I am seriously concerned about the fate of this particular matter. In today's hearing, I have asked the witnesses to discuss the progress of MD02. I would like to direct the witnesses' attention to a January 2003 report produced by the Public Policy Institute of California entitled the California Energy Crisis: Causes and Public Options. This report does an excellent job of enunciating the need for electricity market reform. The report states that any market reform must meet the following goals: one, lower prices; two, system reliability; three, efficient use of resources; four, administrative feasibility; and five, environmental enhancement and protection. I wholeheartedly agree with these goals and ask the witnesses to keep them in mind today as we discuss the details of MD02. I intend for this to be an opportunity to discuss the details of reform and debate possible alternatives. But this process must go forward. It must. California cannot continue to live in an energy purgatory where we neither know right from wrong, up from down, or no power from power. The State's economy remains soft and today energy prices are low. But this will not continue forever. This is an opportunity we need to seize. We need to keep in mind that it takes years to propose, site and build a power plant. Up and down the State, power plant construction is being delayed and companies are scrapping plans to build more generation. Energy companies cite political and regulatory uncertainty as a principal obstacle to new energy supply. Wall Street refuses to invest in such an unstable environment. Yet experts predict that California will experience shortages again in a few short years. It is therefore essential that we get on with the reform process in order to encourage investments in energy generation and transmission. A stable marketplace with clear, rational rules is the only way to supply the lowest cost, most environmentally friendly energy that Californians deserve. We simply cannot afford to wait any longer. I want to welcome our witnesses today. They include Patrick Wood III, the chairman of the Federal Energy Regulatory Commission; Terry Winter, the president and CEO of California Independent System Operator; Karen Tomcala, the vice president of Regulatory Relations for PG&E; Gary Ackerman, the executive director for the Western Power Trading Forum; Jan Smutny-Jones, the executive director of the Independent Energy Producers; and George Fraser, a personal friend of mine who is general manager of Northern California Power Agency. [The prepared statement of Hon. Doug Ose follows:] [GRAPHIC] [TIFF OMITTED] T7231.001 [GRAPHIC] [TIFF OMITTED] T7231.002 Mr. Ose. I'd like to recognize the gentleman from Oklahoma for the purpose of an opening statement. Mr. Sullivan. Thank you, Chairman Ose, for holding this hearing. It is important that the causes behind the California energy crisis be considered. Coming from a State with an interest in energy markets, it is important to me that the truth comes out about the situation. Finger pointing by both sides does the consumer no good in the end. One of the recurring issues in the debate of California's energy crisis is whether or not generators physically withheld power in order to drive up prices. California has repeatedly claimed that generators did withhold power. In one case, where FERC staff has reviewed California's withholding allegations and found them to be overwhelming false and inaccurate, on September 17, 2002, the California Public Utilities Commission issued a report claiming that generators had withheld power on the 6-days when California suffered blackouts and brownouts. They claimed that had generators made this power available, blackouts could have been averted. The FERC staff analysis refuted the CPUC's allegations. I hope that FERC will look carefully to make sure that similar claims now being made by California are not equally false. I look forward to hearing Mr. Wood's statement and hope that it will shed light on the current state of investigations. I yield back the balance of my time. Mr. Ose. I thank the gentleman. As many of you may realize, this committee is an investigative committee. We routinely swear in our witnesses. So Chairman Wood, if you'd rise, please, raise your right hand. [Witness sworn.] Mr. Ose. Let the record show that the witness answered in the affirmative. Once again, we welcome to our panel the distinguished chairman of the Federal Energy Regulatory Commission, Patrick Wood III. Chairman Wood, you are recognized for the purpose of a statement for 5 minutes. STATEMENT OF PATRICK WOOD III, CHAIRMAN, FEDERAL ENERGY REGULATORY COMMISSION Mr. Wood. Thank you, Chairman Ose, Mr. Sullivan. I appreciate the opportunity. I can't help but be struck by the juxtaposition of the two items before us today, which are a look at what happened in the past and then a view toward the future, and the importance of making sure that those two items are connected. Certainly a large part of the time I've spent since I think I saw you last, Mr. Chairman, is really trying to bring to a close our investigation on the activities in the western markets. Shortly before I even joined the Commission, the Commission had reviewed the underlying fundamental supply shortfalls as an issue and looked at the market design in December 2000, the prior Commission. We have one commissioner with us today on our Commission that was there at the time. But analysis showed that those two parts of the problem were a significant aspect of what went wrong in California. What we did after I joined the Commission and we began to explore these issues further was, we recognized that there were, in fact, those two conditions of significant supply shortfalls and flawed market design implementation, that those did create an environment in which market manipulation could happen. And, in fact, over the last year, a significant part of our staff, with resources spent for outside consultants to assist us in this effort, reviewing tremendous amounts of market data, actually concluded that in fact there have been instances, in fact some cases, very notable instances of manipulations in the power and gas markets that took advantage of this supply and market rules failure. So our report came out last Wednesday. As a consequence of that report, the staff recommended that the Commission take action on 31 different items relating from alterations of how we calculate refunds in the ongoing California refund case to recommendations to pursue causes of action against certain market participants for violations of the rules to a number of prospective fixes to make sure that these issues never show up again in California or in any other State. So the Commission is currently involved in implementing all those recommendations. We might change a few of them based on feedback from parties who have provided some commentary on this, and also based on our own assessment. But our staff pursued this effort independently, provided this report back to the Commission late last month. Actually, for most of the month, we had the opportunity to review this and digest it. And, I do have to say, I have some reservations about the activities that are reported here. I think it's without question that some of the behavior of market participants that was analyzed, identified and I think fairly balanced throughout the staff report is the kind of behavior that ought to be, if it's not illegal now it ought to be. So we are taking actions to make sure that our rules reflect, on a going forward basis, the type of things that I would have hoped good common sense would have kept people from doing. But quite frankly, it wasn't in some cases written down that some of these issues were wrong. And, it makes it difficult to tell customers that we are trying to do justice when in fact we cannot reach to activities that we all acknowledge are wrong. Looking forward, I do remember our visit back in Sacramento at the hearing we had last year with a number of our same witnesses today, Mr. Chairman. And, I, like you, am concerned that while we've had a lot of discussion, we don't have the Market Design 2002 implemented. It's my hope that, even in 2003, that we could get Market Design 2002 implemented. But I am concerned that even that time line may slip. It is critical to get these issues addressed so that these types of opportunities for manipulation and fraud do not ever make themselves profitable again, even in a stressed market, which California has had, and may again have in the future. Good rules can prevent excessive behavior from manifesting itself. So it's my hope that certainly from the discussions today and the activities that the market participants are pursuing, which I think have been reported on in the witnesses' testimony, we can make a lot of progress to ensure this never happens again. Thank you. [The prepared statement of Mr. Wood follows:] [GRAPHIC] [TIFF OMITTED] T7231.003 [GRAPHIC] [TIFF OMITTED] T7231.004 [GRAPHIC] [TIFF OMITTED] T7231.005 [GRAPHIC] [TIFF OMITTED] T7231.006 [GRAPHIC] [TIFF OMITTED] T7231.007 [GRAPHIC] [TIFF OMITTED] T7231.008 [GRAPHIC] [TIFF OMITTED] T7231.009 [GRAPHIC] [TIFF OMITTED] T7231.010 [GRAPHIC] [TIFF OMITTED] T7231.011 [GRAPHIC] [TIFF OMITTED] T7231.012 [GRAPHIC] [TIFF OMITTED] T7231.013 [GRAPHIC] [TIFF OMITTED] T7231.014 [GRAPHIC] [TIFF OMITTED] T7231.015 [GRAPHIC] [TIFF OMITTED] T7231.016 [GRAPHIC] [TIFF OMITTED] T7231.017 [GRAPHIC] [TIFF OMITTED] T7231.018 [GRAPHIC] [TIFF OMITTED] T7231.019 [GRAPHIC] [TIFF OMITTED] T7231.020 [GRAPHIC] [TIFF OMITTED] T7231.021 [GRAPHIC] [TIFF OMITTED] T7231.022 [GRAPHIC] [TIFF OMITTED] T7231.023 Mr. Ose. Thank you, Chairman Wood. I am asking unanimous consent to enter into the record the statement of the ranking member of the full Committee, Mr. Waxman. Hearing no objection, that will be done. [The prepared statement of Hon. Henry A. Waxman follows:] [GRAPHIC] [TIFF OMITTED] T7231.024 [GRAPHIC] [TIFF OMITTED] T7231.025 [GRAPHIC] [TIFF OMITTED] T7231.026 [GRAPHIC] [TIFF OMITTED] T7231.027 [GRAPHIC] [TIFF OMITTED] T7231.028 Mr. Ose. We are going to go to questions now. As usual, Chairman Wood, you are exactly punctual in your 5 minutes, for which we are appreciative. I want to go through a particular concept here, and that is that FERC, has investigated the issue of pricing of natural gas and the five indices that were used to calculate it. And, on the basis of that investigation, has ordered refunds in two cases and asked for additional information I think in eight additional, as to the activities of eight additional companies. The question I have is, if we are able to determine manipulation post October 2, 2000 in the drivers of pricing for natural gas, would that manipulation spread to all participants rather than just be constrained in the two, and would that necessitate a far grander view of whether or not refunds are entitled? Mr. Wood. Pre October 2nd or post? Mr. Ose. Post October. Mr. Wood. Post October 2nd---- Mr. Ose. We'll get to the pre-October question. Mr. Wood. I want to make sure, because there are two different approaches we take. From October 2nd forward, which is 60 days after the utility from San Diego filed a complaint saying that they wanted FERC to take action in the California ISO and PX markets to do price caps or some other approach to address the concerns that were raised. From October 2nd forward the Commission has really looked at, with the refund case, and that's what we kind of call generically the refund case, the $1.8 billion plus extra that will fall from last week's action. We looked at all providers and said, we are not going to allocate fault or whatever, but we are just going to reset the price at what it would have been had a competitive market worked as it was designed to work in California, what would that price be, and anything above that has basically got to be refunded. So whoever charged that, we are not looking at intent or asking them what they were doing that day. It's just kind of a de facto calculation, here's what the numbers are. So we don't, for that reason, we have not looked at individual players as to refunds, because in fact everybody that is over the threshold has given it back. Now, the items you referred to, there's a couple of baskets of things that fell out of last week's order. One of them was, there were I believe four companies that were electric and eight on the natural gas side that we went ahead last week and moved forward with proceedings to consider revoking their market-based rates based on some activities that are outlined in the report. There are different kinds of baskets. We are doing further work on three other large baskets of items. One is what we call the Enron gaming strategies, people that participated in those, some 30 some odd companies, 16 that had business relationships with Enron, that's a separate basket of orders, and then 9 companies that may have engaged in economic withholding. This is pre October 2nd. If any of those things spilled over into post October 2, 2000, then those would be actually available for additional refunds if we haven't already received them. But our remedial authority under the law, as it currently is, is focused on a time period 60 days after a complaint is filed. So that's where the October date comes from. And actually, because we do not have penalty authority yet, we can seek disgorgement of profits from certain transactions that violate the law or violate the tariff. So we are kind of in the middle of the stream with a number of these proceedings. But the ones you referred to are just part of the total. Mr. Ose. The question I am trying to get at is that you've made a determination as it relates to two cases that there was market manipulation. And, I can't remember the companies. I know we can get that in the record if you like. It would seem to me that if there is market manipulation practiced by these two companies, it has unavoidably spilled over into additional companies, whether innocently or otherwise, having their prices affected. I don't see how logically that can be avoided. Mr. Wood. Correct. Mr. Ose. If that's the case, the question of how much to refund is far greater. Now, in the report that FERC did, there is a reference to rules, or the protocols or the tariffs, I don't remember the exact word, but the rules that govern behavior in markets. There are provisions, in some cases vague, in some cases not, preventing gaming strategies of the like that you have found. If that is what you have found, pre October 2nd, does that give FERC the ability to go and seek refunds for that period of time prior to October 2nd? Mr. Wood. Yes, with a caveat. The hook that we've got to go back on, and the staff identified some tariff language that they think is the hook, we've got to say that you actually, you, company, were notified that this behavior was prohibited, or violated a rule. Then, we prove that they've done that. They don't have to excuse that, well, you know, I did it because the lights were going to go off otherwise, or what's a good mitigating excuse that certainly we would provide that opportunity to make that. And then, if those two things are met, if the law was clear and you violated it, then you get refunds for that. We are in the process now, because the parties did have the opportunity to file on March 20th, which was kind of close to the date of this meeting, their rebuttal to claims that were made by a number of the California parties and State agencies that a number of these violations had happened. We indicated at our March 26th meeting we want to look at the he said and the she said. So the overlap between the staff report and the parties' investigations that came to a climax in March, we are looking at that this month and anticipate for those issues that go backward to issue orders on those by the April 30th meeting that our Commission has scheduled. Mr. Ose. Now, you referenced in, if the gentleman will just yield a couple more minutes, you referenced in your testimony the ability to assess penalty and the lack of FERC authority to do that to date. In the last Congress, I put in a bill to provide FERC with authority to assess penalties from the date of filing, and I am advised, having put that same bill in again this year, that it's been rolled into the Energy Bill that should be on the floor later this week. Does FERC support being given the additional authority envisioned in that legislation? Mr. Wood. Absolutely. Yes. And we appreciate it. In addition to moving the date back to the date a complaint was filed, you also allowed the Commission, in your law from last year and the one that was put back in the hopper this year, to not only get disgorgement of profits, but actually assess penalties, in some cases up to, let me make sure I get it right, $25,000 per event. It was $500. Mr. Ose. $500? Mr. Wood. Per event. Mr. Ose. Right. Mr. Wood. And, it is over a broad, over the entire Federal Power Act electricity title that we live under. So those three things together, the refund date, the broadening to include the entire electricity title, and the elevation of the penalty amount does give the Commission a much stronger tool chest to use in overseeing markets. Mr. Ose. I appreciate the chairman's comments on that. My last question would be, if you found companies that have engaged in this behavior in violation of the terms of their certificate or violation of what you call tariffs, what I call rules, what the proposal has been is to deny them the ability to sell power or gas at market-based rates. It seems to me that such companies frankly ought to be put out of business, period. They ought to get the death penalty, if you will, as a clear and unequivocal message about this kind of behavior not being tolerated. Could you share with us why, if you would, you're only going halfway? My words, not yours. Mr. Wood. Well, we've got, I mean, the two tools we've got are taking away the privilege to do business at market-based rates. I think, I haven't actually given a lot of thought to can you just take them out of business altogether and revoke their license to even have cost-based rates. Can I get back to you on that one? Mr. Ose. Yes. Mr. Wood. We honestly have not looked at that. I think the perception in the outside world has been that the loss of market-based rates in a world that's dominated by markets is a significant penalty, and is one that we certainly have. Again, it's one of the two things that we have, get the profits back and yank your market-based rates. To have something on the intermediate scale, which the penalties would provide, is certainly something we welcome. Not all behavior is worthy of putting people out of business. Certainly errant employees, bad management, you know, if there is something rotten at the core, certainly that's a different issue. I think there are gradations, just as a judge in a criminal case gets to look at. There are gradations of punishment that a jurist ought to have. And, I'll have to think about that. Mr. Ose. Let me show you a flip side of that. The flip side of that is people in my district who process food, paying two or three or four times what they had budgeted or expected for electricity and having to shut down processing lines and lay people off. Or people in the business that use hot water basically can't buy the natural gas to heat the water that they need in their business. And, in effect, they are being shoved out of the position of being profitable into a position where they cannot survive. And, if someone is engaging in inappropriate behavior that creates that, it seems to me that maybe they ought to share the same fate. Just a different perspective. The gentleman from Oklahoma. Mr. Sullivan. Thank you, Mr. Chairman. Chairman Wood, I'd like to talk about a FERC staff report that has not gotten much attention. In 2002, the California Public Utility Commission alleged that generators had contributed to the blackouts experienced in California by deliberately keeping plants shut down rather than running them. If true, this would be extremely disturbing. Yet, as I understand it, your staff's investigation found, ``No evidence that any of the generators withheld any material amount of available power during the hours of the service interruptions.'' Is this correct? Mr. Wood. Yes, sir, it's correct. The staff did look at the days identified in the California PUC's report from last year. They looked at exactly the days of firm service interruptions, i.e., when there were blackouts in California due to inadequate supply. And, I will admit, it was difficult to kind of go through the, for our staff spent several months going through the data that the ISO had to actually look at what generators were available, what they had scheduled, what they had not scheduled, what was committed elsewise to some other customer. And, concluded that for 87 percent of the power, the megawatt hours, that in fact the firm service interruptions happened when the power was actually not available. It was legitimately not available through the ISO's records. Now, admittedly, the ISO does not keep records specifically for this point. So to give the CPUC, I guess the fair side of the analysis is, the records weren't just sitting there ready to be written up. It took a lot of digestion and analysis and that was really what our staff did at our direction to really get to the bottom of this. Because whatever the answers are, we've got to deal with them. If nothing happened and people should be exonerated, then that ought to be done. And, that's in fact what we did. If there is something going on, and again, we are looking at other hours today, we are looking at other hours than just these ones in this report to make sure in fact that this didn't happen in some other period. But in looking at the blackout periods, which were the crucial times when Mr. Winter and his colleagues at the ISO were scrambling around the whole west to keep the lights on, we did look at the claims here and chased them all the way down. Thirteen percent of the hours we are unable from the records to account for. But in total, they did not add up to the amount that would have prevented a blackout. So while we don't have a complete answer on the 13 percent, I think the takeaway is that the, while those megawatts may in fact have been withheld, they were such significantly small amounts that they would not have enabled the ISO to keep the lights on. So that's what our conclusions were on this report. And, as I mentioned, we are continuing to look throughout all the records. Some claims have come in as of last week about physical withholding, which is a really bad practice, if engaged in for the purpose of elevating market prices, and we will continue to chase those all the way down as we did these. Mr. Sullivan. Not only was there no evidence of withholding, the report goes on to conclude that the evidence actually refutes the CPUC's allegation that power was withheld. The report says, ``Approximately 87 percent of the power that the CPUC concluded was available power not generated was in fact available.'' Isn't this right? Mr. Wood. It was actually not available. Yes, sir. Mr. Ose. Could you clarify that for me, please? Run through that again. I just want to make sure we get it. Mr. Sullivan. The full question again? Mr. Ose. Yes. Mr. Sullivan. Not only was there no evidence of withholding, the report goes on to conclude that the evidence actually refutes the CPUC's allegation that power was withheld. The report says, ``Approximately 87 percent of the power that the CPUC concluded was available power, not generated, was not in fact available.'' Isn't this right? Mr. Wood. That's correct. Mr. Ose. Thank you. Keep going. Mr. Sullivan. While I am concerned because I think this report directly calls into question the credibility of the allegations made by the California parties, according to your staff report, the CPUC was wrong at least 87 percent of the hours it questioned. Eighty-seven percent is not a small error. In my view, that report was more of a political document than an objective analysis. Now I read of a new or recycled allegations being made by California where companies have told me the allegations have no merit. Is the FERC staff going to examine the reliability and merit of these allegations and eliminate the incorrect ones before issuing show cause orders to the companies? Giving that show cause orders tend to assume a company is guilty until proven otherwise, shouldn't FERC determine how accurate these latest allegations are? Mr. Wood. We are, and that is the reason, Mr. Sullivan and Chairman Ose, that we did not issue the show cause orders in the other 30 or so companies last week. In fact, the parties I mentioned a moment ago have the opportunity to respond to the claims by California parties by March 20th. And, it's about 3 feet high worth of responses. So needless to say, we couldn't digest those and give both sides proper weight in 6 days. So we are in the process of doing that now. And, in fact, may indeed winnow down that list to just focus on not only the specific companies but the specific companies with specific claims that appear to have violated tariffs or rules at the time, rather than just broad brush complaints. Mr. Sullivan. Thank you. Mr. Ose. Chairman Wood, I want to make sure I've got this straight in my head. Under the rules that FERC operates under, people who are selling in the interstate market come to you for certificates that dictate the manner in which they can market their power. Is that accurate? Mr. Wood. Correct. Prior to 1992, they just came to us to set their rate. We did cost-based rates for everybody. Mr. Ose. Now, those licenses, if you will, are called market-based certificates? Mr. Wood. Right. And, since 1992, people have come in and asked for and in most cases been granted the authority to sell power at market-based rates, i.e., what the market will bear. Mr. Ose. OK. Now, in November 2001, let me back up here a bit. The Federal Power Act says that FERC cannot go prior to October 2, 2000 to order refunds unless sellers violated their market-based certificates. Mr. Wood. Or the CAISO tariff or FERC, Federal Power Act or FERC rules. Mr. Ose. The question I have has to do with getting the rules that the certificates are issued under, sufficiently strengthened so that there is no question, there is no vagueness, there is no ability to equivocate, everybody knows what the rules are. Now, FERC recognized this same problem in November 2001 and has been attempting since then to reform both the natural gas and electric power tariffs. And yet, the Commission hasn't been able to come to closure on that to date. Mr. Wood. That is correct. Mr. Ose. The question when I go home is, you know, when are you going to fix this, my constituents say to me. My question to you is, when are you going to get closure? Mr. Wood. On the market-based certificates, we actually a year ago this month, we were at that point a four-member Commission, came to two-two vote on how to refine the market- based rate tariff conditions. And, our two-two condition honestly existed until the end of last year. Knowing that Mr. Gelinas, who is in charge of putting this report together, was going to recommend changes to a number of aspects of market-based rates on both power and gas, we beforehand had not looked at the gas certificates because I think we had focused probably unduly on the electric only, but at that point, we now, it's 1 of the 31 items that we've got to punch through in the next series of weeks. So you are correct, sir, to point out that we have not tightened up this, I don't want to call it loophole, but tightened up this certificate. But we have not completed that work yet. Mr. Ose. In the summary that you, we are going to use the summary because I can hold it up here, it's not 400 pages, in the summary you have a number of recommendations that are enunciated relative to the changes that need to be made. For instance, in the reporting process, look at page ES6, chapter 3, traders attempted to manipulate price indices through false reporting. Now, there's a number of recommendations here under the bullet points that I am willing to go through one by one or in aggregate send to you in writing. But I am trying to get at what kind of rules changes you are presently considering to prevent this market manipulation from occurring again. Mr. Wood. I could go through these, in fact, because we have just recently discussed those among my colleagues. They are all summarized on ES14. Mr. Ose. All right. Mr. Wood. The first four under ES14 are basically as we just discussed, conditioning certificates of electric and gas companies. It's our intention to get that done. We've got the open proceeding that you referred to that we had locked two-two on. That's the vehicle for doing that on the electric side, and we've got to initiate a new proceeding, as mentioned there, actually amending our regulations, and they're referenced there in the first bullet, to do that on the natural gas side. But that would be, for example, that is the one to provide explicit guidelines and prohibitions for trading natural gas. The manipulation of the indices and the behavior that led to inaccurate price reporting, which shows up elsewhere in the next series of bullets, actually the fifth, sixth, seventh and eighth bullet relate to the specific gas price index issue. The Commission is having a workshop on that on the 24th, I guess the week after next, on what to do about these natural gas price indices that a lot of people in the marketplace rely upon, but which have been called into question not only by this Commission staff report, but by market participants probably over the last 6 months. Mr. Ose. I especially want to go to the eighth one there. Encourage standard product definitions for published natural gas and electricity price indices and standard methodologies for calculating the price indices. This would seem to me to kind of be at the core of variability in how you calculate costs versus what's going to be charged. Of the five indices that were used to calculate natural gas price, if you don't have a standard product definition for what is or isn't a market-based product, how do you find that someone's not giving you square data? Mr. Wood. I think you've kind of hit the nail on the head. It's for that reason that we really, as of last week, just said, we cannot rely for the purposes of calculating the California customers' refund, we cannot rely on a weighted basket of these price indices for gas. They might have been directionally correct, and I'll say certainly, the indices have the potential to be right on target. But it's not a number that we on the regulatory side of the fence could really hang our hat on and say, this is what we know the actual market price of gas was on that day. So we went back to a much more regulatory approach to figuring out what should the input for gas price be and then provided opportunities for suppliers to show us their receipts basically, and get their money for what they actually spent. But you're right, the lack of standardization in the index reporting definitions and in the collection and computation of the data do leave some potential for variation that it's hard to get real comfortable with, from our point of view. Mr. Ose. In terms of defining a standard product or a standard methodology, has it gone beyond merely identifying the problem in the 400 page report, or there is actual effort to come to conclusion on that? Mr. Wood. As I mentioned, we teed up an all day workshop with different people in the industry across the board, including the current publishers of price indices, which are all trade press organizations, a committee of chief risk officers, which are the CROs from all the energy companies and their customers, the current exchanges, NIMEX, ICE, Intercontinental Exchange and I believe one other are also on the list, and some customers and users that are also involved. So it's my expectation based on the questions we ask them to respond to which are these, the ones here and broader. The definition of the product I don't think is going to be that big of an issue. I think the gas market today has pretty much a level maturity as to what the product is. It's what you do with the price as reported for purchases of those products or sales of those products, how are they averaged, how do you throw out the high numbers and the low numbers, what statistical sampling technique is used. I think it's those types of things that parties may want to explore, and will be exploring, I expect, on the 24th. Mr. Ose. Now, similarly, there's clear indication that there were gaming strategies being employed at some point in this marketplace. Similar to a definition of a standard product or standard methodology for fixing price or calculating price. I am not aware of any clear or definite tariffs, rules, that say this gaming strategy is illegal, this one's illegal, this one's approved, that one's illegal. What progress is FERC making on that? Mr. Wood. Well, we published last summer our standard market design rulemaking on the electric side. Just to say up front, we've made no progress at all on any of these relating to the gas side, other than indicating we are going to take action in the first two bullets proceedings on the gas gains and the gas reporting. But on the electric side, primarily based on our experience in the California market, we did put forth, well, not 10 commandments, I think there were 7. But in the proposed rule that is not being commented on and that the Commission is actually shifting its focus to, to really finalize that rule. But there are a number, I mean, certainly looking at wash trades, looking at false reporting, misreporting load for the purposes of gaming the congestion management system. I think there were four more, I'd have to look those up and report those back. But we have kind of laid those out for the electric side. I think the real lesson from this report is, we need to attend to the gas side as well. Mr. Ose. At the end of the day, I don't know whether history will show this got dropped in your lap or otherwise. I mean, that you came into something midway through and it just blew up, just by chronological coincidence or otherwise. But I have to say, I just find it amazing, given the volume of natural gas and electricity that transacts on a day-to-day basis or in the forward markets and the like, that we don't have any clear definition of what a market product is, a methodology for factoring it into these prices, what is or isn't a legal trading strategy and the like. We have to get to the bottom of this. We have to have defined rules so that we can stop this gamesmanship. Because I can tell you, for every 10 good traders out there, people who are trying to do the responsible thing and abide by the tariffs and the rules for FERC and CAISO and everybody else, there's one out there who's going to try and game it. I just know that. And, until we get to a defined set of rules, we are going to be chasing our tail. And, it's very frustrating up here, especially as someone who has to pay for all this stuff, living in California. Mr. Wood. Again, I could not agree more. It wasn't certainly with my eyes closed that I knew this was going to be a big part of the job, was cleaning up the mess. But I do think it's very important for these two critical infrastructure industries as we go forward to have very well defined rules of the road. I think it's, I am sure everybody's sick of me talking about it, but it's the only way to come and get this thing back on track. I should add, on the gas side, because it has worked, I think almost spectacularly well over the last 16 years that it's been more market based, there's been, the conservative estimate is $200 billion stayed in customers' pockets that wouldn't otherwise have been there. The high end is $600 billion over a 16 year period. It has worked very well in many instances, in most instances. In fact, in probably all instances except when you had the major use for incremental gas in California for an electric market that was on the edge. And, I think any commodity market is going to be pushed against a tremendous amount of stress when you have kind of a fundamental market structure design flaw, which relying on the spot market was, in the California power market. And, when you also have really severe stress on the supply side, with the absence of significant amounts of hydro from the grid that year, it really shifted tremendous reliance to these old, 40 year plus, natural gas plants. And, I do think that those conditions, as we concluded in the report, the staff did, made it very fertile ground for manipulation. But recognize that when those conditions, when the balanced market rules and the sufficient infrastructure are in place, it's very difficult to profit from manipulation. Because if you get manipulation, then someone undercuts you and takes your customer away. That's how it's supposed to work, and it has worked very well. So I share your concern. I am committed, and we will, before I am done with this job, get these market rules all the way down and put forth. But recognize that it's not a whole festering pot of garbage. It is a few bad actors that we are going to identify and remove, and let the rest of the people that are participating in this good marketplace continue to serve customers and serve them well. Mr. Ose. The gentleman from Oklahoma. Mr. Sullivan. No questions, thank you, Mr. Chairman. Mr. Ose. The press reports you're struggling with have to do with the difference between a short-term contract and a long-term contract, relative to the pricing of the natural gas that goes into the formula for calculating the price of electricity. Your point being that there may be an influence that the spot market price for natural gas has on the longer term markets, but there is some point at which that influence ceases to be material. And, the question I have is, at what point in the future, in your opinion, are forward prices for natural gas divorced from spot market price influence? Mr. Wood. One of the things that we have seen in the gas market actually, and I think the staff has a name for it, it's backwardation, is today where the spot prices are right around, say, a month ago, they were in the $6 range, they've fallen closer to $5 and hopefully will stay in that range or lower. But the forward price, I think the expectation that the market has been having is that in 2 years from now, even I think the expectation has become, we will pick back up and we will kind of get back on track and demand will be up. But in 2 years from now, I think the forward curves are looking like they're $1.50, $1.75 lower than they are today. I think we saw the same thing in the power markets in California, that the supply crunch of today will not be perpetuated years and months on end in the future. I think that happens. I think in commodity markets you can have short-term increases but recognize that over time they will settle back down to a lower level. We've seen that, and in fact, the last time, last week I looked at the forward curves on gas, it was still, it wasn't as high as $6, it was closer to $5. But there was still a forward curve that was lower in the future months than it is today. I hope that's correct. Mr. Ose. You have the difficulty of calculating just and reasonable prices on short-term and long-term contracts. So how do you factor in the price curve that you've just described on a long-term contract? If you're going to order a refund on a long-term contract, how do you know whether the price curve on natural gas or electricity is appropriate or not? Mr. Wood. One of the things that we asked our staff to do in this report, the fat one, was to look at the correlation between spot market and, which is defined as the 24 hour or less market, and the longer term markets. And, in chapter 5 of that report, they in fact looked at all the contract data and had a statistical consultant from the outside, let me see who it was. I'll have to look up his name later. Actually he compared all the costs of all the contracts that were entered into in the California market. And, on page D-17, did actually pull together a relationship chart, demonstrating the relationship between spot market prices and contracts based on the length of various contracts. As I think your question anticipated, had a much more pronounced linkage in the 1 to 2 year timeframe than it did in the 3 to 4 or in the 5 to 8 year timeframe. So it is one factor that we've got to take into account in looking at any sort of contract claims. And, we do have some before us, as you know. Mr. Ose. Is it your opinion, then, that the relationship between the spot and the forward market breaks at some point? That irrespective of whether there's been manipulation at some point chronologically into the future it washes out? Mr. Wood. That's what I've got to think, what I think about it, because quite frankly, we are in the process now of, with the pending cases, grafting this together. But I would say that the staff analysis that I referred to in chapter 5 there does indicate a tapering off, really, after the 1 to 2 year timeframe. Mr. Ose. I have to express some reservations about that. My rationale being is that if the spot market is manipulated so that the price is elevated from what it would otherwise be, then at some point or another beyond a 1 or a 2-year timeframe you're going to have that reflected in the price curves at the out years. And, if that's the case, if that manipulation in the spot market in fact does go into those out years, then does that constitute rationale for refunds? Mr. Wood. If in fact it does, it could, Congressman. But again, I am just reporting back here, they have actually looked at the actual contracts that were entered into during this period. This isn't a hypothetical exercise. They actually looked at all the contracts. We required under subpoena all these contracts to be provided to the Commission so the statistical correlation runs could be done, and in fact came up with a much more attenuated view of the link in the 3 to 4 year category and the 5 to 8 year category. Mr. Ose. All right. The gentleman from Maryland. Mr. Van Hollen. I yield back my time, Mr. Chairman. Mr. Ose. You're yielding back for the moment? Mr. Van Hollen. I am yielding back. Mr. Ose. All right, we are just going around and around here. Mr. Van Hollen. All right. Mr. Ose. The gentleman from Oklahoma? Mr. Sullivan. I yield back, Mr. Chairman. Mr. Ose. I tell you what, I sure like freshmen. [Laughter.] Commissioner, the market monitoring ability that you have been able to put in place over at FERC, we've had this discussion a number of times as to what kind of tools you now have as opposed to what you didn't have. What is the status, or can you give us an update on your market monitoring programs so that we can in turn share that with the public, so that they can get some level of comfort that we've got the tools to do the job, or if we don't have the tools to do the job, what we do need to have in order to be able to do the job? Mr. Wood. Three things you need to have to make a market work: infrastructure, rules, which I know we are talking about on the next panel, and third is vigilant oversight. While we do have in the different regions of the country, as California does, as we do here in the Pennsylvania, Maryland, New Jersey interconnection, as my home State of Texas has and others, a market monitoring unit on the ground that looks up front at what is going on with the market, what we were missing at FERC was really a centralized, professional, experienced cadre of people who could look at the national perspective and do that well. So thankfully Congress did give us appropriation right as I took over as chairman in September 2001, and we did start at that point a nationwide search for an office director, senior staff, and we also had some existing staff at the Commission who moved to the new office. We've got about 90 people now who not only enforcement and remedial activities, but the kind of work like you saw that Mr. Sullivan asked about from the staff's review on the CPUC fiscal withholding report. Those folks are here behind me today. We also have people that look at the health of markets, these forward curves, we look at where there are interruptions in gas pipeline service, when there are escalations of gas price as we saw in the past 2 months, investigating that not days later but minutes later. And, the ability to do that is something our agency did not have and does now and acts on it very quickly. Market participants hear from us often. We monitor not only electric data and gas data but also oil data. We regulate, kind of the untold story of FERC is we have regulated the large oil pipeline industry for their rates for quite a while. It's one of those aspects that we are really proud of. In addition to that, we've now got employees from the FERC that are out in the marketplace. We have three employees, for example, at the ISO that---- Mr. Ose. On the floor of the ISO? Mr. Wood. No, we actually are not allowed to be on the floor of the ISO. But there are three employees there. We lease office space from the ISO and our folks there interact closely with the market monitoring unit as well as with market participants in the California market. They've been there since October of last year, when we put in the new market power mitigation measures that we changed to at that time. And, we also now just recently announced that we are putting two in Carmel, IN, to monitor the midwestern markets which are in the process of being established and are kind of going through their startup and growth period. So I expect we will see more of that as the markets mature and develop around the country. We will make sure that we don't just sit here but we have folks that are our front line out there as well. Mr. Ose. My recollection is that you also took the step of hiring one or two professional traders to come to work for FERC, the purpose of which is to get not so much the scientific side but the trader seat of the pants sense of what's happening. Is that still the case? Mr. Wood. It is, and actually more than one or two just came to work at FERC from the industry side. And, it's not just the trading, but all aspects of both production, on the production side, on gas, we have some good gas expertise as well as some electric expertise from different parts of the industry. It's been, certainly we would rather not have the downturn in the industry, but it has allowed us to be a more attractive employer than we otherwise would have been, and have been able to attract certainly hopefully for longer than short- term some good, diverse talent to the agency. So I am again very grateful for the funding and the FTEs from Congress, but doubly grateful that we've been able to actually attract the quality people that we've been able to get. Mr. Ose. One of the things you have in the market monitoring area is you have a large map of the United States. And, up on that map you can visually see the, if memory serves, the path by which power gets to the markets. Now, the purpose of the map is to identify where you get roadblocks or impediments or congestion or what have you. How often do you tweak, if you will, the formula by which you identify where congestion occurs or where a problem arises? Mr. Wood. Well, we do rely on certainly the NERC, which is the North American Electric Reliability Council, does set forth the criteria under which interruptions would happen. Those are called transmission loading relief, which means you just basically take transactions off the grid and say, you can't send your power that way. Those happen every day. Some of them are like, I guess, bronze, silver and gold. You've kind of got a lot of bronzes, maybe a silver every day somewhere and every so often, a full curtailment of loads. Curtailment doesn't mean blackout, it just means that commercial transactions don't happen and customers end up paying more money. So congestion basically is a money issue. At extreme times, as we've seen in your home State, it can be a reliability issue as well. Mr. Ose. I just want to share, that's not why we are called the Golden State. [Laughter.] Are all of these resources we are putting for market monitoring, will they alone prevent higher prices or blackouts in the future? Mr. Wood. No. And, I hope I haven't promised that they would. But for example, California, let's look at that. In May 2000, the prices in the wholesale market started to rise. We got a complaint 3 months later from a utility that was paying these prices and thinking, gosh, I am going to go bankrupt if I have to sell at this retail price and pay at this wholesale price. Sixty days later than that, so a good 150 days after the fact, customers had some remedy. I just find that unacceptable. So we want to make sure that if there are issues, that we identify them the day they are happening, so we can take action that day so if there is some violation, if it's the normal forces of the market working, then they should be allowed to work. And, people curtail their use or buy alternate products, switch from gas to fuel oil, perhaps, and do economically rational things. But if they're the result of somebody taking advantage of the rules or creating a situation that is illegal or unlawful, then that ought to be able to be remedied, not 150 days later, but that day. And, I think, if we continue to maintain the approach that we've got, in relying on our extensions in the regions, then that can be very quick activity and not extended, as we saw in the California crisis. Mr. Ose. Do you now have the ability to act on an immediate basis? Or are there things you need from Congress yet? Mr. Wood. You've got it. As you mentioned, your bill does that for us. We do not have that ability on the natural gas side. In our prior discussions, we focused on electricity. But the Commission, in my testimony to our oversight committee, did indicate a request to have such authority on the natural gas side as well, similar to what we just talked about in bill 964. But I think what we've found, and I think it's certainly the case, is when market participants know that not only are we looking, but we have capable, qualified, bright people who are doing that looking, not politically motivated looking, but people who are interested in the long-term health of the markets looking, then those behaviors get remedied pretty fast, if they get tried at all. It's hard to know what caused the California markets to kind of settle down, but I think a substantial number of people have credited the fact that now they knew that the cop was looking, not parked at Dunkin' Donuts but actually out there looking. And, we will continue to do that. Mr. Ose. Dunkin' Donuts is based in his district. No, just kidding. [Laughter.] Mr. Wood. I just think that the ability to be nimble and quick and smart is 90 percent of what is needed to oversee the market. The other 10 is to have a tool chest that gets attention. Mr. Ose. I do want to thank you for the work you do. I may continually nag at you to come on, come on, faster, more, sooner, frankly, because I've got 35 million people of which 600 odd thousand live in my district, and they're concerned about this. I know Mr. Sullivan and his constituents are concerned about this. I do want you to know that, we do not believe this issue is over. Excuse me, I don't believe this issue is completed. I do think we are going to have a continuing issue in California relative to supply and price. The ability to bring to the rulemaking process some definition on methodologies for pricing and marketplace behavior is critical to what we are going to do successfully in California. We are going to talk a little bit about that in the next panel. I do appreciate FERC's willingness and interest to stay on this, because I will continue to watch and if necessary, have additional hearings. Because I know you love coming up here. Mr. Wood. Let's go to Sacramento again. Mr. Ose. Yes, maybe someday. I will tell you, I am troubled, I fail to see the logic between being able to find evidence of manipulation and moving to order refunds and then finding similar evidence of manipulation and being reluctant to order refunds. You haven't made that case to me yet, that there is a break between those two. Manipulation is manipulation. And, frankly, my people suffered accordingly. To the extent that they did suffer, they are entitled to refunds over and above a just and reasonable price. We'll come back to that issue in future hearings if necessary, and you'll probably get endless letters from me accordingly. But I do want to thank you for coming down here. I am appreciative of the fact that you've accommodated our next panel and will participate in that too. We are going to take a 3-minute break here. Commissioner Wood, thank you for joining us. Mr. Wood. Thank you, Mr. Chairman. [Recess.] Mr. Ose. All right, we are going to go ahead and reconvene with our second panel. Joining us on our second panel are the following individuals. We have Terry Winter, who's the president and chief executive officer of the California Independent System Operator; Karen Tomcala, who's the vice president of regulatory relations of Pacific Gas and Electric Co.; Gary Ackerman, who's the executive director of the Western Power Trading Forum; Jan Smutny-Jones, who's the executive director of the Independent Energy Producers; and we have George Fraser, who's the general manager of the Northern California Power Agency. As you know, we swear in all our witnesses. Commissioner Wood is joining us also. We are going to ask him to rise and be sworn in again. If you'd rise, please. Commissioner Wood does not need to be sworn in a second time? All right. Well, he's volunteering. [Laughter.] [Witnesses sworn.] Mr. Ose. Let the record show that all the witnesses answered in the affirmative. Now, we have an order here, we are going to move from my left to my right. Commissioner Wood having given his testimony, if he wishes to add anything, will be welcome to do that. Each witness is going to be provided 5 minutes. We've received your testimony in advance. I have in fact read it. And I have numerous questions. We'll get to those as we move through. So Mr. Winter, you're first for 5 minutes. STATEMENTS OF TERRY WINTER, PRESIDENT AND CHIEF EXECUTIVE OFFICER, CALIFORNIA INDEPENDENT SYSTEM OPERATOR; KAREN TOMCALA, VICE PRESIDENT, REGULATORY RELATIONS, PACIFIC GAS AND ELECTRIC CO.; GARY ACKERMAN, EXECUTIVE DIRECTOR, WESTERN POWER TRADING FORUM; JAN SMUTNY-JONES, EXECUTIVE DIRECTOR, CALIFORNIA INDEPENDENT ENERGY PRODUCERS; AND GEORGE FRASER, GENERAL MANAGER, NORTHERN CALIFORNIA POWER AGENCY Mr. Winter. Thank you. I appreciate the opportunity to come and talk to the group. As normal, I have to say that as the CEO and president of the ISO, I am representing myself here today and would not want to represent that my comments deal with the board, any State agency or the Governor's office. So with that disclaimer, you're going to get whatever you see. With your concurrence, I would like to submit for the record an opinion from our market surveillance committee, which consists of Dr. Wolak, Dr. Bushnell, Dr. Hobbs and Dr. Barber. I had asked them to do a review on LMP. They got that to me yesterday. So if I could put that into the record. Mr. Ose. Without objection. [The information referred to follows:] [GRAPHIC] [TIFF OMITTED] T7231.029 [GRAPHIC] [TIFF OMITTED] T7231.030 [GRAPHIC] [TIFF OMITTED] T7231.031 [GRAPHIC] [TIFF OMITTED] T7231.032 [GRAPHIC] [TIFF OMITTED] T7231.033 Mr. Winter. Thank you. I think the first question, why MD02, you've defined what it is, and for the record, that's Market Design 2002. And, one of the things that we've heard loud and clear is that the California market is broken, and I certainly agree with that. We no longer have a PX, we no longer have the ability to get supply. We certainly have seen high prices, and even though they have moderated considerably over the last year, they were still astronomical and we are concerned about those continuing. Actually, the redesign by different names started in 2000 when we started having market things that we were concerned about. And, it's been over the last 2 years, we actually were ready in about January 2001, we received a new board. They wanted to get familiar with it. So the final MD2002 was filed with FERC in May 2002. And, this was a result of untold hours of stakeholder meetings, searches for best practices among the other ISOs, and recognizing the constraints of the California market and the situation the transmission system was in. The end result is MD02. And, it is our proposal to solve the six major concerns that we have. One, it addresses and prevents gaming and market power abuse. Two, it's to help us reliably operate the system. Three, it allocates scarce transmission resources fairly and provides open and non- discriminatory service. Four, it provides a day ahead market and removes from real, as much from real time as possible, the decisions that we have to make. Five, it provides transparency to market participants so that they can better manage their costs and exposures. And, six, we are hoping that it will return confidence to the marketplace, so that the efficiencies gained can benefit the consumers. Until this is in place, I feel that we are still vulnerable to all the things that have happened to the market in the past. So we feel we need to move rapidly to get this done. You've asked me to address four areas: resource adequacy, mitigation, LMP, and seams issues. Each of those subjects you could literally write books on. But I will try to capture in one or two sentences where we stand on each of those. Resource adequacy. The ISO feels as a very bare minimum that load serving entities should provide an amount equal to 112 percent of their peak load. This will meet operational reliability concerns and ensure a competitive market. The ISO did not file this with FERC at the request of the State, which is working to provide a procurement policy for the utilities and the needs of the State. They have moved somewhat rapidly and in terms of getting hearings started, the PUC, the CEC are all working on these. They have told us that they will have results by November 1st. I think it is the State's prerogative to be able to say, we are going to meet this capacity with demand programs, with efficiencies, with additional generation, renewables. I feel that is a State prerogative. So we are waiting. But again, I think the ISO, from our standpoint, we have to be guaranteed that you have at least 112. The State is looking to give us more than that at the 115 to 120 percent level, which I am encouraged by. Mitigation. FERC has in place three things that they gave us at the end of, or the fall of last year. One of those was a must offer requirement, which ensures that generators will bid into the market. Second, a bid cap of $250. And third, an automated mitigation procedure that checks for prices versus the cost of gas. And, while those are absolutely necessary and helpful in the market, I would ask for two additional things. One of those is a method to mitigate local market power, because we see that when we have transmission lines out, we see it in pockets where the transmission service is not adequate. The second is, as much as I would dislike having to enforce penalties, I feel that the market, to gain confidence and also control some of the activities that we have seen, that we need penalties for things such as uninstructed deviations, when people do game the market. We've got to have a clear set of rules and say this is unacceptable and a way to stop that behavior. LMP. LMP has been much discussed, but merely, I think if you look at what it is, LMP is just a way of allocating transmission resources. The drawback, of course, to some is that it gives you a different price at different locations. If you happen to be in one of those high priced locations, then you're very anxious to make sure that you don't get stuck with a high price. We think it's absolutely essential for the generators and the wholesale purchasers to understand what price they are paying at a particular location, and so we are recommending that we go with the LMP, and I'll stop in just a second. But we are going to average the price over PG&E, Edison and SDG&E's territories, so that the retail customer will see one common price. Seams issues, we are working on those and I am sure you'll have a question for me on that. Thank you. [The prepared statement of Mr. Winter follows:] [GRAPHIC] [TIFF OMITTED] T7231.034 [GRAPHIC] [TIFF OMITTED] T7231.035 [GRAPHIC] [TIFF OMITTED] T7231.036 [GRAPHIC] [TIFF OMITTED] T7231.037 [GRAPHIC] [TIFF OMITTED] T7231.038 [GRAPHIC] [TIFF OMITTED] T7231.039 [GRAPHIC] [TIFF OMITTED] T7231.040 [GRAPHIC] [TIFF OMITTED] T7231.041 [GRAPHIC] [TIFF OMITTED] T7231.042 Mr. Ose. I thank the gentleman for his time and his testimony. Our next witness is Karen Tomcala from Pacific Gas and Electric. Welcome. You have 5 minutes. Ms. Tomcala. Thank you, Mr. Chairman. I am Karen Tomcala, vice president of regulatory relations, of Pacific Gas and Electric Co. I appreciate the opportunity to testify before you here today, and I would ask that my full written testimony be submitted into the record. Mr. Ose. Nobody is going to object to that. Ms. Tomcala. PG&E supports the ISO's MD02 efforts, because a well functioning wholesale power market is necessary for utilities like PG&E to provide the reliable service our customers require. We should all recognize that the MD02 related tasks before the ISO are both technically complex and politically sensitive, and the ISO must move forward respecting both of those facts. With this in mind, I'd like to emphasize the processes necessary for the ISO to achieve a successful MD02 program. First, the ISO must coordinate its market redesign activities with State efforts. Fixing California's energy market requires both Federal and State regulatory attention. The California PUC, under new leadership and in coordination with the other California energy agencies, is beginning to construct a coherent model for the State's energy future. The ISO's activities must proceed in synchronization with these efforts, so that its ultimate MD02 product supports the emerging model. Second, the ISO must provide an effective process for stakeholder participation and input in developing MD02. The energy crisis has shaken the confidence of everyone involved. Redoubled efforts to ensure that stakeholders' concerns are heard and addressed in the MD02 process are necessary to establish confidence that California will have a fair and stable market design on which participants and consumers can rely. Creating such stakeholder buy-in can provide the additional benefit of minimizing litigation, both during the design process and down the road. Our collective resources are better dedicated to fixing California's market and bolstering the State economy. Third, the ISO must develop, as necessary, and engage in regional coordination processes that recognize the regional nature of the western market. As has often been discussed, the seasonal exchange of power in the West has benefited customers across the entire area. To retain these synergies, the ISO must work cooperatively with the region to provide appropriate mechanisms for addressing seams issues between the Pacific Northwest, California and the Desert Southwest. Such a regional approach does not require that the market designs in western States be identical, only that they be consistent enough to permit the regional cooperation and coordination that have been the hallmarks of the western market for years. Examples of issues that should be coordinated across seams include operational and commercial rules, market mitigation and resource adequacy, all of which are more appropriately addressed in the regional footprint of the market and discussed further in my written testimony. Finally, by engaging in the processes I have just described, the ISO can do much to create a well functioning wholesale power market in California. The ISO, through its role as a non-discriminatory grid manager, is positioned to provide a range of transmission related benefits to the regional electric power market, including more efficient and reliable operations, transmission pricing that eliminates so-called ``rate pancaking,'' improved congestion management, improved reliability through application of its open access transmission tariff, and more coordinated planning of transmission investment. All of these activities will result in a robust transmission system for the benefit of consumers. In tandem with transmission benefits, getting essential market rules right will ensure that MD02 provides the most reliable service and the greatest protections available for consumers. One example of getting it right would be using MD02 to craft mitigation rules targeted to address specific market problems. The crisis demonstrated that inappropriate or uncoordinated mitigation is a potential source of gaming. When price caps in California were low relative to neighboring States, some suppliers were motivated to export power from California, thereby making the supply situation in the State worse. Another way in which the ISO can use MD02 to get it right is to implement stable, transparent market rules, an essential precursor to investment in new infrastructure. The upheaval associated with the California crisis, which is not yet fully resolved, has chilled investment in the State, leading to projections of supply shortage recurrence in the 2007-2008 timeframe. Implementing stable rules on which investors can rely can reverse this trend and ensure fully adequate resources. The fact of the matter is that doing all these things may take some time. But doing them right is the most important objective. Taking the extra effort to coordinate, strive for consensus, plan and implement MD02 properly is the only way to provide customers with the stable, reliable service that they deserve. Thank you, Mr. Chairman. I'd be pleased to answer any questions. [The prepared statement of Ms. Tomcala follows:] [GRAPHIC] [TIFF OMITTED] T7231.043 [GRAPHIC] [TIFF OMITTED] T7231.044 [GRAPHIC] [TIFF OMITTED] T7231.045 [GRAPHIC] [TIFF OMITTED] T7231.046 [GRAPHIC] [TIFF OMITTED] T7231.047 Mr. Ose. Thank you for your testimony. We'll go right to Mr. Ackerman for 5 minutes. He joins us from the Western Power Trading Forum. Mr. Ackerman. Thank you for getting the name right, Mr. Chairman. My name is Gary Ackerman, and I am executive director of the Western Power Trading Forum, a non-profit trade association dedicated to enhancing competitive energy markets in the western States. I appreciate the opportunity to offer my comments in addition to the written testimony I have submitted to your subcommittee regarding the efforts of the California ISO and the Federal Energy Regulatory Commission to redesign California's restructured market. First, let me say that the people I represent are the folks providing the key ingredient to making our homes and businesses safe and secure; that's electric energy. They provide the energy to light the dark spaces, and connect folks into the 21st century. They are the people who build alternative energy projects that emit fewer pollutants, sustain our vital natural resources and lessen our Nation's dependence on foreign oil. Notwithstanding the negative press that has surrounded our industry of late, we have a vision whereby consumers enjoy lower average energy costs through competitive markets. And, we remain steadfast in our desire to show you and the Nation what can be achieved. Without competition, consumers are stuck with a single energy provider, and costs are passed through to the ratepayers. With competition, private companies battle for the right to serve consumers, thereby lowering average prices, with all the financial risk borne by the companies, not the ratepayers. For example, my group updated a comparison of the average monthly wholesale prices in California since deregulation began in California in 1998. We compared it to the pre-deregulation just and reasonable generation component of retail rates. The outcome is clear. The deregulated average for the full 5 years since competition began is lower than the utility's cost to provide the same even with the bumps and perturbations of the well documented wholesale price spikes that occurred during the crisis. Had Californians the opportunity to pay competitive wholesale prices, as opposed to paying the just and reasonable price, then California consumers would have saved $3.7 billion that otherwise went to paying their electric bill. If one adds to that savings the proposed refund amount announced by FERC 2 weeks ago, then the total 5 year consumer benefit would be $7 billion. That's not a bad value in either case for 70 percent of the consumers in your State. Market design in the West, particularly in California, is moving forward in fits and starts. The worst design will suffice amid abundant energy supply. The best design may falter in a shortage. I would encourage this subcommittee, the Commission, and the California ISO, rather than getting all the elements of the design perfect, to spend more time on the elements of the design that affect private investment in new generation plant and transmission. There is a common belief that getting the rules just right will eliminate market manipulation and the abuse of market power. But the other side of the coin is that suppressing market forces to the point where markets don't exist any more will further exacerbate the looming shortage that will occur when the economy rebounds and if there is a drought in the Pacific Northwest. In short, no one is going to care how hard we tried to get the market rules right in 2003 when the lights flicker in 2005. My written testimony covers the specific items the subcommittee has posed to the panel and I won't repeat those answers here. However, I look forward to answering your questions, and again, thank you for the opportunity to appear before you and provide our point of view. [The prepared statement of Mr. Ackerman follows:] [GRAPHIC] [TIFF OMITTED] T7231.048 [GRAPHIC] [TIFF OMITTED] T7231.049 [GRAPHIC] [TIFF OMITTED] T7231.050 [GRAPHIC] [TIFF OMITTED] T7231.051 [GRAPHIC] [TIFF OMITTED] T7231.052 [GRAPHIC] [TIFF OMITTED] T7231.053 Mr. Ose. Thank you for joining us, Mr. Ackerman. Our next witness is Jan Smutny-Jones. Mr. Smutny-Jones, you are recognized for 5 minutes. Mr. Smutny-Jones. Thank you, Chairman Ose. My name is Jan Smutny-Jones. I am the executive director of the California Independent Energy Producers. I also previously served as the Chair of the ISO from until June of probably January 2001. I would like to submit some written comments for the record and I am just going to summarize them here today, in the interest of time. Mr. Ose. We'll accept them without objection. Mr. Smutny-Jones. Mr. Chairman, in the beginning of today's hearing, you characterized California as continuing to live in an intolerable state of energy purgatory. I share that view, although I believe that California is on the road to recovery. Hopefully the road to recovery is not like the road to hell and just paved with good intentions. I think our purpose today is to make sure that the primary work before us with regard to market restructuring actually takes place. Key to the infrastructure development that you indicated is necessary in California is stability. Stability requires clearly articulated market rules, which I think you and Chairman Wood talked about previously. Second, a coherent procurement process, which I think several of the previous witnesses have suggested is underway in California. There have been some positive developments on the part of the State with developing procurement roles. And, last, but certainly not least, a redesigned market structure, which is currently underway in California ISO. What I'd like to focus on here is the need for resource adequacy. IEP is in the resource adequacy business. Our members build and operate power plants, both gas-fired and renewable. There's over 10,000 megawatts added to California since restructuring, and have been added to California's resource mix. Importantly, these facilities are not only reliable, but have shifted the development and operational risks from basically ratepayers to private sector developers and operators of these plants. That's a huge benefit to the people of California. An ancillary benefit of this modernization also has very real, significant environmental benefits. The Calpine plant, for example, in Sutter County, produces electricity with 98 percent fewer emissions than the average plant would in terms of the fleet in 2000. So that's significant. The resource adequacy component of the CAISO is currently being held in abeyance until the State completes their work in November of this year. I want to underscore this point. It is absolutely critical that the work that the State is doing is fully integrated into the ISO's tariffs. Otherwise, this is not going to work and we are going to revisit the problems that we've previously experienced. Some other specific market rules that I think we need to be going forward with here is, the market redesign in California needs to be based on sound economics and markets that work elsewhere. There is a significant debate going on about why California is different and why the West is different and whatever. Fine. Let's identify where we are different and move on. I for one used to hold that view very religiously, but I think we need to just recognize the fact that there are other markets that do seem to work elsewhere and now is not the time to reinvent the wheel. We need a day ahead market so people can actually trade electricity. As I indicated earlier, a resource adequacy component is absolutely critical to overall market stability. And, we need a stakeholder advisory committee that basically is able to address issues that are coming up in a way that provides people a meaningful opportunity to basically impact the outcome of rules that are under development. Last, but not least, the seams issue. This is a regional market. California is not an island, has not been for a very, very long time. We need regional rules that are monitored and basically enforced on a regional basis. We think that's of critical import. And, so in closing, I would just like to conclude that the energy crisis was a convergence of a serious supply and demand imbalance, poor market design and inadequate regulatory response. It need not and should not be repeated. We need to encourage infrastructure investment providing new supply, implement meaningful market redesign and ensure that our regulatory institutions are reformed in a manner that is responsive to modern market realities. It is time for action, because quite candidly, Mr. Chair, we cannot afford another failure. Thank you very much. [The prepared statement of Mr. Smutny-Jones follows:] [GRAPHIC] [TIFF OMITTED] T7231.054 [GRAPHIC] [TIFF OMITTED] T7231.055 [GRAPHIC] [TIFF OMITTED] T7231.056 [GRAPHIC] [TIFF OMITTED] T7231.057 Mr. Ose. Thank you for joining us today. Our final witness is Mr. George Fraser, who's the general manager of the Northern California Power Agency. Mr. Fraser, you're recognized for 5 minutes. And, by the way, his grandchildren are in the audience today. Mr. Fraser. Thank you, Mr. Chairman. We are a different segment of the market, as opposed to folks who are in the business to make a profit. I represent numerous community-owned utilities in Northern California. We are not merchants, we are integrated utilities in that we provide the generation, we purchase and sell power, to the extent that it's surplus, and we serve our retail customers. Our point of view regarding the Market Design 2002 is that it will not, as it's currently been described to us and designed, facilitate bilateral contracts. And, we live on bilateral contracts. We are encouraged by what Mr. Winter said, because we believe that meaningful resource adequacy is absolutely essential. And, before you start changing a new design and getting involved in a new experiment in California, we need to make sure that we have sufficient generation and especially transmission, so that we don't have to deal with congestion throughout California. There is no reason from what we can see right now to believe that Market Design 2002 will provide incentive for investment either. Standard market design is supposed to encourage voluntary bilateral contracts. We are very encouraged by the words we hear, but what we see in the detail of the design doesn't appear to support bilateral contracts. When a detailed proposal is put forth that truly supports voluntary bilateral contracts, I think you'll find us supporting such a plan. We think it's more important to do this design right rather than doing it fast, so we are urging that this thing be carefully put together and not rushed. The current process seems to be geared toward managing stakeholders, and moving toward a pre-ordained outcome rather than actually including the input from stakeholders as we go. Just to reemphasize my point of view about transmission, I believe Spencer Abraham has been quoted as characterizing the existing transmission in California as Third World. We don't see any fundamental elements of Market Design 2002 that addresses transmission construction and transmission adequacy. Let me move ahead and talk about market incentives and resource adequacy. Let me summarize my verbal comments here and they're consistent with the written comments we've turned in. Market Design 2002 is inconsistent with the stated goal of SMD to encourage and facilitate voluntary bilateral contract arrangements. We believe that resource adequacy must precede market design, that the plan with Market Design 2002 is a serious case of putting the cart before the horse. We are not starting out with resource adequacy, we are starting out with a new design. In its current state, we see, and we've studied Market Design 2002, we believe it lacks sufficient detail concerning such critical elements as the ones I've described, as well as congestion management and market power mitigation. We would like to, as I said, support the design when we see more detail and see it tested in the relatively near future. Thank you very much, Mr. Chairman. [The prepared statement of Mr. Fraser follows:] [GRAPHIC] [TIFF OMITTED] T7231.058 [GRAPHIC] [TIFF OMITTED] T7231.059 [GRAPHIC] [TIFF OMITTED] T7231.060 [GRAPHIC] [TIFF OMITTED] T7231.061 [GRAPHIC] [TIFF OMITTED] T7231.062 [GRAPHIC] [TIFF OMITTED] T7231.063 Mr. Ose. I thank the gentleman for his testimony. As we said, everybody's statement, we've received it, we are entering that into the record. There's a couple things I want to go through in particular. The January 2003 report produced by the Public Policy Institute of California, which is entitled, ``The California Electricity Crisis: Causes and Policy Options,'' lays out a series of goals that any market structure should achieve. And, these include lower prices, system reliability, efficient use of resources, administrative feasibility and environmental protection. These are significant issues and many times very difficult to resolve, let alone grasp in total. I want to make sure that as we go forward through this hearing that those particular five contexts be the basis for the feedback you give us. Because that's essentially where we've got to go, is we've got to figure out how to stitch this all together. So with that particular thing in mind, I do want to proceed. Now, you've all talked at one point or another in your testimony, either because we've asked you to or otherwise, about resource adequacy. The proposal for California, for its Market Design 2002, has pushed off the adoption of resource adequacy standards until the last phase. I happen to think that most if not all of the dysfunction we suffered in California was due to an inability of the utilities to enter into safe harbor, long-term, bilateral contracts. And, it seems to me that whatever we do in market design, we ought to make sure that we incorporate the ability to enter into short, medium and long-term contracts into that market design for our utilities. Now, as I understand, Mr. Winter, CAISO has not been able to move forward on that because the California Public Utilities Commission basically hasn't taken up the challenge of resolving that issue. Am I correct in that? Mr. Winters. That is correct. They came before our board and our chairman gave them until November 1st to come up with a plan and then he made it very clear that if they did not have a plan put together by that time, that he would continue with the request that we had made to FERC for the 112 percent. Mr. Ose. That raises an interesting question, because when we had the first of these hearings, and this I am going to direct to Ms. Tomcala, when we had the first of these hearings, I asked a specific question whether or not the PUC had adopted, from a regulatory standpoint, safe harbor provisions for the investor-owned utilities to enter into long-term contracts. In other words, go ahead and do it, we are not going to second guess you. I was told under direct questioning by Loretta Lynch that the PUC had adopted safe harbor provisions for the investor- owned utilities to go ahead and enter into long-term contracts. And yet, if that's the case, why are they now considering whether or not to do that? It seems to me there's a disconnection. The question is, has the PUC provided the investor-owned utilities the ability to enter into safe harbor, long-term contracts for the provision of power to their customers? Ms. Tomcala. The PUC has divided that question into two time related segments, the short-term, the intermediate, to get us over the hump, and the long-term procurement proceeding, which they're engaged in right now. So the PUC has provided us the ability to enter into contracts for the time being, but is still pursuing an integrated, long-term procurement proceeding that will look at the combination of some of the elements that you identified earlier, contracts, demand response, efficiency, those sorts of things and how they fit together for the long- term. Mr. Ose. So you have the ability to enter into a long-term contract? Ms. Tomcala. We have the ability to enter into contracts. We would probably quibble over whether we have a safe harbor provision. Mr. Ose. How important is a safe harbor provision to your ability to enter into those contracts? Ms. Tomcala. Tremendously important, not only for the ability to enter into those contracts, but also to return us to investment creditworthiness, which we feel is essential to provide the service that we must provide to our customers. Mr. Ose. When you say you don't have the safe harbor provisions, what do you mean? Ms. Tomcala. What we mean is we are not in a position yet where our contracts won't be second guessed after the fact. Mr. Ose. By whom? Why would anybody second guess your contracts? I mean, you're the utilities. Ms. Tomcala. Because we are still working out the standards for the long-term and the long-term procurement proceeding. Mr. Ose. So this issue arose, I mean, I broached this issue in April 2001. And, you still don't have any definitive rules from the CPUC about what is or isn't acceptable for long-term contracting for power delivery. Ms. Tomcala. That's right. That procurement proceeding is continuing as we speak. Mr. Ose. And, Mr. Winter, you're saying that the board of the ISO has given the PUC until November 1st to get their act in order? Mr. Winter. Correct. Mr. Ose. Chairman Wood, under MD02 or any market structure, if people operating in the market can't get regulatory or political certainty until the last of the process, what does that mean for resolving all the--it seems to me that the delivery of power is what this is all about. What does that portend? Mr. Wood. It means you won't invest. And, that's what I think, honestly there's, I think all five of these folks have said the exact same thing on this issue from a different perspective. There's got to be, if California is going to regulate the retail customer, I think that's a choice that the legislature now has made. Kind of return to a more, to a traditionally regulated retail environment. The approach has got to be one very similar to that taken in other States, that if you do a very organized process, which I understand from our staff's visit with the CPUC staff 3 weeks ago they're looking at, you do have to basically say, if you go through an open solicitation for power contracts and you take the best bid or lowest bid or whatever you define it to be, that will be de facto granted, that is the best choice, before you actually sign the contract. These folks have to have that kind of certainty. Then these folks can go ahead and build and trade on that and it all works. But if you don't have that build-ahead component of this market, which we still don't have there today, then you do have, I think, what Mr. Winter pointed out, I guess I am going to put words in your mouth, but kind of a problem down the road and it may not be a very long road. Mr. Ose. Mr. Fraser is a public agency, but Mr. Ackerman and Mr. Smutny-Jones have private side producers. Some of your members actually generate power, or at least would like to, and would like to sell it for a profit. And yet, you don't have a customer that you could enter into a long-term contract with. Do you have any input on this? Mr. Smutny-Jones. Mr. Smutny-Jones. I would say the No. 1 problem in California right now is that there is not a long-term contract that you can take to a bank and get financed that basically comes out of a procurement process where PG&E or the other investor-owned utilities will know that they'll get cost recovery later on. It's a very significant problem. The second point I want to make here, because even if the PUC comes up with, and I don't by the way think that this is rocket science, it shouldn't be that hard, but even if they come up with a perfect rule that applies to the investor-owned utilities, resource adequacy will also have an impact on Mr. Fraser's community, which is about 30 percent of the market in California. And, there is an additional group of load serving entities that are neither municipal utilities nor publicly regulated utilities. These are load serving entities servicing the retail market. So how to pull this all together I personally believe that the connective tissue is the ISO tariff. So basically we determine how much can be determined by the State of California and the municipal utilities that they have to respond to, who provides it is obviously an open question. But more importantly, how it's ultimately enforced is going to be through an ISO tariff and ultimately I think through Commissioner Wood's Commission. Mr. Ackerman. Mr. Chairman, I think you're looking at part of the problem. The whole problem also includes aged power plants in the State of California which could be shut down and a lot quicker if they don't see the kinds of markets that would facilitate being used at all. So we have to look not only at the new construction which might not take place, because the certainty isn't there, but the additional megawatts that might be taken off the table because people are looking at the costs of continuing to run those power plants and saying, the economics aren't there, putting more pressure on the supply demand imbalance, if you wish to call it that. Mr. Ose. You've identified two questions. There's the capital necessary to keep existing plants running on a maintenance and repair basis. Mr. Ackerman. That's right. Mr. Ose. Then there's a second question having to do with creating, generating power for the growth in the market. Mr. Ackerman. That's right. And, we can add to make it complicated a third element, which is new transmission facility. I'll give you a specific example. Let's take the generation that's being built in Arizona and along the Mexican border. It doesn't have enough transmission to get in to help serve the needs of California and the Pacific Northwest. So we have inadequate transmission to bring some of this currently stranded new-asset power into the State of California and the Pacific Northwest. There's the chance that we might lose some existing power plants, because they can't sustain themselves and add new environmental requirements in order to keep producing power. And, then of course, we have the fear of new generation not being built because they don't have the market certainty. Other than that, things are going pretty well. Mr. Ose. You're an optimist. Mr. Winter, it seems to me that we've got enough power for this summer. But I am not very optimistic about the out years, if you will, 2 or 3 or 4 years downstream, as it relates to any potential shortages or significantly higher prices. Now, I know ISO is working on a report to forecast power supplies for this summer and the near future, which seems to be prudent, and I want to compliment you on that. Do you have anything you can share with us to summarize what appears to be the case, both in the immediate term and in the near term beyond that as it relates to power supplies for California? Mr. Winter. I have the advantage of having the draft report that you're referring to. It's 3,246 megawatts that we have ``in excess'' of the identified needs. That would portray that for the summer of 2004, we would have adequate power. Now, I always qualify that with, if I lose a couple of nuclear units, suddenly some transmission lines are down, or if we have a situation where there's a local hot spot that we just don't have sufficient transmission to serve it, that we of course would have to take whatever action was necessary for those. But for that period of this summer, it looks like we will be able to make it. That also takes into account a reduced import from the Northwest. During the summer, we usually see somewhere between 5,000 and 6,000. In our studies we have projected only 3,500, because we expect the Northwest to be somewhat drier. My understanding in talking to them last week was that they have a very good March as far as snow and rain is concerned, but we don't know what the impact of that will be. Looking beyond that, I have considerable concerns, many of the things people have mentioned here. We have old plants, many of them are under a requirement to add significant capital, to add SCRs or catalytic converter type things to clean up the air. People are just not going to make that investment unless they know they've got a market that they can play in. The other is that we have many old units. The other thing that I am seeing that, one of the advantages of being rather old is, you see things tend to repeat themselves quite a bit. And, I am seeing the utilities now getting caught up in the economy is down, the load is not growing as it has in the past. And, my experience in the utility was, we were very, very good at predicting nice, steady growth or nice, steady leveling off. But we could never quite hit it right when things either started growing fast or they started going down. I see this trend to try and lower things because of the economy. If our economy turns around, especially with the activities we have in Silicon Valley, where so many of them have reduced their consumption, they can add that back in literally months. And then, I think we are going to very quickly get into a concern. My guess is that if things go normally, the economy doesn't rapidly recover, we are probably good until 2006, 2007. If things don't go well or if they go well and the economy picks up but we have less additions and there's no more added generation, I think as early as 2005 we could be getting back into a problem. And, if bad weather in 2004, we could get into trouble. So I know that's not a clear answer, but forecasting load is not a real science. My feeling is, we need more generation. But even more than that, we need some transmission. And, one of the things that George said that troubles me a little bit, mainly because maybe I don't understand it, was the identification that the MD02 design was not friendly to bilateral. I think what he's referring to is that, the design does not guarantee, if you will, transmission for bilateral contracts. And, I would certainly agree with that. But as far as bilaterals, with the design, bilaterals are done completely outside the market and are just a way of getting resources in. So now we get to the point of do we have sufficient transmission. And, the answer to that is clearly no. But that's not a market design that can provide that. That's something that we've got to sit down, and while MD02 tries to indicate, through the nodal identification of constraints and power costs that you need a transmission line, I don't think it will ever be sufficient to be the total driver for the addition of transmission. So while MD02 is a portion of it, there's all kinds of other parts of the procurement of power, the addition of transmission, the building and adequacy of the generation, demand side, distributive generation, that all has to be pulled together. I feel MD02 gives us a basis to work on those. But it by itself cannot solve all the problems. Mr. Ose. So you have a draft report that indicates using what I would describe as conservative assumptions from power transfers from the Pacific Northwest, that in the summer of 2003 we have 3,200 more megawatts available under ``normal circumstances'' than we have demand for? Mr. Winter. Correct. Mr. Ose. Which is about 6 or 7 percent of the total market? Mr. Winter. Right. But now realizing that I've already added my reserves, which are 6 to 7 percent, so if you put those together, you're about the 12 percent that I've talked about. But next year, if load growth occurs and we don't have any new generation, which I am not seeing being built in California, then I think we start cutting into that 6 percent very rapidly. Mr. Ose. So if the total, I just want to make sure I understand this from a generic standpoint, if the total market is around, let's say, 50,000, total market load is 50,000 including the reserves 6 or 7 percent, you've actually got around 53,000 megawatts available against a market demand of around 47,000. Those aren't the exact numbers, I know that, but I am trying to get it clear it my head. Mr. Winter. Right. Mr. Ose. And then, you've accounted in your out years using some assumptions that we will be short in 2005 or 2006, again depending on how fast the economy grows and whether something goes down and what have you. But in any case, it's not a particularly optimistic scenario. Mr. Winter. And again, that's not our study. We look at the short term. But that was just my feelings based on the experience I've had in utilities. Mr. Ose. Well, I came to Congress from business, so the economy is at the heart of what I pay attention to. I want the economy to come back. Trust me, I want it to be just percolating like crazy. If my objective and that of so many of my colleagues here is achieved, that is, if we get economic growth of 2.8 or 2.9 or 3 percent per year, what I hear you saying is that we are going to be in a box, so to speak. Mr. Winter. I would certainly concur. Mr. Ose. OK. That's kind of where I am at. That's one of the reasons I want to get the design done. I want to get these things aligned and in place and moving. Mr. Winter, you and I have had this discussion about whether or not the CAISO is independent. We are not going to rehash that today. I do want to talk a little bit about the stakeholder process, whether or not the people, for instance, sitting between Mr. Wood and Mr. Fraser have been part and parcel of the deliberations that CAISO is undertaking. For the stakeholders, let me just make sure I've got it correct. Are you guys being consulted with relative to the design of MD02? Is that consultation taking place on a satisfactory level? Mr. Ackerman. I don't think that my members would agree that consultation is taking place. There's an education process that's going on, whereby the ISO staff educates the market participants, who I represent, and Jan represents as well, as to what the ISO is thinking. We have some limited amount of input. It has not been the feeling expressed to me by my members that they are part and parcel, they are somehow partners in terms of designing this marketplace as it was once upon a time, let's say, back in 1997 or 1998. Mr. Fraser. I would agree with that. I would support what he said. To illustrate that, I believe there's an RFP out for software to basically run the MD02 system put out before our input has been entirely included in the design process. Mr. Ose. Mr. Smutny-Jones. Mr. Smutny-Jones. I think that there is a great deal of concern of how well the stakeholder process has been working. I would concur with what Mr. Ackerman suggested with respect to, it's more educational than anything else. We have put together, with some other parties, a formal stakeholder advisory committee proposal to the ISO and ISO board for their consideration. That is crafted along the lines of other stakeholder advisory committees that currently exists in other successful markets, like PJM, for example, where there's a much more, a process we believe takes input from the marketplace. We think this is important for a couple different reasons. One is obviously getting input from people who are affected by the market, I think, is a positive thing. Two is, it does reduce the amount of things we ultimately then need to litigate before Chairman Wood's commission. If we can resolve these things in California before they get to Washington, we can save an awful lot of time and a lot of money. So we basically believe there needs to be stakeholder reform in California. Mr. Ose. Mr. Winter and Mr. Wood, I direct this question at you. The stakeholders are saying they'd like to have some direct line of input into this process that's formal in nature, with voting and all this other stuff. What's your reaction? Mr. Winter first, apparently it doesn't exist now to their satisfaction? Is there another view to this? Mr. Winter. Well, certainly I have another view. Not to debate what they have said, because what your customers, all of them say is reality, whether you feel it's the truth or not. I guess after probably 5 years of sitting through more meetings than you can ever imagine with input from everybody I can also imagine, having agreements then filing your filing and having people contest it at FERC anyway because your decision was not to agree with them, has kind of left me a little bit less than willing to accept that we didn't have a process. I forget how many hundreds of meetings, how many manhours we've spent trying to bring people along. I think it is a fair criticism that after input for a couple of years we move forward. But trying, and this is what I am going to pass to Pat a little bit, because during the summer of 2002, we were concerned about this very fact. Because we had put together the design, we had modified it constantly with people's input, we had tried to go to chat rooms, we had tried to do everything we could to get information from folks. Finally, somewhat in frustration, we asked FERC to come out and hold some technical working conferences on MD02, so that if for no other reason, they could see that we at least had tried to get the input in some rational way. They held those meetings, I guess, Pat, I don't think they were all that successful, but nonetheless, we had them and got input. And, so we have moved forward. Now, let me also address the problem, if the example is that you've gone out for an RFP, let me tell you that four Senators from California sent me a letter and said, you will not move forward on---- Mr. Ose. California has four Senators? Mr. Winter. Well, four of them that sent me a letter. The State, they have--it feels like 100. But nonetheless, they had requested us not to go forward until we had done an LMP study. We sat down with representatives of those folks and clearly laid out that the reason we needed to go forward was to keep things on schedule, and that we needed input from the designers of the system to No. 1, give us schedules, No. 2, give us alternatives that we could put into the design so that we could determine whether or not we could accommodate many of the things that people were asking us to do. So we proceeded with that. Nothing is cast in concrete. The board has committed to the State Senators that they in fact will not go forward until we have reviewed all the issues. So I guess I feel we've made quite an effort to do it. You're never perfect on getting everything to everybody's satisfaction. But the idea to slow down, slow down, kind of disturbs me, because most of the things we are doing are either in place in other ISOs and where markets are well running, and certainly I think there are some issues around FTRs or CRRs as to how we are going to allocate transmission. But one of our major problems is, we don't have adequate transmission and we've got to come up with a way to allocate that to people and some of them have existing contract rights, which we have to carve out and protect. So we are where we are, and we are trying to do the best we can to get that input. We are modifying the design every day as people come in. We just spent 4 days or 3 days last week walking everybody through every step of the process of the design and how it's going to work, so that they could give us input. Mr. Ose. Commissioner Wood, how valuable is the stakeholder process that you utilize over at FERC? I don't know if it's institutionalized or otherwise. Mr. Wood. We certainly, in setting up all the other markets, and just to take an example, one that's going on right now in the Southeastern United States, have a formal stakeholder committee, which is not just everybody showing up in a room with their designated representatives from each kind of constituent group who comprise the committee. So it is a manageable, diverse group that does not, is not mandated to agree on everything, but is mandated to get to, as close to consensus solutions on major issues as you can get. It is very valuable. It ultimately goes through the ISO board up to the Commission. It's very valuable to know that a proposal has been vetted through the stakeholder process. Those stakeholders do have the right, which you can't deprive them of, to directly address FERC on their concerns about the ISO solution. I don't think that anything would ever really change that. But certainly folks in my position, including me, do look at whether a process has been, or a new procedure has been vetted through a stakeholder process. I think these are too important not to do that. But on the other hand, an independent view has to be looked at as well. That's why we do value an independent board's review of what stakeholders come up with, to make sure that it not only advantages stakeholders, but ultimately is good for the public, it is good for the broad industry. And, there will be at times proposals that can make it through a stakeholder process that are not in the best interest of the public. And, we've got to always be able to say no to the stakeholder process. But that's what I think Terry and his folks are going through. It's probably the most difficult place in the country to do a multilateral negotiation on issues related to electricity that I could ever imagine. So I don't know that it's a necessarily textbook example. Mr. Ose. All right. I want to move on to the seams issues here. We have 11 different States, we have Canada, we have Mexico, we have plans to generate in each of these 11 States. We have transmission lines, we get a lot of power from Power X. We have facilities south of our border with Mexico that are under construction, if not already producing. And, the sum of that is that on any given day, we may import a significant amount of power from outside the State and then on any given day, when we have surplus, we may export power outside the State. The issue here is how do the market places interact with each other? In other words, if the rules in one area are different than the rules in another, how do you stitch them together? That's that seam between the issues. Now, Mr. Winter, in your testimony, you talk about a working group, the SSIWG. I can't remember what the acronym is. Seam Steering something or another Dash Working Group. And, you talk about how they interact. My concern is that we don't create a market design in California that makes it impossible to import from other areas or export when we have surplus. So what are the leading concerns on that particular aspect that you're dealing with? Mr. Winter. Well, I think first off that group has been tremendously successful in at least identifying the problems. It's one of the reasons that we tend to support FERC's SMD as it makes these different issues, somewhat gives you a framework to work off of. I would say probably the No. 1 contention is going to be how are you going to handle congestion, management of the transmission system. We've chosen locational marginal pricing because it has worked in the Northeast and PJM and New York models. I don't think that the others are quite there yet. But at least we are talking to them about it. I think a bigger concern oftentimes that I have is, I think there will be ways to work out the market issues. But some of the timing issues around the real time operation get to be major. In other words, if one market is accepting changes and bids up to 20 minutes before they dispatch the power---- Mr. Ose. As opposed to 10 minutes. Mr. Winter. Right, as opposed to 10 minutes or 5 minutes or wherever we get, those are the kinds of issues that have to be resolved in the design phase, so that the operators don't have to try and deal with that in real time. So you know, I can't list all the things they've gone through, because they've been going through an evolutionary process of whether they're going to use flow gates or they're going to use LMP or they're going to use zonal or how they're going to divide their markets up. I think the main thing California has to do is stay flexible so that we can accommodate most of those. I think if we get the operational time lines, then we can work out the others as long as there's transmission capacity to bring the power in. That's a real time, every 10 minute issue of whether or not you have sufficient transmission to get the power in. Mr. Ose. Do you think you can handle this through agency action, or do you need direct legislation? Mr. Winter. My 'druthers is, I don't like to push anybody into joining the ISO or having to live with the market. So one of the things we have done a tremendous amount of is trying to make it flexible enough to accommodate everyone. On the municipal side, we've developed what we call metered subsystems that allow them to operate their systems pretty much away from what the ISO does and what the markets do. I think we would offer the same type of opportunities to the regions outside. Mr. Ose. This brings me to one of the things as a consumer that I am most interested in seeing effectively implemented. And, that is when you get to this interaction or this interface between, if you will, the RTOs from different geographic areas, how do you ensure that the behavior at that point of interface is properly occurring? In other words, do you need a market wide monitor, so to speak? Mr. Winter. Yes. Clearly one of the things at the ISO, we identified many of the gaming activities that were going on inside our borders and we could suspect them on the outside. But once you went outside the State, we really couldn't determine whether someone was behaving according to the rules or not. So I clearly support the FERC's West-wide market monitoring activities. I would say that I think there is a need for the local monitors also because they're sitting there, right there watching the market every day, move up and down. Therefore, they can identify problems more quickly than somebody at a regional area who has to then monitor the interfaces and may not see the data for several days or even weeks. Mr. Ose. Mr. Wood, if I understand this particular concept, FERC would be the agency to whom this independent market monitor would report? Mr. Wood. Correct. Mr. Ose. And, the tool that they would use perhaps would be the, either the reports from the field, from these people deployed into the different markets, or the data gathering machinery or equipment you have over at the headquarters? Mr. Wood. Or their own independent analysis. They could depend on the folks that work at Terry's shop or in the Northwest or in the desert Southwest. Again, we are pretty flexible in how the different regions want to set up the market monitoring function. But we do require that there be a component of it that answers directly to us that's not responsible to Terry to tell him he's doing good, but could actually talk directly to us and also to the appropriate State regulatory authority at the same time. They could use a variety of tools, ours, theirs, and a third set, their own. Mr. Ose. Ms. Tomcala, in the context of an IOU, whether it be you or San Diego Gas and Electric or Southern California Edison, is a West-wide market monitor a necessary component of making these different RTOs operate efficiently? Ms. Tomcala. Absolutely. Mr. Ose. So just from an industry perspective, obviously you're not speaking for anybody other than perhaps PG&E, you would support having an independent market monitor to govern, if you will, the interactions? Ms. Tomcala. Yes. And, we have supported that in written comments to the FERC, both associated with Order 2000 a couple of years ago and associated with the SMD proceeding. Mr. Ose. Mr. Ackerman, do you share that opinion? Mr. Ackerman. Yes, we do. The three most important points that have to be done on a regional analysis, and I just want to emphasize that the members of my group are of course trading across all the Western States, not just in California, is resource adequacy, which we've talked about a little bit. That's the bean counting function--do we have enough supply in order to meet demand under various conditions? Second is market monitoring, which you're asking about right now, we do need a West-wide monitor. We want to have it under an apolitical, to the extent that's possible, an apolitical umbrella so we don't feel as we do today that what occurs in California is under the guise and under the direction of an ISO governing board that's quite biased, quite biased against us. And, finally, congestion management of the transmission system. Those are the three most important things. And, I'll reserve specific recommendations after that. Mr. Ose. Mr. Smutny-Jones. Mr. Smutny-Jones. Yes, we obviously believe that there needs to be regional market roles. I'll even go one step further. I am not necessarily advocating an ISO amongst the entire Western United States, but there needs to be basic rules that are understood on a regional basis. It's important that it not only be monitored regionally but also enforced regionally. And, I think here's an area that probably requires some further exploration, given the fact that this is interstate commerce and you do have different States that have obviously very different views on how this might work. But we are very supportive of the concept that if, you know, we have a regional market, an interstate market, and those rules need to be both monitored and enforced by a regional market monitor. Mr. Ose. Mr. Fraser, what's your input on this? Mr. Fraser. I totally agree. We both purchase in the Northwest and Southwest and sell into both markets, and have the same concern that we not get way out in front of the designs in those other areas, so that we move ahead in concert with them, rather than way ahead of them. Mr. Ose. Anybody else want to offer? Mr. Winter. Ms. Tomcala. Mr. Ackerman. Could I just add one thing? Chairman Wood reminded me of one element that's also important on a regional basis, which is transmission planning. I was thinking it, but I didn't say it. So add that to the list. That would make four essential elements. Mr. Ose. Just a moment here. Mr. Winter, you brought up the issue of local market power. What I believe you were attempting to convey is concern about the ability of a sole source to control pricing and availability and the like under a certain set of circumstances where transmission into an area may go down and the like, so that there is no alternative means of providing power. You said something that I don't quite understand. You stated that there was a need for additional mitigation measures for plants that have local market power. The question I have is that under a normally functioning market, the competitors for that particular producer would move into that market and attempt to sell or create power generation. And, it would seem to me that at least under a pure theory of markets, putting artificial constraints on local market power would serve as an adverse incentive to bringing that power in. Can you reconcile that? Mr. Winter. Clearly it is going to put the impact of not wanting people to generate or build new generation in that area. On the other hand, no one is going to build a new generator if in fact the line outage is for 2 weeks during the year and that's the only time you need to mitigate it. So if you have a generator who is located in a very isolated spot, you have two transmission lines going into the area, one of them goes out, therefore you can't get any power from outside the area, the only guy you can call on is the guy located right in the area. He has no restraint on his prices now. Mr. Ose. So how would you deal with that? Mr. Winter. Well, the way I would deal with it is as much the method that PJM has of dealing with it. What they do is they have established a price that the generator is entitled to. If something happens to the system so that they clearly have market power and the prices start going up, they just mandate that the person operates at that cost. Mr. Ose. Mr. Wood, under a scenario like that, how do you ever bring new generation to that marketplace? Who would ever put their capital at risk? Mr. Wood. It would be difficult if that were the only tool. One that the New England market redesign has proposed is to let, local pockets happen. They just do, because you've got industry that for 100 years was encouraged to be concentrated. So now we are trying to disaggregate it to get competition to work. So it may be transitional, you know, a couple of years to get transmission built or until you sell generation plants to various companies, so there are competitive forces at work. But I think of southwestern Connecticut as kind of that constrained example. Probably the north peninsula in San Francisco down to probably Palo Alto area, is similarly constrained. What they have proposed in New England, and just adopted in March, was to set the price cap, basically, at the cost of what a new entrant would charge to recover his costs fully. So that could in fact be higher than the formula Terry was just talking about. But it is one that I think we've heard from both generators and regulators and customer groups alike, that seems to probably hit the right balance. Because I think everybody recognizes that local market power exists and really can't run unabated. But the really bigger debate at our level so far has been, so what's the right way to address that local market power. Do you do it through a cost plus formula or through a proxy for the new power plant, what he would cost to enter into the market. Mr. Ose. Ms. Tomcala, how does PG&E deal with situations of this nature? Ms. Tomcala. Well, in the past we've had RMR contracts to deal with this. Going forward---- Mr. Ose. Share with us---- Ms. Tomcala. I am sorry. Reliability Must Run contracts, we use the acronym so often it's hard to get out of them. There are mixed reviews about how well that has worked in the past and whether that approach fits in with a fully competitive market going forward. So we have some proposals at the ISO through the MD02 process that we are addressing as possible alternatives for RMR. Mr. Ose. And, those would be coming out of the deliberative process some time after November? Mr. Winter. Good question. I am not familiar with exactly what proposal she's talking about. But clearly it would have to be coordinated with the November procurement and whatever the State came up as the requirements. She mentions RMR, and I think that's a perfect example, where you just can't look at the cost of generation, because in the example I gave, you could build a third transmission line, and that may be the least expensive alternative. So all these have to be coordinated. I am sorry, I don't know exactly what her proposal was in the program. Mr. Ose. Mr. Ackerman, how would your members react to this kind of thing? Mr. Ackerman. Well, they agree that it's a thorny problem in terms of identifying where market power exists and how to mitigate it. But here's what's really far more scary. When I was at the 4-day MD02 workshops ISO conducted last week, the scary part was, they said, we are going to apply this mitigation measure for local market power everywhere except for points where power comes into the State and interconnects with the ISO and in the middle of the State, where we have Path 15, that's south of your district, and south of that, Path 26. But everywhere else, the ISO will assume that local market power exists and we are going to apply these market mitigation rules. So your supposition is absolutely correct. Why would anybody invest in an area where we have this difficult load pocket to deal with, but now apply it to a much broader area, that includes the whole Bay area, Humboldt County, Round Mountain, Los Angeles, San Diego, the eastern part of California and on and on. And, they are going to start there because the ISO doesn't believe that there's sufficiently competitive markets in order to take off these ``mitigation'' shackles, as it were. So people are not going to invest. And, when we get into the definition of partnering with the ISO to say, well, where do we start solving this problem, I think the first question is where do these problems truly exist? We will have to come to some compromise solution. Mr. Ose. Well, let me flip it around on you. There's a price cap of $250, if I understand it. Are you saying that $250 is not a sufficiently high price for a power generator to come in and build a plant? Mr. Ackerman. I would say for a power plant that only intends to operate 1,000 hours or less a year, $250 is nowhere near enough. Mr. Ose. To cover that gap? Mr. Ackerman. To cover that gap. Now, we are not talking about a cap of $250 when we talk about local market power mitigation. We really don't know what number it might be. There's no dollar number floating out there. But I'm darned sure it's less than $250/mwh. We wouldn't be spending time talking about this topic if it weren't. Mr. Ose. Mr. Smutny-Jones, any input on this? Mr. Smutny-Jones. Well, it's certainly not a new problem. Obviously it's being handled elsewhere. I think the Northeastern approach actually is a variation on something that was looked at in California a while back to deal with San Francisco, because San Francisco is a load constrained area. At the time we were looking at a, I guess it was a bid cap at a level of the new entrant or the closest adjacent competitive, what's called a node, or substation. In other words, there may be other reasons why the prices in the market are high that have nothing to do with the location of the unit. And, the person who owns that unit shouldn't be harmed by that. We also had a large number of RMR contracts when we first set the market up in California. And, it was a great deal of effort. We took a great deal of pride in the fact that we removed a significant amount of these RMR contracts, both in northern and southern California. So that is yet another way of dealing with this issue. I share the concern that market power and concerns about market manipulation have sort of tainted everything. So what we are doing is, we are spending an inordinate amount of time focused just on market power and not on designing a market that I think Commissioner Wood talked about, or Chairman Wood talked about earlier, that if you have adequate resources, and there's real competition, the market power problem really doesn't arise. Mr. Ose. Mr. Fraser. Mr. Fraser. Well, I'd like to add another level of complexity to all this. I suppose one of the paradoxes in our business going back to the earlier comments about the need to have sufficient resources to meet all the load plus a 10 or 12 percent reserve, the paradox is that you have a power plant and you hope never to run it. So you've got to, within your market design, figure out some way to accommodate that. In many cases, it might be an old plant that used to run efficiently but nowadays is held in reserve. And, ideally, if nothing goes wrong, it is not run. So you've got to have a market design that would accommodate the owner of that plant, so that he or she would keep it in operation and ready to start when needed. Just to support what Mr. Ackerman said, we have a number of combustion turbines that when things are running well, they are not operated, other than maybe 40 or 50 hours a year. In the bad old days in 2000 and 2001, they were run right up to the limit of their resource availability. But in normal years, if you look at the cost on a per kilowatt hour basis, if you judge it on per kilowatt hour, it's very high. So the capacity adequacy issue is indeed pretty complex when it's essential that we have a very reliable electric system. Mr. Ose. I am sitting here listening, and I have to say I am somewhat confused. The argument that was just made regarding local market power would serve to protect if you will the oldest, most inefficient producers that are doing the most harm to our environment, producing the highest cost power in our marketplace. That is the net result of this particular potential policy, is that the dinosaurs of our industry end up getting protected in lieu of replacing them with far more efficient, far lower cost producers. And, I have to sit up here balancing the different objectives we have of power for our people and capital allocation that produces plants and protecting our environment. I am sitting here scratching my head, how do you reasonably come forward with a policy, the net result of which is that we have dirtier air than we might otherwise if we replaced that old plant with a more efficient plant in the first place? Would any of you care to comment on that? Commissioner Wood. Mr. Wood. I think it clearly points out the need for sufficient transmission. The best solution to a clogged up local market power plug is to have more highways into that congested area. Now, there are parts of California, as there are in any other State, that are very, very difficult to build in. So there will be places like New York City, probably like San Francisco, we've got an upper Wisconsin, southwestern Connecticut, where you've got significant environmental pushback. And, I think what we are seeing certainly with the rate design changes that were introduced in Connecticut is, OK, then the people that live there see the price impact of those choices. So the choices to run an expensive unit and not to have transmission result in the bill not being paid by everyone in New England, but now by people in that part of Connecticut getting paid. So that's one of the harsh realities, but good realities of some of the changes in MD02, which I think Terry indicated they're able to mute. But with locational marginal pricing, we start to see the costs of these environmental choices or non-choices that then get paid by the folks who make those choices as opposed to spreading the costs to everyone else. Mr. Ose. Well, if I understand the investor owned utility structure in California, which delivers a significant percentage of the power, those costs are aggregated and then spread to the entire ratepayer base. Mr. Wood. They are. Mr. Ose. So in effect, it's---- Mr. Wood. It's muted. Mr. Ose. Yes. Mr. Wood. But nonetheless, those signals are identified so that these transmission planners and the utilities who will go fix the problem will know exactly where it is and can make the case to the PUC, who's got to prove it on need and on cost benefit, that in fact this is costing PG&E in the aggregate $80 million a year. This is a $200 million line. It pays for itself in whatever, 2\1/2\ years. That's something that a regulator can say, yes, hard as it is to site, it's worth doing. Mr. Ose. I have to tell you, this is an amazing argument, but I find myself beginning to subscribe to this issue of environmental justice. Because what you're laying out is someone who makes a conscious decision to not build transmission and not build generation for whatever reason, basically shifting the responsibility to somebody else accordingly. And, I can't see that's very good policy. Mr. Wood. Plus the environmental point. Mr. Ose. Plus the impact. I mean, my air quality is bad so somebody else doesn't have that issue. Mr. Ackerman. Mr. Ackerman. There are two other creative elements that would allow people in a load pocket to reduce demand. One is demand bidding, of course, which allows large users of energy to every day, maybe even every hour, to enter bids as to how much they would be willing to be paid in order to shut down operations. And, the other one is real-time pricing. But here's the problem. Jurisdictionally, those items are on the State side of the line, not on the Federal side of the line. It becomes somewhat messy in terms of how to coordinate those two sides so that you have a coherent policy. It's not possible for FERC, for example, to go to a State and say, you know, you really ought to be doing demand-side bidding. Although they can give it lip service, and they have in many of their polices and many of their orders. But they can't go all the way. The States must pick up the slack. Mr. Ose. And, Mr. Winter, in your testimony, you talked about some of these permutations, if you will, on the demand- side. Are these part and parcel of the design that you're talking about? Mr. Winter. That is certainly one of the ways of meeting your capacity requirements. So if the State decides that they want to identify demand-side reduction, let's just take San Francisco, for example, because that is, as Pat Wood said, a constrained area. So if you look at that particular area, in regard to being constrained, and I am sorry, what was the question? I lost you. Mr. Ose. Whether or not these demand-side reduction provisions are part of the market design discussion. Mr. Winter. Right. They are not part of the design, but they would meet the requirement. And, at such time as those particular areas became constrained, then they would use the demand reduction to allow the sufficient generation to get into the area. Mr. Ose. I believe you just told me it's one of the tools that would be available. Mr. Winter. Correct. But not through the design itself. It just has to be, everybody keeps saying, put that in the design. I think they're talking more broadly of the design of how energy is going to be provided in the State as opposed to MD02, which is really the design of how the market would work. Mr. Ose. All right. Mr. Smutny-Jones, do you want to add anything on this, on local market power? Mr. Smutny-Jones. Only to emphasize that we do share your observation and concern with respect that the cure is worse than the disease here. In using San Francisco, not just to pick on them because I am from Sacramento, but there is a significant constraint there, we've debated this now for 6, 7 years. It seems to me that we can resolve this. If you set your price gap but also allow people to bid into the closest competitive node, you need an LMP to do this. Then you remove the problem that I think you're observing, which is you're not giving people any incentive to basically build there. I also think it does in fact send signals to policymakers, even if you peanut butter as they say, the rate impact of this. It does give the utility and the policymakers real information in terms of what it's really costing to serve a particular area. That is absent right now. Mr. Ose. Mr. Fraser, any input? Mr. Fraser. No, thank you, Mr. Chairman. Mr. Ose. My last question here, I am concerned about the market design being such as to prevent the gaming that occurred such as Death Star and Fat Boy and all the others that have gotten such play in the modern lexicon. Mr. Ackerman, how do we embed in market design the structures that prevent that kind of gamesmanship? Mr. Ackerman. I think that moving to a system that's been given the initials of ``LMP,'' which means the locational marginal pricing, goes a big step toward preventing the type of gaming you saw previously. And, I don't want to go into so many details that I lose the point here. I think that the Market Design 2002 is heading toward several positive charges; one of them being locational marginal pricing, another trying to specify how they're going to mitigate prices globally, and third, how they're going to mitigate prices on a local basis. Those three things alone will do a lot to remove the worry that I think consumers should have that they're being subject to the kinds of games that were identified in previous hearings in the State of California and many, many other reports. But to answer your question more broadly, I believe the whole industry has matured, because we've been exposed in the public light. There's a lot of public anger about what has occurred. With MD02 or without MD02, trading is not going to look like it was before. So I wouldn't rest upon MD02 to solve all the problems and assure people that everything is going to work cleanly. If there is a charge, it comes right down to the individuals who are making decisions on the trade floors. How are they going to make those decisions? I think now they understand that what they do, what they say and who they report to has the light of public review. I don't think anybody ever considered that or dreamed it, way back when. Mr. Ose. Commissioner Wood, same question. How do you use MD02 to prevent market manipulation in the future? What specific tools need to be in it? Mr. Wood. I think it was the most clear consensus item I heard from my fellow panelists here today, is get that resource adequacy requirement in place as soon as possible. I heard that from the folks who would build and trade, from the man who operates the grid, from the utility that both public and private view, have customers and who also have generation. I think it is the cleanest way to hop over all the noise about the California being a bad place to build, etc. If you have customers who have authority and ability to pay, which is an important issue with the large IOUs, certainly, to be dealt with hopefully soon, then all the rest of this work, the ability to manipulate again is exacerbated when you have insufficient supply and I think the market rules, certainly I can't pass that up. We clearly have to get congestion allocated in a better way. The price signal is being sent to not only builders of power plants, but to customers and to transmission builders about where investment is needed. But clearly steps to keep the supply bubble ahead of that kind of tight level that Terry laid out for 2004. That's not just jump up and down kind of news for me. Any steps that can be taken in the very near future to send that buy-ahead signal to developers of all sorts, to come into California and start building again, would be very welcome. Mr. Ose. Mr. Winter, how do you use Market Design 2002 to prevent the manipulation? Mr. Winter. First off, I agree both with Pat and Gary. Clearly if you have plenty of resources there, people don't do things that they normally do. On the other hand, I don't think any generator is going to build based on his ability to try to game the market, if you will. And, clearly, the LMP allows me as the operator to quickly identify the problem and get right on it. Because the dilemma we had with the old design was that people could actually in the day ahead congest lines. Then, when we got to real time, I had to solve it because the models didn't tell me that it was congested until I got to real time and saw the line overloaded. Then I had to take action. And, it was just a beautiful opportunity to game things by scheduling loads such as to cause congestion. So I think that will help. Clearly, getting more generation and transmission, it isn't just generation, because right now I sit with power in Northern Mexico and power in southern Arizona, and because of transmission constraints, I can't get it in. I've got to have a way to increase that capacity and make it available. And, I look at the transmission system as an enabler for the markets, and it's really a rather small percentage of the cost of energy. Therefore, let's try and get some lines built that will relieve it, then you allow the generator to build in more places he would like to where he's got water, transmission service, etc. And, then, we can move forward. But if we keep constraining it, even if you build all the generation in the world, if I can't get it to the load, it doesn't do me much good. Mr. Ose. Ms. Tomcala. Ms. Tomcala. Yes, we can all agree, I think, on this area, and that's a nice thing. Adequate resources, clear rules, independent region-wide monitoring, and the ISO has done some things already in the MD02 process in conjunction with FERC that help. There are some screens in place now, an impact screen, a conduct screen, and a reference price, all of which give the monitor something to look at, to give a quick check to see if everything's in place or if there's a problem. And then, FERC's ability to act when they do see a problem coming out of those screens. Mr. Ose. Mr. Fraser. Mr. Fraser. I couldn't agree more. Resource adequacy has got to come first, I think I made those comments earlier. Particularly transmission, and I think you've got to look at transmission a little bit different from the traditional least cost planning, and view it from a strategic point of view that transmission brings more than just the cost in the cost benefit analysis. It brings reliability as we've discussed, it's a very effective tool in mitigating gaming, and certainly not the least of which it facilitates inter-regional transfers, particularly in the West, where we have major temperature differences between California and the Northwest that we at the NCPA have taken advantage of for some 15 years. Mr. Ose. Mr. Smutny-Jones. Mr. Smutny-Jones. I think what the other speakers are saying is very similar to my observations here. I think it's important that we learn lessons from what happened in California but we don't learn the wrong lessons. Unfortunately, there's a lot of people who I will call neo-monopolists that sort of want to go back to some other model that frankly didn't work all that well either. I think as we move forward, the market redesign that's being proposed here needs to parallel other markets that we have real world experience in. And, I think we are almost there. But that real world experience is based on using the LMP, which does have a very high level of transparency associated with it. I think all the people on the panel have indicated a set of regional rules that are monitored and enforced regionally that basically, whether you call it megawatt laundering or arbitrage or ricochet or whatever, the rules are the same in Sacramento as they are in Portland as they are in Phoenix, people will behave according to those rules. So we need to basically, I think, move in that direction so we actually do have, that we do in fact learn from what happened in California and we do not have a repeat of that in 2005 and 2006. Mr. Ose. I want to thank you all for coming today. This has been educational, to say the least. I am not particularly comforted by what we talked about relative to the current market design that exists in California. I still happen to think we can do better. I think the current design leaves us vulnerable to manipulation. And, I am not convinced that we as a State, that is California, have yet to address the fundamental flaws in its market. I don't believe we are done with this situation. I don't think we are going to have rosy markets forever. I think we've got maybe a year to get this thing under control before we have another crisis. Frankly, I don't think we can afford to let that happen. To the extent that, Mr. Winter, you can expedite the market design and the rest can provide input to get us to closure on that, I think that's a critical piece of the pie here, to getting the California market fixed. Absent a fix, we are not going to have any investment, whether it be generation or transmission, whether it be public or private, whether it be munis or utilities or third party merchant generators. We'll be stuck with old plants at high cost and high pollution and that's not a future that I really want to have come to pass. This Member of Congress is going to stay focused on this. You have a basic piece of the economic puzzle that you're working with. My objective is to get lower prices for ratepayers and have it delivered in a fashion that allows people to have power when they turn on the switch and clean air when they want to breathe. I hope CAISO's Market Design 2002 works out. I am here to tell you I am going to be watching, and if necessary, we will have you all back here again, because I know you enjoy it. Thank you all for coming. I appreciate it. This hearing is adjourned. 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