<DOC>
[107th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:87293.wais]
CALIFORNIA'S ELECTRICITY MARKET: THE CASE OF PEROT SYSTEMS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON ENERGY POLICY, NATURAL
RESOURCES AND REGULATORY AFFAIRS
of the
COMMITTEE ON
GOVERNMENT REFORM
HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
__________
JULY 22, 2002
__________
Serial No. 107-215
__________
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
87-293 PDF
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COMMITTEE ON GOVERNMENT REFORM
DAN BURTON, Indiana, Chairman
BENJAMIN A. GILMAN, New York HENRY A. WAXMAN, California
CONSTANCE A. MORELLA, Maryland TOM LANTOS, California
CHRISTOPHER SHAYS, Connecticut MAJOR R. OWENS, New York
ILEANA ROS-LEHTINEN, Florida EDOLPHUS TOWNS, New York
JOHN M. McHUGH, New York PAUL E. KANJORSKI, Pennsylvania
STEPHEN HORN, California PATSY T. MINK, Hawaii
JOHN L. MICA, Florida CAROLYN B. MALONEY, New York
THOMAS M. DAVIS, Virginia ELEANOR HOLMES NORTON, Washington,
MARK E. SOUDER, Indiana DC
STEVEN C. LaTOURETTE, Ohio ELIJAH E. CUMMINGS, Maryland
BOB BARR, Georgia DENNIS J. KUCINICH, Ohio
DAN MILLER, Florida ROD R. BLAGOJEVICH, Illinois
DOUG OSE, California DANNY K. DAVIS, Illinois
RON LEWIS, Kentucky JOHN F. TIERNEY, Massachusetts
JO ANN DAVIS, Virginia JIM TURNER, Texas
TODD RUSSELL PLATTS, Pennsylvania THOMAS H. ALLEN, Maine
DAVE WELDON, Florida JANICE D. SCHAKOWSKY, Illinois
CHRIS CANNON, Utah WM. LACY CLAY, Missouri
ADAM H. PUTNAM, Florida DIANE E. WATSON, California
C.L. ``BUTCH'' OTTER, Idaho STEPHEN F. LYNCH, Massachusetts
EDWARD L. SCHROCK, Virginia ------
JOHN J. DUNCAN, Jr., Tennessee BERNARD SANDERS, Vermont
JOHN SULLIVAN, Oklahoma (Independent)
Kevin Binger, Staff Director
Daniel R. Moll, Deputy Staff Director
James C. Wilson, Chief Counsel
Robert A. Briggs, Chief Clerk
Phil Schiliro, Minority Staff Director
Subcommittee on Energy Policy, Natural Resources and Regulatory Affairs
DOUG OSE, California, Chairman
C.L. ``BUTCH'' OTTER, Idaho JOHN F. TIERNEY, Massachusetts
CHRISTOPHER SHAYS, Connecticut TOM LANTOS, California
JOHN M. McHUGH, New York EDOLPHUS TOWNS, New York
STEVEN C. LaTOURETTE, Ohio PATSY T. MINK, Hawaii
CHRIS CANNON, Utah DENNIS J. KUCINICH, Ohio
JOHN J. DUNCAN, Jr., Tennessee ROD R. BLAGOJEVICH, Illinois
JOHN SULLIVAN, Oklahoma
Ex Officio
DAN BURTON, Indiana HENRY A. WAXMAN, California
Dan Skopec, Staff Director
Robert Sullivan, Professional Staff Member
Allison Freeman, Clerk
Greg Dotson, Minority Counsel
C O N T E N T S
----------
Page
Hearing held on July 22, 2002.................................... 1
Statement of:
Winter, Terry, president, California Independent System
Operator; Charles J. Cicchetti, occupant, Jeffrey Miller
Chair in Government, Business and the Economy, University
of Southern California; George Backus, president, Policy
Assessment Corp.; and Paul Gribik, former employee, Perot
Systems Corp............................................... 23
Letters, statements, etc., submitted for the record by:
Backus, George, president, Policy Assessment Corp.:
Clarification of testimony............................... 181
Prepared statement of.................................... 117
Cicchetti, Charles J., occupant, Jeffrey Miller Chair in
Government, Business and the Economy, University of
Southern California, prepared statement of................. 82
Gribik, Paul, former employee, Perot Systems Corp., prepared
statement of............................................... 152
Ose, Hon. Doug, a Representative in Congress from the State
of California:
Information concerning gaming issues..................... 193
Letter dated July 19, 2002............................... 22
Memorandum dated January 30, 1998........................ 223
Memorandum dated April 9, 1998........................... 229
Prepared statement of.................................... 3
Waxman, Hon. Henry A., a Representative in Congress from the
State of California, prepared statement of................. 7
Winter, Terry, president, California Independent System
Operator, prepared statement of............................ 26
CALIFORNIA'S ELECTRICITY MARKET: THE CASE OF PEROT SYSTEMS
----------
MONDAY, JULY 22, 2002
House of Representatives,
Subcommittee on Energy Policy, Natural Resources
and Regulatory Affairs,
Committee on Government Reform,
Washington, DC.
The subcommittee met, pursuant to notice, at 2:03 p.m., in
room 2154, Rayburn House Office Building, Hon. Doug Ose
(chairman of the subcommittee) presiding.
Present: Representatives Ose, Kucinich, and Waxman (ex
officio).
Staff present: Dan Skopec, staff director; Barbara Kahlow,
deputy staff director; Yier Shi, press secretary; Allison
Freeman, clerk; Robert Sullivan, professional staff member;
Greg Dotson, Elizabeth Mundinger, and Paul Weinberger, minority
counsels; and Jean Gosa, minority assistant clerk.
Mr. Ose. Good afternoon, everybody. Welcome to today's
hearing of the Subcommittee on Energy Policy, Natural Resources
and Regulatory Affairs. Under the rules of the committee, I am
going to welcome Mr. Waxman; we now have a quorum. We are going
to commence with the 2 o'clock hearing.
In the last few months, the news media has been filled with
examples of companies attempting to game the California
electricity market. Many elected officials in my home State of
California have pointed to these examples as proof that
Californians were taken advantage of by corporate greed. Today
this subcommittee will investigate these matters to get a
better understanding of their true role in the California
energy crisis.
I do look forward to the testimony of the witnesses today.
I am eager to hear firsthand about the activities of Perot
Systems in particular. Did it, in fact, share confidential
information with other market participants? Was it running what
some have called a ``crime school'' in this regard? Did it
notify the California Independent System Operator or the
California Power Exchange of the flaws in the market design
that it found?
More importantly than the actions of any market
participant, I am interested in how the CAISO responded to the
various challenges that it faced. When it learned of the
outside marketing activities, how did it respond? Did it deem
such activities a threat to the market? Was the CAISO aware of
and did it understand these games at the time? If so, did it
attempt to fix the holes in the market structure? Finally, will
the CAISO's Market Design 2002 proposal, which FERC approved
last week, prevent the kind of activities that occurred in
California from recurring?
As I continue to state on every occasion I can, getting the
electricity market design right should be our foremost
priority. As we continue to review this issue, I will be
particularly focused on how market design contributed to or
prevented the types of games that were played in California.
Now, as an aside, I will tell you, I am not happy today. We
have asked a couple people to join us, and they have declined
the opportunity. I happen to think that, particularly in light
of the activities going on in the financial markets, having
folks who were actively participating in these efforts is
critical in assuring the American people that this type of
thing will be brought to a halt, and that they can be confident
in corporate America and their personal portfolios, if nothing
else. I am profoundly disappointed at the absence of Mr. Perot
and Mr. Belden, and I am not happy about it, and it is probably
not the last time we are going to hear about this matter.
[The prepared statement of Hon. Doug Ose follows:]
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Mr. Ose. I would like to yield to my friend from
California, Mr. Waxman, for the purposes of an opening
statement.
Mr. Waxman. Thank you very much, Mr. Chairman.
I, too, share your unhappiness with those witnesses that
are not here today. Before I give my opening statement, I want
to point out that you and I have had discussions about other
witnesses, particularly State Senator Dunn from California, and
in our conversation you agreed that we would have another
opportunity to have a meeting of this committee to hear from
him and other witnesses recommended by the Democrats.
Mr. Ose. If the gentleman will yield?
Mr. Waxman. Certainly.
Mr. Ose. I guarantee you, we will visit this issue, and I
will work with you to make that happen.
Mr. Waxman. And that we will have----
Mr. Ose. And we will have a hearing, and it will be the
minority witnesses.
Mr. Waxman. I thank you very much.
Mr. Chairman, it is important that we investigate what
happened in the Western energy markets in 2000 and 2001.
However, the way this hearing has been set up is very odd. It
is more notable for who is not here today instead of who is.
This hearing is entitled, ``The California Energy Market:
The Case of Enron and Perot Systems.'' Yet today not only don't
we have any witness from Enron testifying, but Ross Perot, who
is supposed to be this afternoon's key witness, isn't here
either.
As of Friday, we had been told that former Enron employee
Mr. Tim Belden would be testifying today. Mr. Belden would have
been a very useful witness to hear from since he headed the
Enron office, which apparently cooked up the trading schemes
that manipulated Western markets. The odd thing is, Mr.
Chairman, that we learned over the weekend from Mr. Belden's
lawyer that Mr. Belden never had any intention of testifying
today.
I do not think it is inappropriate to expect that we should
have Enron witnesses at a hearing that focuses on Enron.
We should also benefit from other ongoing investigations
when it is possible to do so. The one person who has uncovered
the most information on Perot Systems is California State
Senator Joe Dunn, and I hoped he would be here today, but I
appreciate that you have offered to have him testify at an
additional day of hearings.
It is worth taking a moment to recall how we got here and
why this is such an important issue. In 2000 and 2001, Western
families were ruthlessly price-gouged by energy companies. The
future of families in California and other Western States was
in effect mortgaged for the short-term benefit of energy
executives like Ken Lay and Jeffrey Skilling. The economic
welfare of the entire West was jeopardized as energy prices
skyrocketed out of control.
The wholesale cost of electricity for California in 1999
was $7 billion. In 2000, it was $27 billion. And, if not for
timely actions taken by the State government, it would easily
have surpassed that number in 2001. At the time, evidence from
government, academia and the private sector showed that energy
companies were manipulating markets to increase profits. For
example, over 18 months ago Enron chairman Ken Lay publicly
discussed his view that, ``the system invites gaming,'' yet the
administration refused to acknowledge the price gouging. Energy
Secretary Spencer Abraham dismissed claims that energy
companies were conspiring to drive up prices as a ``myth.''
What a difference a year makes. Enron has stunningly
collapsed, and industry documents and admissions confirm that
market manipulation was an important cause of the energy
crisis. This market manipulation cost California consumers
billions of dollars. The most serious manipulation involved
energy generators exercising market power by selling
electricity at exorbitant prices or by holding supply off the
market in order to drive up those prices.
Power marketers also engaged in various trading strategies
that increased costs and the possibility of rolling blackouts.
These strategies are discussed in internal Enron memos which
became public this spring. They include submitting phony power
schedules; deliberately overstating load to create the
appearance of congestion on transmission lines, which would
result in the State paying Enron to cut back on its load; and
megawatt laundering or exporting power out of State, and then
immediately importing it back in order to evade price caps. The
Enron memos gave these ploys names like Fat Boy, Death Star,
and Get Shorty.
Perhaps the most cynical ploy was the simplest: buying
price-capped power in California and exporting it to other
regions without a price cap. According to one memo written in
December 2000, Enron believed that this strategy, ``appears not
to present any problems other than a public relations risk
arising from the fact that such exports may have contributed to
California's declaration of a Stage 2 emergency yesterday.'' In
their own memos, they said that's what they thought would make
sense from their perspective, although they worried about the
public relations problem.
Recent admissions by at least seven major energy traders
that they participated in fake round-trip trades have further
underscored the extent to which energy markets are subject to
manipulation. Those companies, several of which conducted
business in California, all conducted trades in which they
exchanged the same amount of power at the same price with
another company. The trades were apparently intended to
exaggerate the company's revenues and make it appear that
markets were more active than they really were. They may also
have contributed to higher energy prices. One energy analyst
described the trades as having enormous potential significance.
And, we have also recently learned that Ross Perot's
company, Perot Systems, may have had a hand in California's
energy crisis. In 1997, Perot Systems gained significant
expertise with California's newly deregulated energy market by
contracting with the California Independent System Operator.
Apparently, Perot Systems then turned around and tried to
market this expertise to energy companies seeking to increase
their profits in the West.
For months, many Members of Congress have been calling on
the Energy and Commerce Committee to hold hearings about the
outrages that occurred in Western energy markets.
Unfortunately, the Republican leadership has refused to allow
hearings in that committee.
So, I am pleased that we are finally holding a hearing on
the schemes that traders used to manipulate the markets in 2000
and 2001. Unfortunately, I am concerned that this hearing will
simply provide Perot Systems the opportunity to provide its
unrebutted side of the story. I understand why that is good for
Ross Perot, but I don't understand how that will help us
understand what happened in California and prevent it from ever
happening again.
I want to thank the chairman for agreeing to a minority day
of hearings on this issue. At that hearing we will finally be
able to hear from Enron and Senator Dunn. I would like to reach
agreement on a date for that hearing before the end of this
afternoon's hearing, Mr. Chairman, if that is possible.
I would also like to ask unanimous consent to introduce
into the record a prepared statement from Senator Dunn, along
with a letter he has written to the chairman. And, I would also
like to request that the hearing record be left open so that
Members can submit relevant materials and written questions to
today's witnesses, and those witnesses which declined to appear
today, so that we can get responses to put into the record.
Mr. Ose. Mr. Waxman, as it relates to the record, the
record will be left open for 10 days for Members to submit
questions.
I have sent the clerk to get the schedule of the committee
and the availability of the room, and hopefully during the
course of the hearing we can work that out. And, let me think
about the other things you--what were the other items you
mentioned?
Mr. Waxman. Whatever else it was to put in the record.
Mr. Ose. Whatever else it was----
Mr. Waxman. All the documents that we have available.
Mr. Ose. We will work together. We will make sure that the
documents you reference get in the record and the other issues
that you rose, we'll work those out, too.
Mr. Waxman. Thank you very much, Mr. Chairman, for your
spirit of cooperation and your willingness to try to get all
these facts on the record. It is important that we do so for
our State. And, it is not a partisan matter; it is a matter of
simply trying to understand what happened in California and the
other States in the West, and make sure we don't have this sort
of thing happen again. I know that's your intent as well.
Mr. Ose. Thank you, Mr. Waxman.
[The prepared statement of Hon. Henry A. Waxman follows:]
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Mr. Ose. I know we delivered a copy of the letter from
Perot to the minority. We are going to enter this into the
record also at this time.
[The information referred to follows:]
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Mr. Ose. Now, gentleman, this committee is an investigative
committee. This is not judgmental in the sense about what we
are going to do. We swear everybody in. So, we are going to ask
you all to rise, raise your right hand. Those who would advise
you, in the background, whose names we may need to have on the
record; if you think they are going to provide input here, we
are going to need to have them rise, be identified, and raise
their right hand and be sworn in also. So, gentlemen.
[Witnesses sworn.]
Mr. Ose. Let the record show that the witnesses all
answered in the affirmative.
Now, the way we proceed here is that each of the witnesses
is given 5 minutes for the purpose of an opening statement. We
have received your written statements, and we have reviewed
them. I know that Mr. Waxman and I are very interested in
getting to questions. I am going to be punctual on the 5-minute
rule this afternoon. So to the extent that you can, you need to
make sure you can constrain yourselves to 5 minutes.
Now, we have four witnesses with us today. We have Terry
Winter, who is the president of the California Independent
System Operator. We have Dr. Charles Cicchetti, who is the
occupant of the Jeffrey Miller Chair in Government, Business
and the Economy, from the University of Southern California. We
have George Backus, who is the president of the Policy
Assessment Corp.; and we have Paul Gribik, who is a former
Perot Systems Corp. employee.
As Mr. Waxman indicated, we also had invited Mr. Perot and
Mr. Belden. Those invitations have been declined, and we have
no written statement from them.
Mr. Winter, you are our first witness. You are recognized
for 5 minutes.
STATEMENTS OF TERRY WINTER, PRESIDENT, CALIFORNIA INDEPENDENT
SYSTEM OPERATOR; CHARLES J. CICCHETTI, OCCUPANT, JEFFREY MILLER
CHAIR IN GOVERNMENT, BUSINESS AND THE ECONOMY, UNIVERSITY OF
SOUTHERN CALIFORNIA; GEORGE BACKUS, PRESIDENT, POLICY
ASSESSMENT CORP.; AND PAUL GRIBIK, FORMER EMPLOYEE, PEROT
SYSTEMS CORP.
Mr. Winter. Mr. Chairman, members of the committee, thank
you for inviting me here to discuss the importance of electric
consumers in California and throughout the Western United
States.
I would like to emphasize four points today. First, you
have invited me to discuss, among other things, the trading
schemes described in the materials produced by Enron and Perot
Systems in the past few months, and I will do so in a moment. I
must stress, though, that as disturbing as some of the
strategies described in the Enron and Perot Systems materials
are, the greatest potential harm to electric consumers in
California and elsewhere comes not from the games that some
clever traders may play, but from the persistent exercise of
market power by suppliers and traders. By market power, I mean
the ability of a single seller or group of sellers to command
excessive prices on a sustained basis. It is this exercise of
market power that cost California literally billions of dollars
in the last 2 years.
From startup 4 years ago, the ISO has placed particular
emphasis on documenting and mitigating both suppliers' exercise
of market power and their use of gaming strategies such as
those described by the Enron/Perot Systems materials. I am
providing the committee with a chronology of activities the ISO
has pursued in the past 4 years, directed to market power,
gaming, and providing relief to consumers that have been
victimized by the market. You will see there a strong and
consistent emphasis on detecting, constraining, and combating
market power. Through the turmoil of late 2000 and early 2001,
our market analysis department and the independent market
surveillance committee repeatedly documented both the presence
of market power in the California markets and its impact on the
consumers, and we have proposed measures to control that market
power.
There have been times indeed when people have thought we
have acted too aggressively. For instance, in June 1998, we
imposed a $250 price cap when prices suddenly rose to $9,000
plus.
How have we responded to market manipulation? First, the
ISO detected and issued directives specifically prohibiting
some of the gaming strategies identified in the Enron memo.
Second, the ISO modified its market designs to withhold
payments to suppliers who were engaged in gaming strategies.
Third, the ISO persuaded FERC to impose regional price caps
to address strategies involving the laundering of powering to
avoid limitation of bids in the ISO markets and has recently
asked FERC to extend those regional protection measures.
Fourth, the ISO levied penalties on suppliers who have
withheld energy even when we instructed them to provide it to
avert blackouts.
Five, the ISO referred other matters involving questionable
activities by suppliers to FERC for their review and further
action.
And, six, the ISO issued directives to participants in its
markets identifying trading practices, including those in the
cited Enron memos, that the ISO considered these contrary to
its market rules and would subject a trader employing them to
sanctions.
The ISO's interaction with Perot Systems, which has
recently been the subject of press reports, represents an
example of the ISO's efforts in the past to protect its markets
against manipulation. When the ISO was established in 1997, its
first task was to oversee the development of the computer
systems and software needed to run the electric grid in its
energy markets. In March 1997, the ISO contracted with the ISO
Alliance, a joint venture of Perot Systems and ABB Power T&D
Co., for the development of that computerized system. It should
be noted that a few months after startup, Perot Systems
withdrew from the ISO Alliance.
It should also be understood the role that Perot Systems
had in the development. They were not the market designers;
they were not the code writers. That was ABB and their
subcontractor, Ernst & Young, who did the actual code. Perot's
responsibility was to integrate those systems and make sure
that all of them worked together, and that they had been tested
out before we went live. As such, they gained considerable
knowledge about the systems, but clearly they were not the ones
writing the code.
The ISO demanded in 1997--when we learned from a board
member that there was marketing activity going on--the ISO
demanded that Perot Systems provide assurances that any service
that it provided to market participants would employ only
publicly available information, that it make the limitation
clear to its potential customers and those that they may
solicit in the future, and that it enforce what we called a
Chinese wall so that those working at the ISO would not have
contact with those who were doing the marketing activities.
We never came to a resolution to that discussion, but we
determined that most of the material which they had used, or at
least the written material that we had seen, in fact was
publicly available material. We have reviewed that material and
chose not to continue a discussion with Perot on those items.
However, with some of the recent information we have had made
available to us, we are certainly going back and looking at
those activities.
The most effective means of deterring the exercise----
Mr. Ose. Mr. Winter.
Mr. Winter. Yes.
Mr. Ose. You are a minute over.
Mr. Winter. Oh.
Mr. Ose. How much more have you got?
Mr. Winter. I have just got one more paragraph.
Mr. Ose. Please continue.
Mr. Winter. The most effective means of deterring market
power and unfair gaming is, of course, establishing the correct
market rules, and we feel that we have done that with our
recent market design, which was approved by FERC. They also
gave us some mitigation control items that we think will tend
to buffer those. Most important of that is a ``must offer
westwide,'' so that you don't have the activities going from
out of State versus power that's produced in State.
And, with that, I will come to a close. And then, if you
ask me questions about what Congress can do, I would be happy
to tell you, but it's in my testimony. Thank you.
Mr. Ose. Thank you, Mr. Winter.
[The prepared statement of Mr. Winter follows:]
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Mr. Ose. Dr. Cicchetti, for 5 minutes, please.
Dr. Cicchetti. Thank you, Congressman Ose.
First, let me express my pleasure at appearing before the
committee. I follow electricity matters, and I have done so for
more than 30 years. I am very aware of the so-called California
electricity crisis. In fact, I have served at Governor Davis's
invitation on the ISO's market advisory group, and I was
principal author of the California State Audit Report on
electricity deregulation. I also work for the utilities in the
Pacific Northwest that sold power that kept the lights on
during the energy crisis; the Navajo Nation that supplies power
and coal to California; and most recently, Perot Systems, which
has been accused of training energy companies in the art of
gaming the California market.
Let me begin by explaining why people confuse several
electricity market matters and, in the process, fail to
recognize that each is quite different. I think part of the
confusion comes from the fact that all three of these terms
that I am going to go through include the word ``market.''
First, there are market forces. These include supply,
namely, did California build enough generation; demand, did
anyone forecast the spectacular economic growth in California,
particularly in the high-tech areas; and the prices for inputs,
a fivefold increase in natural gas prices nationally and a
thirtyfold increase in California, as well as a twentyfold
increase in pollution compliance costs.
The answers to the supply and demand questions were both
``no.'' That is, we didn't get supply and demand right in
California. Worse, the climate shift in the West made supply
shortages 10 to 20 percent worse than they otherwise would have
been. That's 5,000 to 8,000 megawatts. And, the input cost in
California alone associated with natural gas would have made
the price of electricity $1,000 in late 2000.
In addition to market forces, there is market power.
Economists define market power as the ability of one seller or
an illegal conspiracy of several sellers to withhold supply to
force up prices; or, alternatively, buyers acting in a similar
manner to cause prices to fall. The issue is straightforward
and is related to moving all prices in the entire relevant
market.
Despite the claims to contrary, in my work for the State
Audit Report I found no example of market power abuse in the
sense of withholding supply from the entire California market.
The third issue is called ``market gaming,'' or ``market
manipulation.'' This refers to individual market participants
engaging in various actions, mostly contrary to the overall
market. Gamers don't try to move the full market; instead, they
seek profits from anticipating the moves of others and, in
effect, betting against the overall market. This is an
offensive game. Gaming works best when it is applied
individually, not collectively. In the games in which everybody
moves the same way, it's simply an equivalent of a horse race
where everybody bets on the same horse, in which nobody wins
but the horse and the house that controls the betting arena.
Of the three, market forces just can't be legislated by
laws of regulation or by laws of Congress. Any attempts to
regulate markets almost always fail, and it is utterly futile
to try to attempt to control market forces.
Market power is and should be closely regulated, and the
potential for actual antitrust violations should be vigorously
ensued and enforced.
The third issue, gaming, this word is very much often
confused. Essentially, all commodity markets are gamed. The
issue is whether or not the games are within the rules, or
whether they are attempts to frustrate the rules and end run
around the rules. Those kinds of activities need to be fixed,
and indeed in the California design the whole market
surveillance process was put in place in order to inform
decisionmakers on how to fix and refine the market rules based
upon the actions of the gamers in the market.
Let me turn now to Perot Systems. I have prepared a report
that I submit as part of this testimony today. My conclusions
are explained in that report, and I repeat them here just for
emphasis.
The facts, as I view them, are that in 1997 and 1998, Perot
Systems offered to provide training to participants in the new
California power market based on public information, employing
the accepted principles of game theory, that is, operating
within the rules. No market participants, however, were
interested in this training. In late 2000, competitive market
forces, the kind that I described earlier, combined with
structural flaws in the design of the California market, as
well as a series of regulatory and political missteps caused
the California energy crisis. Allegations that Perot Systems
was in any way responsible for this crisis are, in my opinion,
totally unfounded, as I explained to the California Senate
Committee.
What happened in California in 2000 and 2001 could not have
reasonably been anticipated in 1997 and 1998, when Perot
Systems was marketing its training services. The strategies
employed by Enron and other market participants evolved in
quite a different set of circumstances than when Perot Systems
was making its presentation. There is nothing in any of those
documents that I reviewed that would come even remotely close
to supporting the allegations, where people have attempted to
link Perot Systems to the California energy crisis.
I will be happy to answer any questions that you might have
on this or any other subject. Thank you.
Mr. Ose. Thank you, Dr. Cicchetti.
[The prepared statement of Dr. Cicchetti follows:]
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Mr. Ose. Dr. Backus for 5 minutes.
Dr. Backus. Good afternoon, Mr. Chairman, and thank you. My
name is Dr. George Backus. I am the president of Policy
Assessment Corp. of Denver, CO. I was originally a nuclear
design safety engineer, providing simulations to make sure that
nuclear facilities remain safe and secure under all possible
events. I trained under the simulationists who helped ensure
the success of the Apollo space program using the same methods.
My degree is in system dynamics, which primarily considers how
physical or economic systems change over time as a result of
human behavior. I focus on policy assessment. I simulate
potential behaviors and failure modes and how to modify the
policies to ensure the desired results.
In 1978, I coauthored the FOSSIL2 simulation model used by
DOE for U.S. national energy policy, including oil and gas
deregulation. I later extended that work to look at State and
regional energy and utility planning. I currently focus on
stress testing potential climate change policies for various
governments.
In 1986, for the State of Illinois, I looked at potential
electric utility deregulation and found some discouraging
dynamics, much like what has now been experienced in California
and elsewhere. In 1996, I prepared a report for the U.S. DOE on
the dynamics of deregulation. That report was based on the
deregulation experience in the U.K. and elsewhere, and showed
that the United States was now heading for the same problems. I
presented the results to the Western System Coordinating
Council in 1996. I then provided a workshop to the Western
Interstate Energy Board, whose members are all the commissions
within WSCC. I also made a presentation to the California
Energy Commission and offered to make presentations to the
California PX, ISO, and CPUC. I then made presentations to
trade groups, power authorities, consumer groups, utilities,
and commissions throughout the United States, as I saw the same
misguided deregulation efforts appear in the Midwest, New
England, etc.
The California approach to deregulation was much worse than
any I had seen or imagined. It would obviously destroy the
distribution companies and make the supply market a chaotic
nightmare. I saw my simulation skills as presenting a
consulting opportunity.
In 1997, I assisted Southern California Edison, who had
seen my WSCC presentation, to review potential California
market rules for problems as well as to recommend alternatives
that would alleviate those problems. At Edison, I was
introduced to Hemant Lall of Perot Systems, who saw the broad
applicability of my work. We decided that combining Perot
Systems' IT expertise with my work would provide a capability
unavailable anywhere else. The product could be offered to
market operators, commissions, and market participants
worldwide. It would allow them to understand the market
dynamics and plan accordingly.
Perot felt the obvious place to start the effort was in
California, and specifically with Edison, because we were
already there. These efforts included no proprietary
information or data. I had no confidential data or any kind
related to California or any other markets. All information was
obtained from published reports and news articles. I never
advised anyone to do anything unethical or illegal. I made sure
everyone was aware of the systems problems so that the problems
could be addressed, hopefully, with my consulting assistance.
Unfortunately, no such consulting business materialized in
California.
The fundamental problem in California is that it violated
the basic concepts of economics. Ordinarily, supply and demand
will come into balance orchestrated by price. Some key problems
were that the California market did not let consumers see the
market prices. The distribution companies were forced to buy
independent of the prices. It would take 30 to 60 days before
the ISO and PX could tell distribution companies and suppliers
the accounting results, and thus, there was no market
transparency.
Further, on the supply side, setting rules precluded needed
additional supply. Stranded cost agreements initially
suppressed market prices, further discouraging adequate supply.
On the demand side, the negotiated reduced consumer prices
stimulated demand. Confronted with high demand and low supply,
the market was incapable of achieving balance. This
precipitated the crisis.
The fatal flaws come not only from the mistakes in market
design, but also from not planning for them and in letting the
problems perpetuate. Public documents show that the ISO and PX
were aware of many of the problems. Many academic investigators
demonstrated the problems and proposed solutions.
While it is easy to cast the blame on the market rules, it
is the regulatory process that needs to be recognized as the
crux of the California crisis. The problems and solutions I
discuss in my written testimony will be revisited until
regulators recognize that markets are imperfect, and that they
must plan ahead to accommodate those limitations. Thank you.
Mr. Ose. Thank you, Dr. Backus.
[The prepared statement of Dr. Backus follows:]
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Mr. Ose. Our last witness is Dr. Gribik, for 5 minutes.
Dr. Gribik. Good afternoon, Mr. Chairman and members of the
committee. My name is Paul Gribik. As you know, I have
experience in and am familiar with the California energy
markets. Much of this knowledge stems from my employment with
Perot Systems Corp.
I began working for Perot Systems as an associate in May
1995 and remained employed there until January 2001. I was
hired to provide consulting to clients on energy market
matters, which later included the California ISO and P X.
In March 1997, Perot Systems joined with ABB to create the
ISO Alliance. Perot was the project manager and computer
systems integrator, and ABB created the ISO's computer system.
Perot was not responsible for drafting the ISO's protocol, nor
was I. My job at the Alliance was to explain the formulation of
the congestion management problem that resulted from the public
WEPEX process to the computer programmers. I also read other
public protocols issued by the ISO to advise the computer
programmers, when asked, as to how the related elements of the
market were supposed to work. I also participated in open
meetings held by ISO where the progress in implementing the
public protocols was discussed.
I left the ISO Alliance team in September 1997 to provide
part-time assistance to the PX. At the PX I reviewed the ISO
and PX public protocols so I could advise the PX on ways to
ensure that their markets would work with ISO's. In addition,
at the PX's direction, I interacted with market participants.
Outside of my work for the ISO and PX, I only recall having
contact with two market participants through marketing efforts
by Perot Systems. The first meeting that I attended was with
Southern California Edison in early 1997. I did not set this
meeting up, give a presentation there, or write or create any
document that was given to Edison.
In October 1997, I prepared a document for and participated
in a presentation to San Diego Gas & Electric. I discussed the
California energy market structure and the gaming process a
participant would need to employ to make strategic decisions.
When I use the word ``game'' or ``gaming,'' I am referring to a
strategic decisionmaking process whereby different strategies
are used to determine the risks and benefits each strategy may
present, given the strategies that other participants may
employ. Of course, these strategies must comply with certain
market rules.
It later came to my attention that someone at San Diego Gas
& Electric misunderstood some of the things I said in the
presentation, and told the ISO that we were talking about
proprietary information. That was not the case. At no time did
I offer to disclose nor disclose any ISO or PX proprietary
information.
A meeting with Enron was set for January 13, 1998, but it
did not occur due to a severe snowstorm. I do not recall
participating in any subsequent meeting with Enron, and I never
made a presentation to Enron.
These marketing efforts, about which much has been made,
resulted in no consulting work from any market participant. I
believe that we were not hired by anyone because we were
offering nothing more than a way to analyze the market and our
knowledge of the public protocols, nothing particularly unique.
Much of the misunderstanding about the marketing efforts in
which I and others at Perot engaged stems from the 44-page
document that Reliant Energy turned over to the California
Senate. The facts surrounding this document are laid out by
full statement, but basically this document was never presented
to anyone. It was not a blueprint for any type of illegal
trading. It was created after the markets opened on April 1,
1998, and I have no idea how the document made it to Reliant
Energy's files.
The examples of the flaws in the protocols that appear in
the 44-page document regarding the real-time market and
negative price problems are two of the problems I brought to
ISO's and PX's attention. I also brought an additional problem
to the ISO--with the ISO's default usage to their attention.
All three of these were fixed before the markets opened. I
recommended that the protocols be revised to address these
problems, because I believe they could have enabled a single
market participant to create instability in the market.
Mr. Chairman and members of the committee, I am a
California resident and have paid more for my electricity and
suffered the same inconveniences that other California
residents have encountered. I can assure you, however, and the
facts show, that neither my nor Perot Systems' work contributed
in any way, shape, or form to high energy prices, brownouts, or
blackouts, or other aspects of the California energy crisis.
Thank you. And, I will do my best to answer any questions
you may have.
Mr. Ose. Thank you, Dr. Gribik.
[The prepared statement of Dr. Gribik follows:]
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Mr. Ose. All right. We are going to start sorting through
some of this stuff here.
Mr. Winter, this discussion about Perot Systems' contract
and contractual constraints with the ISO, I know there was a
bunch of correspondence back and forth. I want to make sure I
get the timeframe correct. Perot Systems and their
subcontractors worked with the ISO and PX on the melding of the
software systems in what timeframe?
Mr. Winter. OK. Let me just run back through the
chronology. First off, the PX and the ISO were separated as two
entities. So we have to keep those ideas kind of straight in
our head, too.
The ISO signed a contract with the Alliance in March 1997.
They then began the development of the software systems, and it
was in late September, early October that we learned of the
Perot activities. Now, all of the----
Mr. Ose. Just a second. So ABB and Ernst & Young, from
March 1997 to September or October 1997, had worked on the
software packages?
Mr. Winter. Correct. And Perot was part of the Alliance.
Mr. Ose. All right.
Mr. Winter. Now, their responsibility was to take--there
were actually three major systems. The settlement system, which
Ernst & Young has developed; there was an energy management
system that was developed on another contract with ABB; and
then there was a scheduling and pricing system that ABB
developed. Well, those three all had to be integrated together
and tested so that it worked as one complete, total system. And
that was Perot's job was to make sure that testing was
completed and that the systems all worked appropriately.
They worked up until--the start date was April 1998, April
1st, March 31st, and then their work in essence, after they did
the integration, was completed. And then, they left the
Alliance contract in June or July of that 1998.
Mr. Ose. So, from August or September 1997, to some point
prior to April 1, 1998, Perot was working to integrate the
software so that they could communicate, and they were checking
for its operational efficiency. And, if there were flaws, what
were they supposed to do with the information?
Mr. Winter. Well, what we had was we had variances that we
identified. And, any time something didn't connect, then we
would write up a variance, and they were then responsible for
getting back with Ernst & Young or ABB and correcting the code
to make sure that it did work.
Mr. Ose. Did Perot do the code adjustments, or did somebody
else do the code adjustments?
Mr. Winter. I believe that ABB and Ernst & Young did the
adjustments, but certainly they were working very closely with
Perot to make sure that it would then work out in the testing
procedures.
Mr. Ose. Who had physical control of the code?
Mr. Winter. At that time ABB and Ernst & Young would have
physical control of the code. I do not know, but I would assume
that Perot also had the soft--or the code words to get in so
that they could change it if it was deemed necessary. We had a
process in place where any changes would be recorded so that
everyone knew what had been changed.
Mr. Ose. Changes recorded? Changes were recorded then; and
the person doing the change would have to log on, put their
personal identification in there so you knew who had access and
who was doing the change?
Mr. Winter. At that time I don't know whether there were
personal or whether there were ``blanket codes,'' because we
were not operational. Now, when we went operational on March
31st, we did what we call a lockdown of the system; and we went
in and changed all the codes so that we then had absolute
control of who was coming in and what changes they were making.
Mr. Ose. Well, one of the things I am trying to get at is
whether or not Perot Systems had possession or access to the
codes. And, if I heard you correctly, you said you don't know.
Mr. Winter. You are correct. I don't know. I would be very
surprised if they didn't have access to the code, because, as
the tester, they had to review it and see how it all fit
together.
Mr. Ose. Did your contract with ABB or Ernst & Young allow
for the code to be shared with other contractors?
Mr. Winter. When you say other contractors, we had
confidentiality in there. If there was another contractor
working for the development of the system, then, yes, it would
have been able to be shared.
Mr. Ose. Would they have to come back to the ISO to get
sign-off from the ISO--or the PX in the case of the PX--for
sharing that code with another contractor under the
confidentiality agreement?
Mr. Winter. I don't know. My guess would be that as long as
it was the Alliance--in other words, Ernst & Young, ABB, or
Perot Systems, they would not; if it went beyond that, then
yes, because then you get into the proprietary of software
systems.
Mr. Ose. Was a record made of the code changes that
occurred from August or September until going live on March
31st?
Mr. Winter. There was certainly a variance record made of
any time that we had the actual code changes. I do not know
whether there was a documentation of each individual line
change that may have been made.
Mr. Ose. When you say variance, do you mean the code is X;
it is not compliant with what we need, so it varies from what
we want, and we need to fix this?
Mr. Winter. Correct. We had those, some 1,045 variances
that we had found that needed correction.
Mr. Ose. 1,045?
Mr. Winter. Right.
Mr. Ose. All right. And, ABB and Ernst & Young were charged
with correcting those variances.
Mr. Winter. That is correct.
Mr. Ose. Would it be--one of the things I just love about
elective office is the wordsmithing. Variances, is that the
same as saying there were flaws in the system?
Mr. Winter. Yes.
Mr. Ose. OK. Thank you.
Now, did Perot's work with the Alliance end when you went
live on March 31st?
Mr. Winter. No. They continued. When you go live, you find
things that you didn't know were broken, so they had to finish
their reports, and they finally left in about July 1998.
Mr. Ose. July 1998. OK.
Now, you had a bunch of correspondence back and forth with
Perot Systems in the late fall of 1997----
Mr. Winter. Yes, we did.
Mr. Ose [continuing]. About the attempts to market the
information that they were marketing. If I heard you correctly
today, I think your testimony is that you never signed off on
the fifth or sixth letter exchange saying, ``Go ahead and do
it.'' Did you ever affirmatively say, ``Don't do it?''
Mr. Winter. No, we did not. When we looked at the
information that was available to us, they, in fact, were not
using anything that was confidential. However, the contract
does state that the parties to the contract would not do
anything that would give the perception of impropriety. And, we
certainly felt that outmarketing, as a knowledgeable person,
ways to beat the system was not quite appropriate.
Mr. Ose. Of course, they didn't do a very good job of
marketing it, did they?
Now, the correspondence that went back and forth, I know
there was a discussion about the Chinese wall issue between
people who were attempting to market the program to third
parties and the people who were actually working with ISO and
PX. There was a disclaimer requirement; there was a letter to
all clients about the existence of the ethics wall and the
like. Were there things that you asked for that Perot did not
do in this correspondence?
Mr. Winter. Yes. We initially had asked that they cease and
desist from their marketing efforts. Later on, when we couldn't
show that it was any confidential information that they were
providing, then we backed off from that position and just asked
for a Chinese wall and disclaimer so that no one would think
that they were getting some secret information out of the
development of the ISO systems.
Mr. Ose. And, presumably, that was accomplished?
Mr. Winter. They told us that they were doing that. Yes.
Mr. Ose. OK.
Dr. Backus, in a commodity business, do you find it unusual
that participants construct a game model or a gaming algorithm?
Dr. Backus. I take that as being a rather common exercise,
where a person or a company always goes through the exercise.
If it's a car manufacturer, should we have zero interest loans
to stimulate demand at a given time?
I would, to my knowledge, say essentially all commodities,
all industries involved with commodities, have a strategic
planning organization or a marketing organization that tries to
figure out how to do as best they can in the market to compete
with their competitors, and that process, as Dr. Gribik has
pointed out, is what we call gaming; sort of like what
Beautiful Mind was about in the show about John Nash. And, it
goes clear back to Antoine Carnot in 1850.
Mr. Ose. Being on the Agriculture Committee, whether it is
rice or wheat or corn or soybeans, you have participants in
those markets who presumably are factoring into their analysis,
whether in transportation and price variances and supply and,
you know, number of railroad cars and----
Dr. Backus. Yes. Given that my family were all farmers
originally, the answer is yes. You always decide whether you
wanted to hold the grain until it was midwinter, or whether you
wanted to dump it on the market early. So even as individual
farmers, they in a sense were doing gaming.
Mr. Ose. All right. Now, your computer model, when did you
create it?
Dr. Backus. The original work was created for the U.S.
Department of Energy as the FOSSIL2 model that was used for oil
and gas deregulation starting in 1978 and used for policy
through 1998. The first time that it was used in a slightly
modified version was for the State of Illinois, who developed
the model to take a look at deregulation in Illinois in 1986.
That time period was when the new nuclear plants were going to
come on, and they were worried about prices going up by a
factor of three as the price shock. They wanted to see whether
deregulation would help out that process. It didn't go very
far, but nonetheless that model already showed the dynamics in
quite good detail of what actually happened as we progressed
both in the U.K., and in the United States.
Mr. Ose. How did you go about getting the algorithm figured
out for your model?
Dr. Backus. It is almost funny to me, because we are the
only ones who still use it. The idea is that if you are going
to deregulate electricity, then why don't you treat it as a
deregulated market, where prices attempt to clear and that
people don't have perfect information, because most markets
aren't perfect? Prior to that--and it is still very much that
way today--everybody uses these very sophisticated optimization
models that assume there is a perfect market, just like was
assumed and could be assumed under the centralized command and
control of the regulated markets. So the only thing that we
added to our work is to say, well, market logic worked for gas,
and it worked for oil, why don't we apply the same algorithm
for electricity and see what happens?
Mr. Ose. And, what happened?
Dr. Backus. Because electricity is not stored very well, it
ends up that you can have very, very volatile markets. A second
part of this, that applies even when we talk about the
deregulation of oil and gas, is that we tend to have a few
rather large companies actually stabilize the market and a lot
of niche players. In the United States, we probably still today
have 4,500 electric utility players, if we take and add
together all the public powers and such. The market is in no
shape whatsoever to be a deregulated market.
So, what the model first showed is that we have got to have
a lot of mergers and acquisitions. It also showed that during
that process, that would be quite disruptive, which would also
mean that people wouldn't know what supply and demand actually
meant. And, as a customer, who am I buying from today or
tomorrow? In fact, it is probably not unlike buying Internet
services in the last couple years. We don't know whether the
person is going to be there or not the next day.
Mr. Ose. So, if I understand you correctly, the unique
feature of your algorithm was the factor accounting for the
inability to store electricity?
Dr. Backus. That certainly showed up as a dominant
characteristic that made things worse. The biggest thing was
just a change in assumptions that now that we had a deregulated
market, we would have an imperfect world where people were
trying to make the best choices they could, and, in a sense,
would have to make them in a hurry because we don't have the
storage.
The biggest fault that I find with the current regulatory
work and the past regulatory work is that the tools that were
used for that analysis continued to assume an optimization
approach only appropriate to a regulated market, and that's
what I considered as a major failure in trying to assess what
would be the impacts of deregulation within California, New
England, wherever.
Mr. Ose. How did you account in your model for the initial
60 or 90-day lag in price transparency?
Dr. Backus. I didn't consider the 60 or 90 days. It was
just the concept that I would bid, and I didn't know what the
price was until after everything was done. My model actually
only runs at a semiannual or annual level, so it is not worried
about market day-to-day transactions. It is simply the idea of
trying to deal with the idea that you don't really know what
prices are, and you as consumer or as a generator have to make
a decision without having price transparency.
Mr. Ose. Now, you acted as a consultant under--is it Policy
Assessment----
Dr. Backus. Yes.
Mr. Ose [continuing]. To Perot Systems?
Dr. Backus. I would say the answer to that is no. Since we
simply had a joint marketing effort that if it was successful,
would combine my understanding of how systems worked with their
IT capabilities, and that we would be able to offer a joint
product to participants, whether they are commissions or the
ISO or utilities, on how to best survive within that market.
Mr. Ose. So your joint venture started when?
Dr. Backus. It would be, I would say, mid or early 1997.
It's whatever time I met Hemant while I was working at Edison--
or doing consulting at Edison.
Mr. Ose. In 1996, you gave a presentation to the Western
System Coordinating Council. Who was in attendance, and what
did the presentation entail?
Dr. Backus. My guess is there was something like--I'm
guessing here--1,200 people. To my knowledge, every utility and
commission and consumer----
Mr. Ose. Can you name them for us?
Dr. Backus. Sorry, I sort of missed all of those. So, they
were all there. And, the presentation is basically identical to
the presentations that you probably see in the data that's on
the Perot Website, which was provided to Senator Dunn. In that
sense, it's sort of that one-trick pony, that the 1996 report I
provided by DOE lays out in very fine detail all the different
dynamics that are going to occur and how they will evolve if
people aren't careful. And, as it turned out, nobody was
careful.
Mr. Ose. So, in 1996, you made a presentation to the
Western System Coordinating Council basically describing these
potential flaws in the market?
Dr. Backus. Simply the dynamics of deregulation, which just
simply said, if you follow the deregulation process as was
followed in the U.K. and South America and New Zealand, which
the United States was also following, here are the problems you
are going to find. And, those problems included mergers that
started up about that time; massive divestitures of the
different utilities, which we saw, where they broke into their
different generating and distribution groups; and certainly
market gaming; and then something called reregulation that we
are probably talking about right now.
Mr. Ose. Now, you gave a second series of presentations in
1997 and 1998 on this material.
Dr. Backus. I was probably giving presentations
continuously, probably to hundreds of organizations, almost all
identical.
Mr. Ose. Did they track the presentation you made to the
Western System Coordinating Council?
Dr. Backus. Yes, they did. In fact, it was quite nice to do
so, because as time is marching on, 100 percent of the
forecasts that I had produced, as to where the problems would
be, what would occur next, were actually occurring exactly in
the sequence and timing that I had predicted.
Mr. Ose. Now, in your presentation to the Western System
Council, you mentioned a game that includes a generator having
an outage of one of its units in order to drive up the price
for all other units.
Dr. Backus. Yes.
Mr. Ose. I guess the question we would have is whether you
were advocating such a game in your presentations?
Dr. Backus. No. I was certainly not. It was simply to
present that and possibly 20 other games as well that occurred
in the U.K., including discussions of how to prevent those
games from occurring. Again, that particular game was developed
by Antoine Cournot in the 1850's, roughly, and is taught in
every university in the United States. So it wasn't like a
secret.
Mr. Ose. So your testimony is that you were analytical in
your presentation rather than advocational?
Dr. Backus. Certainly. In all cases it was simply to point
out here is the situation, and that both utilities and
commissions must recognize that, because certainly the people
who are hurt very significantly are going to be people like
Edison and PG&E if those prices went up. So it was appropriate
that both commissioners, regulators, and the utilities and
market participants understood that problem could exist.
Mr. Ose. Now, you state in your testimony that the outage
problem was a particular weakness in the California market
design.
Dr. Backus. It was particularly troublesome simply because
supply and demand were so out of balance, as Mr. Winter has
pointed out.
Mr. Ose. Is this something you had also recognized in the
U.K. system?
Dr. Backus. Yes, it was.
Mr. Ose. Now, having recognized this, did you inform the
CAISO or the PUC or the PX of this problem?
Dr. Backus. I tried to inform the California Energy
Commission of that, and certainly had the presentation in 1996
also to the Western Interstate Energy Board, which is all of
the commissions. I only had limited contact with the PX and
ISO, and they were up to their gills or necks in trying to get
the system put up, so they weren't interested in listening to
me.
Any contact that I tried to have with the CPUC did not get
anywhere either, because they were busy trying to work with the
different utilities to try to also get the system up and
running.
Mr. Ose. OK. I have an e-mail from you to Dr. Gribik, dated
May 8, 1997.
In that e-mail, you state, ``I am actually trying to get
the CPUC'', the California Public Utility Commission, ``to
recognize the mess they are causing with their pricing and
marketing rules, and relieve some of the restrictions so that
the market can actually behave like a market.''
First, I want to ask you, is that your e-mail?
Dr. Backus. Yes, it is.
Mr. Ose. What was the mess that you refer to that the CPUC
was causing?
Dr. Backus. I had already been looking at the potential
rules that were being developed for Southern California Edison.
Within those rules, as I looked at it, already at that time it
was to the point where you would say there was a 99.9 percent
probability that Edison, SDG&R, PG&E, unless it got out of
business, would go bankrupt.
It also said that because of the way the stranded costs
were put in place, initially the prices would be too low to
stimulate supply. Therefore, it gave an almost absolute
certainty that the market would start to fall apart by 1999,
which I also point out in the WSCC presentation, and said we
should have been having this hearing in 1999 instead of now. To
have waited that long----
Mr. Ose. I was not chairman then.
Dr. Backus. You are forgiven. Thank you.
Mr. Ose. Mr. Winter, let me ask you a couple of questions.
I want to read you a couple of quotes. Obviously, I am confused
here.
I hear testimony about structural issues, and I have seen
the quotes about supply issues, and I have seen the quotes
about abatement and conservation and all of that. Frankly, I am
a little bit confused. I am trying to determine whether or not
we had sufficient supply or insufficient supply, or whether it
was market structure or flaws in the market structure, or
something else.
I guess I would ask you, just extemporaneously, for an
abbreviated response to that. Was it an issue of supply? Was it
an issue of declining conservation? Was it an issue of market
structure, in looking back, trying to avoid repeating that in
the future?
And, I might ask all the witnesses the same question.
What is your input here?
Mr. Winter. My input is twofold. One is clearly, if you
don't have enough supply, the markets aren't going to work and
the prices are going to increase. That is the way markets are
supposed to work, because then that encourages people to add
generation.
I think, in California, because those signals were so
distorted, people were trying to guess whether there was a
supply or a nonsupply shortage; I think it is kind of
interesting that we had our outages not during the summer when
we had high loads, but during the winter when we had actually
reduced loads.
So people want to read the nameplate ratings of all the
generators in the area and say, obviously we had plenty of
power during that timeframe. As an operator, I don't care what
the nameplate rating is, I am interested in how many units are
on and what is going to be my supply that day.
Mr. Ose. The nameplate rating is when you look at the
turbine--it has the little brass plate on there--and it says at
such and such an input, this is the megawattage generated from
there?
Mr. Winter. Right--50 megawatts, 500 megawatts, whatever.
But there are so many restrictions on generators. One is, a
maintenance unit is out for maintenance or has a tube leak, so
it can only generate half; or units are out because the owners
are financially incapable of buying natural gas.
Certainly, in the Northwest, one of the other things to
remember about California is when people look at the supply,
they tend to focus on just the power in California. Well,
California has always imported 20 to 30 percent of its power
from outside the State, so you've got to look at what is the
availability out of the State.
So, structurally, when the PUC forced the investor-owned
utilities to buy all their energy from the day-ahead market,
they really eliminated their ability to make long-term
contracts and go outside the State and in the State and tie up
power. So as I look at it, that was a structural flaw.
Then we start buying in real time and not taking into
account maintenance, droughts, all the other things, lack of
conservation, no demand side transparency of the price, no
demand and supply equilibrium being developed, and we have a
horrible situation.
Mr. Ose. Dr. Cicchetti, do you have any input on that?
Dr. Cicchetti. As I said in my opening statement, all three
of the factors, supply and demand or market forces, market
structural design flaws, and a form of market manipulation or
gaming, all three of those were present in 2000 and 2001 in
California.
On the supply side, people just did not build fast enough,
mostly because the models were all forecasting need in 2001-
2002, so supply was in the works, but it was not to come on-
line until about 2002.
What made things worse was that the economy in California
grew much more rapidly in the late 1990's than anticipated. We
had a return of the California miracle, and we also had new
buildings and new electronic communications in high-tech
industries that had a big surge in demand, so demand was way
up, and people just, quite frankly, missed that fact.
But the most important thing that caused supply and demand
problems in 2000 had to do with the weather. In the West, about
once every 30 years, it is very dry in the north and hot in the
south. Normally, when it is dry in the north, it is cooler in
the south, and when it is wet in the north, it is hot in the
south. This year is a typical year for the West. It is dry in
the north, it has been dry in the north, and it is a cool
summer in California.
All of us, with the exception of that 1 week back in
Sacramento and San Francisco, about 10 days ago, looked at the
numbers and said southern California and most of the Southwest
are much cooler than normal because it is a dry year. That is
the normal condition, this is not just some kind of quirk,
because when you cannot import the hydroelectricity from the
north and it is very hot in the south, and therefore air
conditioning is running, which happened in the year 2000, the
summer and spring of 2000. There was effectively about an 8,000
megawatt hours of shortage created by the weather.
The California market is 40,000 megawatts in peak
conditions, more or less, so 8,000 megawatts is a 20 percent
shortfall. That is the big factor that caused the initial
problem in the spring and summer of 2000. Up to that point, the
California markets were oversupplied and prices under
deregulation were much lower than they had been under
regulation.
In fact, when California deregulated in 1998, there was a
30 percent excess supply, and the pricing the first 2 years of
California deregulation was half of what it had been under
regulation. Everybody was claiming credit for designing this
wonderful system that produced prices half of what they had
been previously, and this was an incredible success story.
But when that weather changed, coupled with not building
the supply fast enough and not forecasting the demand growth
soon enough, those things created the equivalent of the perfect
supply and demand storm, which made prices jump dramatically.
And, in the process, it pointed to the structural design flaw
problems that I also mentioned.
Mr. Winter just talked about one of them. That is the issue
of having no long-term contracts and requiring the utilities to
divest. California was the only market in the world that went
to deregulation with virtually 100 percent of its energy to be
sold in the spot market. Every other part of the world put
maybe 10 or 15 percent of its energy into the commodity or spot
market; California put more than 90 percent.
Today, when California prices are once again stabilized and
low, we have only 10 percent in the spot market. Back in 2000,
we had 90-some-odd percent of all the energy that was in the
spot market, by design. People at the time said that was
foolish, silly to do, but California did it anyway.
Another structural design flaw we had was, we denied the
ability of retail customers to get price signals. This caused
demand to be high until the Governor convinced people there was
an energy emergency, and then he talked people into
conservation. But there were no price signals that anybody in
California paid attention to during 2000. In fact, California
retail prices, except for San Diego, were not raised until
March 2001, well after the height of the energy crisis that
began back in May 2000. So that was a second design flaw.
Mr. Ose. Let me go to Dr. Backus here.
Dr. Backus, do you have anything as it relates to the
interrelationship on this question? Is it an issue of supply?
Is it market structure? Is it lack of conservation?
Dr. Backus. I will always argue that, in a sense, it was
market structure; and actually if we step back a ways, we can
say whenever we design anything from an engineering
perspective, we always include contingency planning and always
stress-test that system before implementing it in the real
world.
Even yet today, for the original and new rules that were
made for the market in California, my guess is that, there has
not been a formal process by which those rules have been tested
on a computer, just as we would on an Apollo spacecraft, to
make sure it can withstand all the things the market is going
to throw at it. That is a major failing of how we look at
determining market structures and deregulation, whether it be
in California or any place in the United States.
Mr. Ose. Dr. Gribik.
Dr. Gribik. I think Dr. Cicchetti gave a masterful summary
of the problems. There are a few things I might add, though.
One, the utilities were forced to buy on the spot markets,
which can be extremely volatile, but then they had to sell to
their customers at a fixed price. The price signals were never
being passed through to the end user, so they had no incentive
to conserve whenever supply got short. Their price was fixed.
And, as Dr. Backus said, it was very foolish, I believe, to
design such a complicated system from scratch with a lot of
different compromises being made, building the systems to
implement it; and only testing to make sure that the systems
talked to each other, you put numbers in and got the numbers
out that you expected. No one sat down and said, let us
simulate the operation of this market. Let us actually have
teams of people play the roles of various market participants
and see how this thing will actually play out, give them
rewards, see what types of strategies people will employ.
If we did that, we might have been able to find some of the
more egregious flaws and fix them before we actually went live
with this. I thought it was rather a bit of insanity to turn
over a multibillion dollar segment of the State's economy to a
market design which essentially was untested.
Mr. Ose. If I might just be so bold, I want to ask you each
a yes or no question. It is dangerous up here.
To those who would contend that this was simply a matter of
supply, my question to each of the witnesses, and I will go
from Dr. Gribik to Mr. Winter--to those who would contend that
this was simply a matter of supply, would you agree or
disagree?
Dr. Gribik. I don't think I would agree with just supply. I
would say no.
Mr. Ose. That is my question.
Dr. Backus.
Dr. Backus. I would say ``no'' with big neon lights on it.
Mr. Ose. Dr. Cicchetti.
Dr. Cicchetti. It was more than supply or a lack of supply.
Mr. Ose. Mr. Winter.
Mr. Winter. More than supply.
Mr. Ose. I want to recognize my friend from Cleveland for
10 minutes.
Mr. Kucinich. I want to thank the Chair for calling this
hearing, and certainly our responsibilities as an oversight
committee become very important when we look at what happened
in California with the manipulation of the energy market. So I
appreciate the Chair's calling the hearing, and I appreciate
the witnesses who are here today.
I have some questions that I would like to ask the
witnesses, and in particular, start with Dr. Backus. If a yes
or no answer would suffice, that would be fine, and we can just
move from there.
Dr. Backus, how many meetings did you or Perot Systems hold
with Enron?
Dr. Backus. Perot Systems held none with Enron. I made two
presentations. The first was to the customers of Enron. It was
in Palm Springs, and I think it was provided on the Perot Web
site. I guess that would have been late 1996, probably late
1996 would be my guess.
Then I also made the same presentation, exactly the same
presentation, to Enron again up at their Portland office. So
both of those presentations are basically just replications of
the WSCC presentation, with some minor updates for the latest
breaking news as to how that presentation in 1996 was playing
out as advertised.
Mr. Kucinich. Who attended these meetings?
Dr. Backus. At the first meeting there were mostly just
several customers there. I didn't keep track of all of them; or
in fact, I kept track of one of the customers, The Northern
California Power Agency, because they later invited me back to
go through the process with their members in that regard.
Certainly there were some executives of Enron there as well. In
fact, one of them--I am trying to remember his name--Rich
Davis, was there, who then invited me out to his organization
out in Portland to make that presentation.
Mr. Kucinich. Do you have any notes of the meetings? Did
you take notes at the meetings?
Dr. Backus. No. I was just making the presentation, coming
in and leaving. I had no notes.
Mr. Kucinich. Did people have any questions at the
meetings?
Dr. Backus. Yes, people were worried this was going to
happen. My answer to them was, yes, most of these things were
going to happen; the problems would occur, the market did have
problems.
For the Enron--originally, as Dr. Gribik has pointed out,
the original Enron meeting was supposed to be a proposal to
Enron similar to that made for Southern California Edison. That
did not take place--about that time, it is my understanding, is
when Perot felt they were going to get the new contract and
therefore really did have a conflict-of-interest problem, and
decided that had to stop.
Mr. Kucinich. Before I came to Congress, I used to do
marketing strategies. I am curious, when you meet with a client
and make a presentation, you mean to tell me, after that
presentation your clients have questions or a prospective
client has a question and you don't take notes on that?
Dr. Backus. In this particular case, no. I knew it could go
nowhere.
Also, in my case, Dr. Gribik and I are sort of what we will
call the technical nerds of this. Certainly in the Perot
process there was the vice president, Ed Smith, who was, I
guess, the worldwide vice president for energy marketing, and
Hemant Lall, I believe the Western States marketing. So that is
the four groups, so certainly the marketing process occurred
elsewhere.
Mr. Kucinich. When you say it would go nowhere, what do you
mean?
Dr. Backus. On my side, all I have is a simulation model
that looks at things at a plant-type level; not even plants or
plant units, it looks at things at a semiannual level, so it is
good for strategic planning. The Portland office is a trading
office. There is absolutely nothing that I know or can do that
relates to that group.
Mr. Kucinich. I am missing something here. You are
acknowledged to be an expert in marketing. You meet with
individuals for some purpose. It is not clear--if you say it
would not go anywhere, why were you meeting with them in the
first place?
Dr. Backus. Because, as noted, I made hundreds of
presentations. I would get paid for those presentations. I was
paid a half-day to simply make the presentation.
Mr. Kucinich. Did you wonder why they wanted you to make a
presentation?
Dr. Backus. No, I did not. Most people did find my
presentation to be quite outrageous, controversial, but it sort
of hit a chord.
Mr. Kucinich. I have not been asking questions for that
long, so I can't say that yet.
Dr. Backus. I am saying that is what I found. Basically,
people were coming back to me and saying, we would like other
people to hear this presentation, because it is a real eye-
opener and will change the way we think about the regulation,
which was actually, in many cases, my function--that I felt
that was something very useful.
Mr. Kucinich. How do people end up looking at it
differently? Does that mean that they suddenly discover that,
hey, there is a game here we can play?
Dr. Backus. I don't think that is the response. People like
to argue that American corporations run on fear and greed. I
like to argue they only run on fear.
Mr. Kucinich. I think there has been evidence in the last
few weeks that we have both of those covered.
Dr. Backus. Not that time--maybe I was naive. Most of those
companies were very afraid of what was going to happen in the
marketplace. I think that is what dominated most of their
concerns.
Mr. Kucinich. You were there to address their fears. Would
you be surprised to learn that you also appealed to their
greed?
Dr. Backus. No, I would not be surprised at all. In fact, I
do believe that Enron--and certainly in those days it was
considered as good a company as any other company in the sense
of its approach to business--also needed to understand that the
old methods of the regulated market no longer applied and that
they had to think differently about how the system would
operate, and that the experience that I had and was telling
everybody about, how the markets worked everywhere, including
indications they were going to work that way in the United
States, that they needed to know that.
Mr. Kucinich. When you were in these meetings, can you
recall whether or not the participants discussed gaming or any
gaming strategies?
Dr. Backus. Certainly they discussed gaming. It is more the
idea of a war story, that almost everybody likes to hear. It
doesn't matter whether you are at the Commission or wherever
you are, they want to hear about what happened in the U.K.
In my regard there, I take it as simply that I was
reporting public information. There was no discussion there to
say, here is a game that you should do and this is going to
make you lots of money. It was merely saying, here is the full
spectrum, and here are all the problems that caused.
Mr. Kucinich. Did you discuss self-created congestion, for
example?
Dr. Backus. That was a line item already in the WSSC 1996
report that I talked about.
Mr. Kucinich. Let's talk about that for a moment. Let us
recreate the discussion. You can be the market strategist and I
will be Enron.
What is this about self-created congestion?
Dr. Backus. I don't think I ever received a question like
that. Note that I am not a market strategist; my work is
designing simulation models. That is my expertise, as an
engineer. So certainly, given that I am a one-person company--
--
Mr. Kucinich. Let us talk for a moment about the simulation
model of self-creating congestion. Tell me about it.
Dr. Backus. All I can tell you is that it exists in the
U.K., it exists in any system, and that all price differentials
in the market occur across congestion.
My own work, just because of your interest----
Mr. Kucinich. Do you want to translate that? Let us say I
am just a person who pays exorbitant electric rates, and I want
to know how that happens, if you want to translate that.
Dr. Backus. If there is an abundant demand on one side of
the transmission line where that load cannot be delivered by
generation on that side, then the plants on the other side of
the transmission line simply cannot deliver, and the price now
must be determined on the side where the demand is, which could
be a very high price, especially in an isolated market. So that
would be what basically causes prices to rise.
Eighty percent of the time the WSSC is one market, and the
price is basically uniform everywhere, and 20 percent of the
time there is usually congestion somewhere, either across the
Rockies, where I am, or on line 15, the north-south----
Mr. Kucinich. The net effect of one of those self-created
congestions is that a company would get paid for moving energy
to relieve congestion without actually moving any energy or
relieving congestion?
Dr. Backus. That is something I had not actually thought
about trying to think----
Mr. Kucinich. Think about it right now. What do you think?
Dr. Backus. The answer to that is, that is correct, but
again that is not the problem. I would argue with the ISO
rules--that if the ISO had the ability to dictate how that
congestion would be relieved, that the ISO was actually part of
the market, those problems could not have occurred.
Mr. Kucinich. Isn't it also a possibility when you are
talking about creating congestion, self-created congestion,
that one effect of such an action would be to create the
appearance of congestion through overstating loads?
Dr. Backus. The answer to that is, yes, but I also have
to--I can go back to the idea that I simply reported that all
these things existed, reported it to everybody that it existed.
For my own work in simulation, I do not have transmission
lines, so I can't really simulate that other than in a broad
sense to think about it. It was merely me trying to tell
everybody that this is a problem that needs to be solved within
the marketplace.
It also is a rather obvious problem, that the prices change
across transmission. So, again, it is not in any way informing
people, especially traders, who know much more about this than
I do, about how this process would work.
Mr. Kucinich. But your awareness of this self-created
congestion--are you aware now that there is a symmetry between
information, according to your testimony, that you presented
and the memorandum that Enron's lawyers wrote about Enron's
gaming activities with respect to their Death Star strategy,
which was where Enron would get paid for moving energy to
relieve congestion without actually moving any energy or
relieving congestion, which you've said can occur, and their
load shift strategy, which is an action to create the
appearance of congestion?
Dr. Backus. Yes. I would say roughly about 40 percent,
maybe more, of the Enron games and memoranda were included in
my presentations. Again, those presentations were presented to
everybody very early on, long before the markets opened, in
fact, and certainly everybody knew about those. They could get
them from the United Kingdom, and therefore the idea was to
make sure that everybody was aware that those problems could be
resolved in the sense that the ISO could certainly develop
rules to prevent those things from happening.
[Clarification of testimony follows:]
[GRAPHIC] [TIFF OMITTED] T7293.152
Mr. Kucinich. So, in your view, you were marketing
knowledge or informing people of knowledge of legal gaming, as
opposed to illegal gaming?
Dr. Backus. I never made that distinction. I was simply
reporting all the things that happened.
Mr. Kucinich. Thank you. Right, that is important to state.
Because in a way, retrospectively, questions, Mr. Chairman,
have been raised about whether or not Enron's activities have,
in fact, constituted a violation of law.
That doesn't mean that you were coaching them to break the
law, but it also represents the possibility that you were
giving them information that they may have taken to create
strategies that ran contrary to the law.
Dr. Backus. I suppose anybody could pick up any textbook on
economics and read the Cournot's duopoly and come up with the
same conclusion.
Mr. Kucinich. It is always helpful to find people who carry
the textbook along and meet with individuals who then break the
law.
Dr. Backus. Which is why we try to talk to all the
commissions and to all the customers, so that everybody knew
that they needed to deal with this problem.
Mr. Ose. I thank the gentleman. Let me ask a couple of
questions here.
Dr. Gribik, it is obvious, if you have possession of the
algorithms and the code that ISO and PX used in their systems,
it would be a competitive advantage in terms of being able to
draw the algorithm out and replicate it accordingly.
Now, my question of you is did you know that CAISO had
computer codes or algorithms?
Dr. Gribik. I did not have any access to the ISO's computer
codes or algorithms, but what I had access to was the public
protocols, the public tariffs, the public problem formulations
that came out of the WPEX process.
Mr. Kucinich. WPEX?
Dr. Gribik. The Western Power Exchange.
Mr. Ose. I just wanted to make sure we got that on the
record.
Dr. Gribik. It was the process that was set up to develop
the initial set of protocols for the ISO and the PX. So I knew
the problem formulations, which were in the public domain.
I had no access to the ISO's computer codes. I didn't know
the algorithms. I believe those were considered proprietary by
ABB and their subcontractors.
Mr. Ose. All right.
Did you have access to any proprietary information? If so,
did you share it with other Perot Systems employees or other
market participants?
Dr. Gribik. During the time we were engaged in these
marketing efforts, I know of no proprietary information that I
had ever received, and I certainly didn't share any with people
outside, since I don't know of any that I would have had.
Mr. Ose. So your analyses and proposals were based entirely
on public information?
Dr. Gribik. Yes. I was reading the public protocols and
trying to decide how people would operate with them, see if I
could find any potential problems that I would alert the ISO
and PX to.
Mr. Ose. So, for instance, if I or any of my colleagues in
Congress had been schooled in this type of analysis, we could
have gone and read the public protocols?
Dr. Gribik. Yes. I think you could have gotten the public
protocols, the documents exchanged in the WPEX process, freely.
You could have seen how the problems were formulated, read it
through; and you would, if you were schooled in the various
fields of mathematics, you would know as much as I would.
Mr. Ose. So you got probability analysis, you have
algorithms, you have all sorts of things. I want to make sure I
understand this very carefully. That is, you are telling me
your analysis was based entirely upon public information?
Dr. Gribik. Yes, it was.
Mr. Ose. All right.
Dr. Backus, the input that you provided, your analysis
provided to whomever your consultants were, was it based on
public information in its entirety, or was there proprietary
information included in your proposals and presentations?
Dr. Backus. There was absolutely no proprietary
information. It was all publicly available, well-known
information.
Mr. Ose. Were there other people who have been schooled in
this particular mathematical skill, that you are aware of, who
are doing similar analyses to what you were doing?
Dr. Backus. No, there was not. Everybody was assuming
everything was perfect, whereas I started off with the position
that things were maybe not so perfect.
Mr. Ose. Dr. Gribik, how about you?
Dr. Gribik. I know at least on one of the problems I
identified and brought to the ISO, there was a problem with how
the real-time market was structured. I went to the ABB
programmers who were developing the software for the real-time
market--and I believe there was an ISO person there at the
time--and outlined the problem I saw in the protocols.
I was told by them that this process--let's see, I think I
notified them around May 1, 1997. I was told by them that this
problem had been identified in the WPEX process, that it had
been discussed, and a solution had been developed for the
problem, but that somehow it fell through the cracks.
It was kind of surprising that whenever--they told me that
they would take care of it, it would be fixed, it was not my
concern. I was surprised in October, October 31, 1997, the ISO
published a new set of protocols. I read them and saw the same
problem was still there.
So I would say, yes, people knew about the problems, but
one of the big problems that was faced was that sometimes they
would fall through the cracks and they would not be addressed.
Mr. Ose. Mr. Winter, one of the things that would be
critical to me as a Californian is whether or not CAISO has
hired such skill to help them protect, prospectively, the
interests of California consumers; in other words, to keep a
constant look at how the market is evolving and how it
interacts with the system that we have in terms of the ability
of people who have had this training either in the marketplace
or in academia, to, in effect, calculate out this question: if
this happens, if that happens?
Does CAISO have that kind of service available to it?
Mr. Winter. Yes. Very clearly, our whole Department of
Market Analysis is made up of Ph.D. economists who--that is
their very role, to watch what is happening in real time,
whether that has market impacts.
We further implemented a market surveillance committee that
is made up of Dr. Wolack and a group of other academics who
then review what is happening in the market, using the data
that our market development or our market analysis people pull
off of real time; so that they constantly monitor the market
and identify any shortfalls that happen.
Now, do we have a computer model that we go into and do
experimental things? No. We tried to develop one of those in
conjunction with some people from Los Alamos, and it is my
understanding that we have not been able to develop one that we
felt was sufficient to actually look at the future.
Mr. Ose. So you have people on staff who are gaming the
system in a protective sense?
Mr. Winter. They certainly are looking at it.
Mr. Ose. In a protective sense, trying to anticipate from
where the attacks are going to come?
Mr. Winter. Right. And as some of the other witnesses have
identified, the whole development was an open process. During
those processes, we would come up and say, well, what about
this? People could do this or could do that.
So we would look at it, and if it appeared to be a major
flaw, then we would correct it. If it was something that would
raise its level to, gee, you had better watch this the first
couple of weeks in the market operation to make sure people are
taking care of it, we looked at those. Some of them, we
recognized very clearly that we did not have the knowledge or
the ability to go outside the State and see what people were
doing on circulating schedules, etc. So we pointed that out to
FERC many times.
Mr. Ose. Now, FERC issued an order, I think in December
1999, regarding the manner in which ISO handled market
congestion.
It asked ISO to implement this particular order, and in the
content of that order, there were a number of things from a
rulemaking standpoint that FERC wanted to see done. Now, this
corresponded quite closely to the period of time during which
the then-existing 26-member board of the CAISO was replaced
with the five-member board of CAISO. It is my understanding
that particular order never was implemented.
Do you have any recollection of that?
Mr. Winter. You know, we have received like 40 orders from
FERC, and I would have to go back and review which one it is.
Mr. Ose. We will followup on that in writing. That is fine.
Now, I just want to go back to the point: You have people
on staff, what we call really smart guys, who sit and they look
at the market and they try and anticipate where the imbalances
might occur, and move the system accordingly to prevent those
imbalances from occurring.
Mr. Winter. Actually, what they are trying to do is look at
market design and see whether or not people are ``gaming the
system,'' and then they look at the real data that is coming in
and identify those areas where we think there is market power
abuse, whether or not when a line goes out, people suddenly
have upped the price, the bidding price, because they said
congestion will be there. They are monitoring all of those
activities.
Mr. Ose. All right. Just for simplicity's sake, I am going
to thank you for putting people on staff to do the anti-game
thing in favor of the California consumer. I do appreciate
that.
Dr. Cicchetti, in your testimony, you state, ``nothing
remotely illegal, unethical, or even questionable about what
Perot Systems did and/or offered to do in California's
markets.''
Following up on Mr. Winter's comments that they even have
people on ISO's staff who look at this stuff, if this kind of
marketing activity that did take place unsuccessfully, is that
unusual? Does it take place in other commodity markets?
Again, if there is a smoking gun here, I am trying to find
it.
Dr. Cicchetti. I think that the idea of trying to teach
utility types of employees about competitive markets and about
how to be armed both offensively and defensively in commodity
markets was an obvious place to try to attempt to offer
services, as I think Dr. Backus and to some extent Perot
Systems attempted to offer this training, because the culture
of those industries was that they were cost-plus engineers; and
there is nothing wrong with that, but that is what they were.
They were not economists or traders. They were not used to
dealing with commodities.
Mr. Ose. You are referring to the type of structure that
they had previously existed?
Dr. Cicchetti. Correct.
Mr. Ose. All right.
Dr. Cicchetti. What happened was, when the California
system was going to go not just to a deregulation market but to
virtually a 100 percent commodity market, some people thought
that it would be a good business to go out and teach people
from this old culture how to participate and be wary of what
could go wrong in this new commodity market.
What happened was that essentially nobody who tried to do
that training got hired because the industry went out and hired
traders from other commodities, thinking that it was easier to
teach people who knew how to trade corn and rice and wheat
about electricity than it was to teach electrical engineers and
people who knew about the electric business in a traditional
sense about commodity markets.
Mr. Ose. Why didn't the investor-owned utilities like PG&E
or Southern California Edison do the same thing?
Dr. Cicchetti. They did. In fact, I think that both the
utilities in California----
Mr. Ose. You say, they did do that?
Dr. Cicchetti. They did do that. They understood trading
needed outside experts.
Mr. Ose. So the investor-owned utilities had their own, so-
to-speak, gaming department?
Dr. Cicchetti. Correct. And, certainly they had a strategy.
In fact, the problems in California, I think, began in terms of
the gaming, if you will, by buyers underscheduling demand in
the day-ahead market of the California Power Exchange to get a
lower price there for buyers, or for consumers, knowing that
they might be paying a higher price in the real-time market
that the ISO ran.
What happened was, after the buyers started that process--
this is something we discovered and reported in the State Audit
Report--that is when the sellers adopted a similar strategy.
What happened was, the real-time market which was supposed to
have maybe 2 or 3 percent of the total energy in the State of
California flow through it, by late 2000, some 35 percent of
all the energy traded in California was going through the CAISO
market. They were having to go out of market, buying power from
other States in the region much beyond the levels that would
normally have been the case. This is where the game of megawatt
laundering was discovered.
None of this--the underscheduling, which was mostly started
by buyers, and megawatt-hour laundering--was something that
anybody would have imagined would have been the natural
evolution of this market back when Perot Systems and Dr. Backus
were offering their services to teach people about what
happened in the U.K. These were purely California problems, and
it was the strategic buying behavior of the utilities in
California that first started both the so-called
``underscheduling issue,'' and then second, the ``megawatt-hour
laundering issue,'' that came about as a result of people
trying to avoid the price cap that emerged, quite foolishly,
only in California, but not in the West.
Mr. Ose. So you are saying in a ``regularly functioning
market'' you would have buyers and sellers taking or doing
offensive and defensive tactics to protect themselves?
Dr. Cicchetti. Correct. And, even the ISO takes offensive
and defensive tactics. They are not quite doing what Mr. Winter
suggested.
Mr. Ose. We just got that on the record.
Dr. Cicchetti. Mr. Winter is suggesting they are playing a
defensive game. I think the ISO even plays an offensive game. I
think they attempted last week on a stage I emergency to get a
lower price cap in effect. The Federal Energy Regulatory
Commission saw that this was at least the result, whether it
was a strategy or just simply a result, and said no, we are not
going to let the price cap fall below the cap that has been
working pretty well since last summer, and restored the cap to
$92.
Mr. Ose. I actually think the problem was when they went to
$57 the supply dried up, so they had to go back to the $92.
Dr. Cicchetti. The fear was that would happen. But I even
doubt whether or not, in my mind, that the $57 was a new result
as opposed to at least the possibility that the CAISO was
involved in gaming the system.
In fact, I was at discussions of the market advisory group
that I serve on, where we discussed just that kind of strategy
and just that kind of opportunity, where the ISO could either
cause prices to go lower in an emergency or take actions to
keep it from going higher in an emergency.
Mr. Ose. Let me just go back for a minute. You are on the
Market Advisory Committee?
Dr. Cicchetti. Of the CAISO, appointed by Governor Davis.
Mr. Ose. Appointed by Governor Davis?
Dr. Cicchetti. Yes.
Mr. Ose. The Market Advisory Committee is discussing how to
game the market?
Dr. Cicchetti. Both how to game it and how to be protected
from gaming the market, yes. This is not some kind of--you
should know that gaming is not some kind of illegal process if
you play within the rules. It is a process that is meant to
understand the rules, play within the rules, and protect
yourself when the rules are going to work against you; and take
advantage when the rules, playing within them, will allow you
to get a benefit.
Mr. Ose. Which brings me to my next question for Dr.
Backus.
Dr. Backus, I am in possession of an e-mail dated May 9,
1997 in which you state that a game to overbook power in the
PX--and again, this is before the market is up, so certainly it
is prospective--you state that a game to overbook power in the
PX could be worth over $50 million to Edison; and I believe you
mean by that Southern California Edison.
Dr. Backus. That is correct.
Mr. Ose. Can you explain the game that you are suggesting
here? You can read it on the screen if you would like.
Dr. Backus. With one eye. Thank you. Yes, that was an
important consideration. We had already very clearly determined
that Edison would go bankrupt, along with PG&E, already at this
very early stage before the markets opened at all.
Mr. Ose. Who is ``we?''
Dr. Backus. Edison and myself, because we had gone through
and looked at what the proposed rules looked like. My analysis
said there is no way this market is going to work, and you are
going to lose a lot of money in a big hurry as soon as supply
and demand get out of balance and prices go up, and you cannot
pass on that price.
Mr. Ose. Edison had at least one consultant telling them
that they were toast?
Dr. Backus. Yes. At least one, but I think multiple people
were already saying that they were toast.
Mr. Ose. You may want to provide me with the names of the
other consultants who were telling them that, too.
Dr. Backus. I will try to think of who those are.
Mr. Ose. Let's go back to my question. Explain this game.
Dr. Backus. The process here is to try to hold off the
marketplace, and also cause a little volatility so everybody
could see that there was a very, very big problem encroaching
on the marketplace, which actually requires a lot of things to
go on, so it actually goes one way and then the other.
So the first logic--and we will go through the sequence, we
already went through some of those--is that we would first
overbook the market dramatically.
Mr. Ose. Overbook it on the day ahead?
Dr. Backus. The day-ahead market. Instead of Edison bidding
in their normal amount, we would bid in much higher than we
would normally bid.
Mr. Ose. Multiples thereof?
Dr. Backus. Multiples? Just merely a fraction. If it was
multiples, it would be the end of life as we know it; just a
small percentage over the amount. So that would actually cause
them to see higher prices in that process, but it would also
scare the generators into feeling that there was now a
shortage; that Edison knew about some load that they did not,
so in all their cleverness they would raise their prices in the
hour ahead and in the imbalance market.
When the time actually came in the imbalance market for
Edison to buy the energy--which would now be very, very
expensive--it actually would sell the energy, and in so doing,
its net average price would be lower than it otherwise would
have been.
This would upset the suppliers.
Mr. Ose. Just a minute. Let us say you have 1,000
megawatts. Southern California said we are going to generate
1,100; and then some private generator over there says, whoa,
what do they know that we don't? So they ramp up----
Dr. Backus. The price to a very large value. I mean, it
might be 100----
Mr. Ose. Then they bid into the hour-ahead market.
Accordingly on the next day, in anticipation of the tight
supply, then all of a sudden, 100 megawatts worth of scheduled
demand goes poof?
Dr. Backus. Actually, it is different than that. In those
days you could sell the demand back into the ISO as if it was
generation, because you essentially own that generation from
the day-ahead market. So you were----
Mr. Ose. So Southern California Edison then puts money in
its pocket for that increment that it sells into the hour-ahead
market?
Dr. Backus. Yes. On that, it only needed the 10,000
megawatts. So therefore the net average price they had to pay
was much less, so it could survive a little bit longer.
Now, this would certainly upset the suppliers. So the next
day, if you would think they were not too clever, you would
grossly underbid and all the suppliers would say, oh, my gosh,
Edison must know there is a storm coming and the market is
useless, we have to keep our plants running, so bid your
minimum cost into the hour-ahead market and into the imbalance
market just to keep our plants running, because we cannot stand
to shut down nukes and coal plants.
So now Edison, when it finally comes to be the day ahead,
really does demand a lot of energy, but the price is low so
they are still better off.
Mr. Ose. So the rules of the marketplace allowed this
phantom demand to be entered into the market?
Dr. Backus. There was the hope that was the case. It was on
the books. To my understanding, Edison then went to the general
counsel who then went to the CPUC, and the answer was no, they
would not allow that.
Mr. Ose. You went to whom?
Dr. Backus. The general counsel of Southern California
Edison.
Mr. Ose. Whose name is?
Dr. Backus. I think it was Mr. Forney at that time, I don't
remember his first name, or somebody in his group.
They went to the CPUC to ask whether this would be a
legitimate process, or do we have to actually bid in, as Dr.
Gribik pointed out, the 90 percent into the PX market and
another 3 into the day-ahead, and the rest of the imbalance or
whatever the numbers are, whether they could actually make this
a variable number to try to prevent prices from going up. They
would not go bankrupt and not see these huge prices on the
marketplace.
My understanding is that the answer came back that no, the
CPUC would look disfavorably at that. So Edison--and actually I
had managers who were ready to cry, saying it really is
hopeless for us.
Mr. Ose. So this request of the CPUC was made between May
9, 1997 and March 31, 1998?
Dr. Backus. Yes.
Mr. Ose. Do you know to whom the request was made at the
CPUC?
Dr. Backus. No. When I brought up the process they said we
will check on it, and several months later I heard back to say
they would not go forward.
Mr. Ose. How many months later?
Dr. Backus. It could have been after the markets started. I
simply don't remember the concept of what the timing was. I
just know they said that they would check it out. They came
back later at a visit I had taken there and said, by the way,
it was not allowed, so therefore we are in bad shape.
Mr. Ose. At that point, the Edison people with whom you
were working----
Dr. Backus. Their strategy then became--which is the
strategy I believe they pursued--they said, our only hope is to
become the perfect victim; that is, we will do nothing to
defend ourselves, we will do nothing on offense, we will just
simply ride this through and hope that California bails us out
when all this is said and done.
Mr. Ose. If I understand you correctly, Edison took the
precaution of hiring consultants who would help them, from a
financially defensive standpoint, game the system for
protective purposes; and then the California Public Utility
Commission said, that is all great, but you can't do that?
Dr. Backus. That is correct. In fact, I understand--and
maybe Dr. Gribik has more examples of this, of many other cases
where perfectly legitimate gaming processes were proposed--and
the statement was, no, you will follow the rules this way.
Mr. Ose. The CPUC not only prevented investor-owned
utilities from entering into the forward contract market after
August 1999, but then they also basically emasculated them in
terms of defending themselves financially by reversing the game
on the guys who were just hammering them?
Dr. Backus. Yes. In fact, I always called it the wolf,
because you always knew every day--the generator always knew
exactly how much demand was going to go on the day-ahead market
and can do whatever they wanted to stop them.
Mr. Ose. This was a function of the rules and regulations
under which the ISO market operated, or the PX market operated?
Dr. Backus. Now it gets to be a little more complicated,
because you could have designed different rules, like allow a
forward market----
Mr. Ose. My next question was, was anything ever done to
fix that? I may direct that to Mr. Winter.
Dr. Backus. To my knowledge, nothing. Certainly, again,
starting very early, we were showing all sorts of problems. Dr.
Gribik was trying to show problems. Many of those problems were
already obvious almost immediately when the market opened.
To my knowledge, nobody was fixing the problem. I mean,
that my yelling and screaming when I went everywhere to
commissions, hundreds of presentations, to try to wave the flag
to say these are big problems, you should fix them. It is all
right to make mistakes, but the bigger problem is when you
don't fix them. That is what was going on in California.
Mr. Ose. It is your testimony between May 9, 1997 and March
31, 1998, Edison knew they were going to get hammered? They had
figured it out?
Dr. Backus. Yes. So did PG&E. My closing remark to PG&E
was, ``In 4 years you will be bankrupt,'' which was not a very
good selling pitch, but nevertheless that was the truth.
Mr. Ose. Mr. Winter, your perspective, please.
Mr. Winter. Well, certainly I am not aware of any
activities between Edison and PG&E and the PUC. I would not be
privy do that.
I guess I am a little curious. The first 2 years we very
clearly saw a market that was extremely beneficial to the
investor-owned utilities. They certainly made back a large
portion of their stranded costs during that timeframe. So in
the beginning, even though we were monitoring the market and
were aware of some of these programs or games, if you will,
they obviously were not being played to any extent.
As other people pointed out, clearly when we started
getting into the demand and supply preliminaries is when things
took off and became very unstable.
I guess beyond that, I am not too clear on exactly what was
being proposed and what was not being proposed.
Mr. Ose. Dr. Cicchetti.
Dr. Cicchetti. Dr. Backus talked about one of the things
that the CPUC said could not be done, which was the game that
was a complicated game, where you would overschedule in the
day-ahead market so as to create conditions of instability in
the real-time energy imbalance, or CAISO market, and to be able
to make money as a utility trading.
The CPUC--and it is my understanding that it agrees with
Dr. Backus--said, ``no, you can't do this.'' But the CPUC
didn't stop the utilities in California from underscheduling,
as opposed to overscheduling, in the day-ahead market.
And, in fact, it was the underscheduling of the utilities
in terms of saying they wanted to buy less than they really
needed in the day-ahead market that caused this incredible
shift of the energy supply in California onto the backs of the
CAISO, which had the responsibility in real time to make
certain that there would be sufficient power that caused them
to go out of State, out of market, out of sequence, and to do
literally anything that it took to keep the lights on.
It was when that happened, in conjunction with the supply
demand imbalance or gap, if you will, that things literally in
November or December 2000 went absolutely into these chaotic
prices that we are all aware of, when the price of electricity
jumped from the level it had been in 1999 of $25, I think
Congressman Waxman said, to over $1,000.
It was this strategy of gaming on behalf of the buyers,
followed then by a matched strategy on the part of the sellers,
that shifted the burden onto the California Independent System
Operator. And I think the numbers were in December 2000 for the
CAISO to have to meet 35 percent of the total energy
requirements of California, when it was designed to be about
maybe 2 or 3 percent on the extreme, and certainly not anything
like the 35 percent the CAISO had to find the ability to go out
and acquire the electricity for California.
This, of course, also set up--because of price caps put
into effect in that same period in the CAISO market only for
California market participants--this caused the so-called
megawatt hour laundering practices to begin where either the
municipal utilities in California or out-of-State entities
could either buy power or take their power that they would have
otherwise sold to the CAISO, but to sell it roundabout back
into the State at a much higher price and avoid those price
caps.
Both of these problems are things that in the State Audit
Report we pointed to: the underscheduling and the megawatt hour
laundering. Eventually the Federal Energy Regulatory Commission
went ahead and took steps to prevent those kinds of things from
happening.
They continue to take steps, as recently as this week at
the Federal Energy Regulatory Commission, to modify the rules,
now having a restriction on a single bid price, which the CAISO
proposed as to get around the kind of gaming between markets
that we saw back in 2000.
So it is like a train wreck that occurred in 2000 in the
California energy market. Many things have been fixed. It is
not safe to say there will never be another train wreck, but
many of the things that were done in 2000 and in 2001 are now
prohibited by the actions of the Federal Energy Regulatory
Commission; after the fact, to be sure. But this is
preventative in terms of keeping things that happened as they
occurred back then from happening again. You can't megawatt
hour launder, you can't game the system through bidding between
markets or different prices between markets. There are
penalties for underscheduling that have some bite in them, and
there are prohibitions against the so-called overloading
congestion lines that are associated with Enron.
These are fixes that have been made, but the fundamental
problems are still potentially present, except for the fact
that now the market is mostly a long-term market and less
volatile, because so much of the energy is under a long-term
contract.
Mr. Ose. Dr. Cicchetti, in your opinion, had the California
Public Utilities Commission allowed the investor-owned
utilities to enter into long-term contracts, pursuant to their
requests in August 1999, would our difficulties ever have
arisen?
Dr. Cicchetti. There would have been high prices because of
supply and demand conditions, just as there was in the Midwest
in 1999. But the Midwest, when they had the high prices in
1999, had about 85 percent or so of the energy that was under
long-term contract, or owned by the midwestern utilities.
Therefore the high prices, when they flew up, only affected 10
to 15 percent of the market. They got the same headlines as
California, but they did not cause the same damage in terms of
bankrupting the utilities or causing the States in the Midwest
to have to come in and buy the power.
Mr. Ose. Your point is not only the ability of the long-
term contract, but that portion of the total portfolio that had
to be purchased in the day ahead market?
Dr. Cicchetti. Exactly. That is the thing that eventually
caused California as a State to step up and sign both the
purchase contracts as well as enter into its own long-term
contracts. Because unlike the utilities, California as a State
was able to enter into long-term contracts beginning, as they
did, in February or March or so of 2001.
Mr. Ose. I want to be clear; Mr. Winter, neither of those
decisions or rules are jurisdictional to ISO? Those are both
PUC regulations?
Mr. Winter. That is correct.
Mr. Ose. All right.
Dr. Gribik, in your opening statement you mentioned that on
several occasions you brought market design flaws to the
attention of the ISO and the PX. According to what you have
given us, you alerted ABB of a design flaw in the real-time
market in early May 1997. I have a document, document No. 11.
And then, when you noticed the problem had not yet been
fixed, you made a November 7, 1997 presentation to the ISO
explaining the flaw, and that is document No. 12.
[The information referred to follows:]
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Mr. Ose. Can you explain the nature of this problem and the
steps that led to it being fixed?
Dr. Gribik. OK. The problem was a flaw in the ISO's real-
time market protocol. At a high level, the flaw, a generator to
place unscheduled power on--into the ISO's real-time market, it
would start dumping power in. And, it could submit some bids to
buy back power, which would in effect cause the real-time
market price to go to whatever level that participant desired.
So it could pump power into the ISO's real-time market and
simultaneously set the price that would be paid for that power
to any level.
As I said in the testimony, I alerted the ISO and ABB
programmers to this in the beginning of May 1997. They told me
that this process was known or this problem was known. They had
discussed it in the WEPEX process. They had a way to fix it;
that somehow it just fell through the cracks, they would take
care of it.
At the end of October 1997, I was at that time providing
consulting services to PX, and I read the ISO's protocols and
saw that the problem still was there. I alerted Jim Kritikson,
who was then director of scheduling at the Power Exchange,
about this problem and devised an example to show how serious
this flaw could be. In essence, I showed him a strategy a
market player could use to dump power and simultaneously set
the price.
He had me explain it to the CEO and the president of the
Power Exchange, and they instructed us to go to the ISO and
inform him of the Power Exchange's concern. We went up, gave
them a presentation where we outlined the problem, outlined the
strategy. I believe the ISO recognized the seriousness of the
problem, and I believe they took it to their market participant
process, because I received calls afterwards from several
market participants asking me to explain the problem. And, the
ISO fixed the problem by, in essence, adjusting the bid prices
that people would submit to prevent the problem from occurring
before the market opened. So it was patched well before the
market opened.
Mr. Ose. OK. And the market opened, again, on?
Dr. Gribik. April 1, 1998.
Mr. Ose. April 1, 1998. And, you had this fixed roughly by
the end of December 1997.
Dr. Gribik. I believe they had it fixed by December 1997.
Mr. Ose. Mr. Winter, my compliments.
Mr. Winter. Thank you.
Mr. Ose. Now, Dr. Gribik, you also noticed a problem with
transmission congestion pricing. And, on--according to my
information, on January 30, 1998, you brought that problem to
the attention of Jim Kritikson at the PX, who instructed you
again to contact the ISO. That's document No. 13 on the screen
right now.
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Dr. Gribik. Yes, sir.
Mr. Ose. Now, who is Jim Kritikson?
Dr. Gribik. Jim Kritikson was director of scheduling for
the Power Exchange, and he was the Power Exchange person
responsible for--basically, did oversight of the work that the
Perot Systems was doing for the Power Exchange.
And, see, the problem in this case was the way that the ISO
was going to set what they call default usage charges. The
problem could have caused high prices and adversely affected
reliability in the ISO's system.
In essence, to explain this in detail would take several
hours, but I will try to give you a very highlighted----
Mr. Ose. Abbreviated, please.
Dr. Gribik. Yes. Unfortunately, this stuff gets very
convoluted.
Roughly, the ISO allocates--or scheduling coordinators
submit schedules to the ISO. The ISO checks to see if it can
accommodate those schedules without overloading any of the
transmission elements. If any transmission elements are
overloaded, it allocates transmission to the scheduling
coordinators who place the highest value on using the
transmission as indicated by bids that they submit. The ISO
allocates the transmission to the highest volume use first, the
next highest, and so on, and at the end it sets the price for
using the transmission to the value set by the last person that
gets on.
The problem is that people do not have to submit bids for
using the transmission. They could say, ``I'm willing to pay
anything to use them.'' Now, if the ISO runs out of bids to
manage the transmission based on economics, it will allocate
pro rata the transmission to those who did not submit bids, who
in essence said, ``I will pay anything to use it.'' It still
has to, however, charge them for using the transmission. The
ISO protocols as of October 31, 1997, said that they were going
to pick the usage charge, in this case the default usage
charge, when they ran out of economic bids by looking at the
price for power in yesterday's real-time market, and they would
set the usage charge equal to yesterday real-time market price.
What I pointed out to Mr. Kriticzen is if yesterday real-
time market price was very low, say, $1 per megawatt--which
could happen; in fact, sometimes it was zero--you have
destroyed any incentive for people who value the path more than
$1 to submit a bid, because why would I bid to use the path at
$10 whenever I may be taken off and it is given to somebody
else for $1? In essence, it becomes a free-for-all. Everyone
comes rushing in to submit the schedules to use transmission.
They will not give you adjustment bids, because why should they
bid to use it when they say, ``I'll pay anything; I only pay
$1?''
Mr. Ose. You're saying that drove the price to zero?
Whatever the situation, it would drive the price to zero
because the guys who needed the transmission figured it out.
Dr. Gribik. Yeah. They'd figure it out and say, ``Hey, I'm
looking at yesterday's price; it's only $1. I will just
overload this transmission line, knowing that I will only be
charged $1.''
Mr. Ose. Right.
Dr. Gribik. And, because it was pro rata allocation, they
would even have incentive to bid to use more.
Mr. Ose. Now, if I understand what you did, working with
Kritikson first and then the ISO, you were able to fix this
problem?
Dr. Gribik. Yes. Jim Kritikson told me to take it to the
ISO stakeholder process. There were a series of conference
calls and meetings, I believe, that the ISO was holding on the
congestion management process, and at those meetings and
conference calls I raised this issue and said that you cannot
set the price for using transmission today using yesterday's
energy price. It was a hard sell to people, because, in
essence, I was trying to tell them----
Mr. Ose. They had to pay.
Dr. Gribik [continuing]. You should be willing to pay more.
Mr. Ose. Right.
Dr. Gribik. No one wants to hear that.
Mr. Ose. But, in effect, at the end of the day prior to the
March 31 operational date, this issue got fixed.
Dr. Gribik. Yes. The ISO submitted two amendments to its
tariff, I think amendments 4 and 6, which alleviated the
problem.
Mr. Ose. All right. Now, on April 9, 1998--first of all,
let me go back and say, Mr. Winter, my compliments on fixing
it, again.
In the April 9, 1998, memo from you to Fred Mobasheri, you
discussed the need for market surveillance capabilities at the
PX. Now, we have talked about market surveillance capabilities
that exist at the ISO. Document 14 is on the screen, I believe.
Who is Fred Mobasheri?
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Dr. Gribik. Fred Mobasheri was the manager of the market
moderating unit at the Power Exchange; in essence, the sister
organization to the market surveillance unit at the ISO.
Mr. Ose. Was the PX vulnerable to being gamed by market
participants?
Dr. Gribik. Well, I would say that anyone out there was
going to start developing strategies to try to defend
themselves, and also to take advantage of the rules where
possible. What I was concerned about, because I had found these
flaws sitting on the surface of the ISO and PX protocols
whereby a single participant could have destabilized the
markets, I was concerned that there might be more of these
floating around out there, and I was recommending to Dr.
Mobasheri that the PX should set up a team that would
proactively seek out those types of flaws, identify them,
identify the types of strategies people might make, figure out
what the markers were that you could detect when somebody was
using them, and either, if they could, change their protocol so
those things could not be employed, or at the very least start
looking for the markers whenever inappropriate behavior was
being done so that they could take action.
Mr. Ose. So you gamed the system on behalf of the PX,
purely in a theoretical manner.
Dr. Gribik. I was recommending----
Mr. Ose. Actually, at that point it would not have been
theoretical; it was post-April 1st.
Dr. Gribik. Yes.
Mr. Ose. So you gamed the system, sent a memo to Mobasheri.
Did the PX take your advice?
Dr. Gribik. Nothing came of it. They did have a market
moderating unit. My estimation was that they were more in a
reactive mode than a proactive mode; that they were reacting to
what they saw in the market rather than trying to get ahead of
the participants to patch holes before people used them.
Mr. Ose. Let me move on in the interest of time here. I do
appreciate your attempts at trying to fix these holes.
Mr. Winter, I have to admit to some serious concern about
the revelations laid out in the Enron memos, you know, about
Fat Boy and Ricochet and all this other stuff, and yet I am
trying to determine whether or not those practices were illegal
at the time they were done. Were they illegal at the time they
were done?
Mr. Winter. Well, this is going to sound evasive. I'm not
an attorney and really can't determine the legality, but having
said that, certainly if you come in and tell someone that you
are providing firm power, and then you are not providing firm
power, I would call that somewhat illegal and violates WSCC
criteria. I think if you say that you have got a unit that is
available to run, and I am going to provide you 1,000
megawatts, and then you find out the unit's been broken and was
never able to run, I think that is totally--I wouldn't--I don't
know that I would say illegal, but certainly not--not something
that you could do.
I think as far as arbitraging between markets, that is
something that clearly was permitted, and if you have
sufficient infrastructure, transmission, and generation, that
is exactly what you want the market to do, because it will then
find its equilibrium, and the markets will then become very
efficient as you use those.
But I think to say whether or not they were illegal, I
would refer you to my appendix 2 of my testimony where we went
through each of them and explained, you know, what the practice
was, what we had done about it, and whether or not it was
prohibited by our market monitoring rules.
Mr. Ose. Do the rules prevent it now? Let me rephrase the
question.
Can California's consumers be comfortable with the nature
of the market now being such as to prevent such gaming?
Mr. Winter. Well, clearly we came out with five points,
five of the practices, and sent out a market notice saying that
these were illegal and people should not practice. And, again,
you can read those in my testimony.
As far as the others, we have been very concerned about
activities that happen outside the State because we don't have
visibility to that. I think FERC's recent decision has gone a
long ways to correct that.
Mr. Ose. They must offer.
Mr. Winter. Must offer the maximum bid cap at 250. They are
on an automated program that kicks in if you suddenly spike
your bid prices. I think these go a long ways to protect it.
Now, if I have learned anything in the last 4 years, it's
no matter what kind of rule you come up with, there are very
clever people who try to find ways around that and often do. So
I can't stand here and just absolutely give you assurance that
it would never happen again, but I think there has been enough
attention on it that if we saw something in the marketplace
that was clearly out of line, we would get the action of FERC
and those others very quickly.
Mr. Ose. Gentlemen, I need to confer with my counsel here
for a couple minutes. We are going to take a 2-minute recess.
[Recess.]
Mr. Ose. When Dr. Backus comes in, we will just go ahead
and proceed accordingly.
Mr. Winter, one of the things I keep coming back to is the
confidence that the California consumer can have as to whether
or not market participants are, in effect, unethically or
illegally gaming the system, what measures are being taken by
the appropriate government entity to protect the California
consumers from that, and then the range of who is participating
in this. I do want to ask you for an update on the issue having
to do with, I believe, one of ISO's people on the floor.
Let me just state my question here. In July 2001, a
conversation took place between one of ISO's employees and an
Enron trader in which the employee asked the Enron trader to
submit a specific bid. This employee was fired, and an
investigation was ordered. I would like to know the status of
that investigation.
Mr. Winter. OK. When we learned through documents that
Senator Dunn had gathered, we found reference to a person who
was on the floor that had had a conversation with an Enron
employee. We reviewed that. First, I think we got that
information on a Friday. We hired an independent law firm to
come in and do an investigation for us. In the meantime, we
talked to the employee. He admitted that he had done it. It was
clearly in violation of our code of conduct, and so we
terminated him.
The investigation then went on, and the law firm had
reviewed both vertically and horizontally different members of
the corporation, different schedulers, the chain of command,
and found out that this did appear. And that is the finding of
the report, that this was one individual's action, and it was
not widespread throughout the corporation.
That report has been completed and given to our board, and
that's the status of it. And, Senator Dunn has also been
informed.
Mr. Ose. Two questions. Can I get a copy of the report at
the conclusion of the investigation?
Mr. Winter. Yes. It was a confidential report since it
dealt with personnel but I don't see why you could not get it.
Mr. Ose. I do appreciate that.
The second question: You used the phrase that these were
not widespread practices. I mean, there is just one person?
Mr. Winter. Just one person.
Mr. Ose. So they are very unique to this person?
Mr. Winter. Yes, it was.
Mr. Ose. According to the investigation. OK. So it is not
widespread.
Mr. Winter. Not at all.
Mr. Ose. All right.
Dr. Cicchetti, the new rules on trading practices that the
ISO has adopted, do you believe these will be successful?
Dr. Cicchetti. I think that they will be successful in
terms of eliminating the pricing gaming between markets. But
two other things that the Federal Energy Regulatory Commission
has started were also necessary. The first is the Federal
Energy Regulatory Commission has effectively ordered the ISO to
develop nodal pricing so that the kind of congestion gaming
that has received so much attention today and as part of the
Enron memo wouldn't be one of the games that could be played,
because nodal pricing would effectively replace the kind of
congestion path pricing or valuation that's in the current
tariff.
And, the second thing that the Federal Energy Regulatory
Commission has ordered is to change the CAISO board to make it
an independent board. The current board is a political board.
There is no other way around it. I don't think that's
particularly a problem or has been a particular problem that's
caused gaming. But the old stakeholder boards, both of the
CAISO and the CPX, in the work I did for the State Audit Bureau
as well as the Federal Energy Regulatory Commission's own
review, we both found that the market monitoring committees and
staff of both the CAISO and the California Power Exchange
reported problems, and the process of getting those problems
reported and then out to Federal Energy Regulatory Commission,
so as to fix the problems, was stalled by the stakeholder board
process.
And so, the independent boards are an important part of
restoring faith, which is an important part of any commodity
market; that is, policing markets is an important function--
that those policing activities of the staffs of both in the
case of the CPX, which no longer really exists, but in the case
of the CAISO, very excellent staff, so that material gets out
and in the hands of the Federal Energy Regulatory Commission
sooner rather than later.
And now, to complete the process I think the Federal Energy
Regulatory Commission this past week has ordered California to
develop a purely independent board, not a stakeholder board,
not a Governor appointee board, but one that is purely
independent, and that will help restore some of the market
confidence along with the new locational nodal pricing that
will be put into effect.
Mr. Ose. Thank you, Doctor.
Let me follow on, if I may. We have had a large debate
about a regional transmission organization, whether California
should or should not participate. What is your opinion on that
issue?
Dr. Cicchetti. Personally I think that a regional
transmission organization for the West makes a great deal of
sense. In fact, we saw problems that occurred through megawatt-
hour laundering, Ricochet, whatever you want to call it,
because we had essentially a two-tier market. That's been fixed
to some extent by the fact that the Federal Energy Regulatory
Commission came up with a Western States price cap. But,
fundamentally, I think we have to do more than that because we
have to deal with the congestion problem for transmission that
exists throughout the entire West, not just in California.
The problem is that, given California's terrible crisis in
2000 and 2001, not very many other Western States want to
partner or participate in a regional transmission organization
with California. So, while I think it is the right way to go,
it is the right model, it is ultimately going to be necessary;
I think that it is probably more likely that the Southwest and
then the Pacific Northwest will form their own RTOs eventually
to be merged together, as well as to be merged with California.
But for the short term I think California has to continue
to do what it has been doing, which is to regain stability and
see the return of competition and lower prices, as we have been
seeing in the past 12 months or so. But we need probably a bit
more time to convince the neighboring States to go along with
an RTO that would include California, unless somehow or another
Congress orders such a thing to happen, which I don't see
happening.
Mr. Ose. Thank you. I have a couple more very specific
questions.
Mr. Winter, down in the San Diego area, there is some
debate as to whether or not to build a transmission line north/
south linking the San Diego market to Southern California
Edison. Are you positive toward that, ambivalent? Are you
negative toward it? What is your perspective?
Mr. Winter. I'm extremely positive toward it, but it is
just first a small link in what we need to do. It is called the
Valley Rainbow 500 Interconnection from northern San Diego up
to a valley substation in the Los Angeles area. Now--but what
we need to do is then complete the next link of that, which is
Rainbow to Miguel, which brings us next to the Mexican border.
Right now we are seeing about 1,000 megawatts plus being
developed in Mexico, and the way that is going to get into the
entire grid is up through San Diego. So we have got to add to
the infrastructure in that area as well as Path 15 to allow the
north/south transfer of large blocks of energy out of the
Southwest and Northwest.
Mr. Ose. I will tell you for a fact that most of the
California delegation is very supportive of Path 15, working
through the Bureau and others. Can you give us some sense of
the status of the negotiations on that, given the different
stakeholders?
Mr. Winter. It is my understanding that there are actually
two proposals, one before the Public Utility Commission that
would have PG&E build the entire line. In the other one, the
Western Area Power Authority would be the Federal agency that
would build it, and an independent transmission company would
provide about 85 percent of the money, with the remainder
coming from PG&E. And, both of those proposals are moving
ahead. As to which one is going to win, I don't know at this
time.
Mr. Ose. But both are integral to solving the transmission
problem?
Mr. Winter. Yes, sir.
Mr. Ose. All right.
Mr. Winter. Either one of them would do it.
Mr. Ose. All right. I want to summarize here. I just want
to be clear. I heard all four of you say you don't know of any
nonpublic information that Perot or--some of you actually
testified you had not used it. Do any of you know of any
nonpublic information that was used in the presentations to
various parties about the structure of the ISO market?
Mr. Winter.
Mr. Winter. I certainly am not aware of any. However, all I
saw was what I had been provided at this point.
Mr. Ose. All right. Dr. Cicchetti.
Dr. Cicchetti. No. And I will only add to what Mr. Winter
said by pointing out that I found some of the identical
material being used in the Perot Systems that the CAISO, or the
California Independent System Operator, uses in its own
training materials.
Mr. Ose. All right.
Dr. Backus, you've testified that you didn't have any
nonpublic information that you used in your presentation.
Dr. Backus. All I knew is the public information. That's
all that could be contained within the presentations.
Mr. Ose. And, Dr. Gribik, your testimony was consistent
with that?
Dr. Gribik. Yes. Used absolutely no proprietary
information.
Mr. Ose. All right, gentlemen. First of all, I want to
thank you all for coming. One of the things we struggle with
back here is, frankly, getting to the bottom of it without a
lot of hue and cry. We have a continuing problem in our State
about supply of energy and the ability to obtain energy at
reasonable prices. Frankly, I can understand why Mr. Winter and
his colleagues at the ISO were upset when they learned what
possibly Perot System was doing. I have to applaud your logical
means of resolving that, where you actually sat down and
communicated to each other your concerns, worked it out.
Frankly, based on the testimony today and the documents we have
received to date, I am at a bit of a loss to explain all the
allegations I am familiar with.
The other aspect of this that I think is germane is that,
No. 1, the work that Perot Systems did took place prior to the
market opening, and then that which they tried to do with what
is alleged to be nonpublic information, nobody bought. I mean,
I just don't understand this. Maybe I'm missing something.
Based on the information we have today, I just am afraid we
have used 2\1/2\ hours for little purpose.
Now, the other things I want you to understand is that to
the extent, Mr. Winter, that you or, Dr. Cicchetti, your
colleagues on the market committee can continue to use gaming
theory to protect California's consumers, I want to encourage
you to do that. I just think it's great for California's
consumers to have that as a defensive effort. I don't know how
you massage this thing with the CPUC who says, well, you can
have some tools, but you can't have others, even though you
know your competitors have them to stick it to you.
This market design issue is going to stay with us. I know
it is going to evolve over time. I look forward to working with
all four of you as we try and address these things in an
evolutionary fashion.
Again, I thank you for coming today. I appreciate your
testimony. We are adjourned.
[Whereupon, at 4:32 p.m., the subcommittee was adjourned.]
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