<DOC>
[107th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:82667.wais]
CALIFORNIA INDEPENDENT SYSTEM OPERATOR: GOVERNANCE AND DESIGN OF
CALIFORNIA'S ELECTRICITY MARKET
=======================================================================
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
__________
FEBRUARY 22, 2002
__________
Serial No. 107-133
__________
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
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____________________________________________________________________________
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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
------ ------ (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
------ ------
Ex Officio
DAN BURTON, Indiana HENRY A. WAXMAN, California
Dan Skopec, Staff Director
Allison Freeman, Clerk
C O N T E N T S
----------
Page
Hearing held on February 22, 2002................................ 1
Statement of:
Wood, Patrick, III, chairman, Federal Energy Regulatory
Commission; Terry Winter, president and chief executive
officer, California Independent Systems Operator; Richard
A. Drom, vice president, general counsel, PJM
Interconnection, L.L.C.; James C. Feider, president,
California Municipal Utilities Association; Jan Smutny-
Jones, executive director, Independent Energy Producers;
and Walter P. Drabinski, president, Vantage Consulting,
Inc........................................................ 28
Wright, Roderick D., chairman, California State Assembly
Committee on Utilities & Commerce; and Anthony Pescetti,
vice chairman, California State Assembly Committee on
Utilities & Commerce....................................... 6
Letters, statements, etc., submitted for the record by:
Drabinski, Walter P., president, Vantage Consulting, Inc.,
prepared statement of...................................... 132
Drom, Richard A., vice president, general counsel, PJM
Interconnection, L.L.C., prepared statement of............. 98
Feider, James C., president, California Municipal Utilities
Association, prepared statement of......................... 110
Ose, Hon. Doug, a Representative in Congress from the State
of California:
Chart on ISO and RTO Independence Traits................. 159
Prepared statement of.................................... 4
Pescetti, Anthony, vice chairman, California State Assembly
Committee on Utilities & Commerce, prepared statement of... 14
Smutny-Jones, Jan, executive director, Independent Energy
Producers, prepared statement of........................... 119
Winter, Terry, president and chief executive officer,
California Independent Systems Operator, prepared statement
of......................................................... 47
Wood, Patrick, III, chairman, Federal Energy Regulatory
Commission, prepared statement of.......................... 30
CALIFORNIA INDEPENDENT SYSTEM OPERATOR: GOVERNANCE AND DESIGN OF
CALIFORNIA'S ELECTRICITY MARKET
----------
FRIDAY, FEBRUARY 22, 2002
House of Representatives,
Subcommittee on Energy Policy, Natural Resources
and Regulatory Affairs,
Committee on Government Reform,
Sacramento, CA.
The subcommittee met, pursuant to notice, at 9 a.m., in
room 1450, Sacramento Board of Supervisors, 700 H Street,
Sacramento, CA, Hon. Doug Ose (chairman of the subcommittee)
presiding.
Present: Representative Ose.
Staff present: Dan Skopec, staff director; Yier Shi, press
secretary; and Allison Freeman, clerk.
Mr. Ose. Good morning, everybody. I want to welcome you to
this hearing before the House Committee on Government Reform,
Subcommittee on Energy Policy, Natural Resources and Regulatory
Affairs. I apologize for starting 4 minutes late.
The way these things work is, we'll have some opening
statements and we'll get to questions, we'll welcome our
witnesses before the questions and their statements. Everybody
in these hearings gets sworn in under the Government Reform
Committee's normal policies, so if we don't swear you in,
remind us, we'll swear you in.
Californians are well aware that in 2000 and 2001 our State
experienced an energy crisis that impacted every citizen in the
State. Some Californians experienced blackouts. Others were
asked to curtail energy use at key moments. All Californians
saw huge increases in their natural gas and electricity bills.
However, through the help of the FERC, the Federal Energy
Regulatory Commission, through its adoption of a market
mitigation plan, with the advantage of a cool summer, as well
as normal precipitation in the West, particularly in the
Pacific Northwest, and with conservation efforts by individual
Californians, energy prices have now dropped back to expected
levels and are far more affordable.
The energy crisis seems to have disappeared as quickly as
it emerged. Given the empirical data, many people could come to
that conclusion easily, and I can understand that. The fact of
the matter is, energy prices are low and the lights are on.
That's pretty good. Why are we having this hearing? What's the
problem?
The reality is that California is not out of the woods yet.
Today's witnesses will tell you that the fundamental factors
that exacerbated the energy crisis are still with us today.
California lacks an adequate energy supply. Our transmission
system is old and overburdened, and, most importantly, the
structure of the electricity market is dysfunctional. The
market suffers from inefficiencies in terms of pricing,
transparency, transmission, and settlement policies.
California must take action now to address these problems.
If we don't, once the economy revives or we experience a hot
summer or suffer another drought, we'll be confronting
potential blackouts and prices will escalate again. Frankly,
for a State facing significant budget deficits, we can ill
afford another energy calamity.
At today's hearing, we will discuss the steps that
California needs to take to reform its electricity markets and
ensure the public that their lights will stay on and their
businesses will keep running.
First and foremost in this endeavor is restoring
independence to the California Independent System Operator. On
January 17, 2001, the Governor dissolved the original Board of
Governors of the CAISO and hand picked a new board answerable
only to him. In doing so, Governor Davis violated FERC's orders
of November 1 and December 15, 2000, which called for the
establishment of a new board of Governors. The Davis-appointed
board also violated FERC's groundbreaking Order 2000, which
clearly states that Independent System Operators must be
independent of all market participants. As the largest
purchaser of electricity, the State of California certainly
qualifies as a market participant.
In previous hearings before this subcommittee, we heard
testimony from FERC's former General Counsel claiming that
independence of the board was a ``linchpin'' of a properly
functioning electricity market. Phillip Harris, the president
and chief executive officer of the Pennsylvania, New Jersey,
Maryland Interconnection, known as PJM, called independence of
an ISO ``absolutely crucial.'' In that hearing and in
subsequent letters to FERC, I strongly criticized the makeup of
the Governor's board. I continue to strongly criticize the
makeup of the Governor's board, and I've called on FERC to do
an operational audit of the CAISO to assess the lack of
independence of the board.
On October 9, 2001, FERC commissioned an operational audit
of the CAISO. The audit was completed by Vantage Consulting,
Inc., and released to the public a couple weeks ago on January
25th. The audit stated that the board was not independent.
Furthermore, it went on to say that the lack of independence
was the ``root cause of many other communication, culture and
trust problems.''
Lack of independence meant that in order to accommodate the
Governors' long-term contracts, the CAISO requested generators
with less expensive power to reduce their output. Lack of
independence led to a breakdown in the relationship between the
CAISO and market participants. The result is that the CAISO
often had to make last-minute energy purchases from expensive
out-of-state suppliers rather than from in-state sources. And
finally, lack of independence continues to hinder important
market reforms.
The president of Vantage Consulting is with us today to
talk about how the lack of independence has damaged
California's electricity market and cost consumers millions of
dollars. It is clear to me that independence must be restored
to the CAISO board before we can solve the many other energy-
related problems that face the State of California.
The other purpose of today's hearing is to begin a public
discussion about what types of reforms are needed in
California's electricity market. This is very timely for a
number of reasons. At FERC, the Commission is grappling with
how to create a standardized market design. The CAISO is also
in the midst of contemplating market reforms. On January 8th of
this year the CAISO introduced a draft Market Design 2002
proposal. I look forward to the testimonies of the FERC
chairman, Mr. Patrick Wood, and CAISO president and CEO, Terry
Winter, on this particular subject. I am sure that they will
agree with me that getting the market design correct is the
only way to provide incentives for new energy supplies and
prevent the high prices, or a repeat of the high prices, we
experienced in California in the immediate past.
I want to be clear that today's hearing is about the future
of California's electricity markets. While I have been critical
in the past of many actions taken by the Governor, I am here
today to look for productive solutions. I do not want to go
through what we went through in the past couple years again. I
recognize that many people want to continue to play this blame
game in order to avoid taking responsibility for their actions.
The fact of the matter is, California is a team, Republicans
and Democrats, Governors, legislators, Members of Congress,
Senators, the FERC people, we are a team. We have to solve this
problem.
I look forward to the testimony of the witnesses today.
[The prepared statement of Hon. Doug Ose follows:]
[GRAPHIC] [TIFF OMITTED] 82667.001
[GRAPHIC] [TIFF OMITTED] 82667.002
Mr. Ose. We are going to start with two good friends, Rod
Wright and Anthony Pescetti, members of the legislature, the
chairman and the State legislature's vice chairman of a very
important committee having to do with energy. As I said, we
swear in our witnesses just as a matter of course here. I
should say that we usually swear in non-elected official
witnesses, so we are not going to swear the two of you in.
Anyway, I do want to welcome our witnesses today. We have
with us Rod Wright, assuming I'm right, Mr. Chairman, you are
the chairman of the----
Mr. Wright. Utilities and Commerce, and Energy Cost and
Availability of Utilities.
Mr. Ose. At the State legislature and assembly.
Mr. Wright. Yes, and the subsequent, the second committee I
mentioned is actually an extraordinary session committee, and
when we get out of the extraordinary session that committee
will go away.
Mr. Ose. All right. We need to fix the mic down here.
Mr. Pescetti, you serve as the vice chairman of the?
Mr. Pescetti. I'm the Vice Chairman of the same two
committees that Mr. Wright just mentioned.
Mr. Ose. OK.
Well, let me flip the coin up here, and we've determined
that Mr. Wright is going to go first. So, we welcome you to our
committee today.
STATEMENTS OF RODERICK D. WRIGHT, CHAIRMAN, CALIFORNIA STATE
ASSEMBLY COMMITTEE ON UTILITIES & COMMERCE; AND ANTHONY
PESCETTI, VICE CHAIRMAN, CALIFORNIA STATE ASSEMBLY COMMITTEE ON
UTILITIES & COMMERCE
Mr. Wright. OK, and let me apologize, Mr. Chair, I actually
got the notice late and got back in town early this morning,
but I think there are a couple of things I'd like to state.
Things are never as simple as folks might have them. You
know, for the person, for example, who argued about the
independence of the committee, the previous FERC was somewhat
independent of the Governor and that didn't work well either.
If it was as simple as saying who appointed the board members
then we'd probably be talking about something else right now
anyway.
It was that board that made the idiotic decision to have a
market order where they purchase power in real time and
undermined the PX. So, it clearly isn't simply a function of
saying, you know, how the board is independent.
It was clear we needed to get rid of the old one because
that stakeholder board had interest in terms of how power was
purchased, and you had the potential for conflict of interests
between those persons who were scheduling the load on the
system and those people who were selling load into the system.
And, the reality is, well, they said, I don't know that you are
ever going to have anything that's completely independent
because everybody is related in some way.
I can appreciate the gentleman from PJM discussing what
they do, but California and PJM are so different in terms of
the physical composition of the distribution system that their
system and ours are almost not analogous. We have, for example,
almost 35-40 percent of the wires in California that belong to
municipal utilities, the Department of Water and Power, SMUD
and other munis, by Federal law, not FERC law, but by the IRS.
You can't take their wires and merge them, which created a huge
problem because some of the congestion that was described is
actually a function of not being able--for a single ISO to be
able to coordinate those wires.
Other folk in the West also have municipal utilities where
those wires can't be blended, which is a problem that's going
to have to be resolved, probably at a Federal level as well.
I think one of the other things that happens, and if you
asked me, what was the principal contributor to the price
spikes in California wasn't the independence or lack thereof of
the ISO. That would actually go way down on the list. What I
think was the principal contributor was the fact that we
entered a restructured market, and we entered that market by
selling off a substantial portion of the retained generation
assets of the utilities, and we did that without purchase power
contracts for the power that was sold. Then we neglected to get
contracts on the power plants or contracts to cover that power.
You could call it hedging, whatever you might call it, but the
lack of those two things probably precipitated where we were
because it put us into a position where we were buying too much
of the net short position on a daily basis, which is no way to
play.
In the PJM, for example, they sometimes have power that
goes to $1,500 or $1,600 a megawatt hour, but it's only for 1
or 2 percent of the load so it doesn't cause the severe rate
spike that we got. We were buying in the net short position
somewhere in excess of 40 percent of the load. That's way too
great an amount to buy on a daily basis. That, I think,
contributed more than anything else.
One of the other things that I thought in the preparation
of what I was able to do for this hearing is that we have some
internal conflicts to resolve in California. I agree with what
little part I read of your auditor's report relative to the
relationship between the ISO and the PUC. If the PUC is going
to regulate the rate, for example, it would be very difficult
for them to also be involved in determining who gets to
participate over the grid schedule. That, to me, I think would
result in something of a conflict, and I think that issue would
need to be resolved.
Going further, and I'm not sure what our time sequence is,
but going further, one of the things that I think is going to
need to be resolved, relative to the ISO, is if we're going to
enter into an RTO format that would be a multi-state RTO as has
been proposed by FERC, then I think that whether or not we have
Governor's appointees on the ISO becomes irrelevant, because
ultimately, that body would be dissolved anyway, and it won't
matter who is on it. So, before we spend a lot of effort
determining what the ISO composition ought to be, we are going
to have to make the decision as to whether or not we are going
to go to an RTO and eliminate it anyway.
I think, certainly, one of the considerations that you'd
have to have as a Federal official--I'm a State official and I
can be California first--you also are a Federal official, but
you represent California. The issues, I think, that are of
concern are that the ISO has some relationship to what happens
to electricity in Nevada, and Arizona, and Washington, and
other parts, we exchange power between all of those regions now
in the Western Power Trading Forum, and the thing about the
independence is not so much in terms of the market participants
inside of California. The issue would be making sure, and this
would be FERC's job, that Nevada is not disadvantaged because
of the ISO situation in California, or Arizona, or Idaho, or
any of the other States that participate in receiving power
from that Western grid.
I think the argument that FERC made a long time ago, the
fact that the California ISO actually serves to sell and import
power from outside the State, means that there's got to be some
level of Federal cooperation.
With respect to the Governor's contracts, and the Governor
certainly doesn't need me to defend him, I would disagree with
your premise about the ISO board having to acknowledge the
contracts. What I mention about the contracts is, you have to
take the contracts from the point where you were. What the
contracts have done, is the contracts have assured that there's
going to be power generated, and with the help of your motion,
and that of Chairman Wood, that means that the generators are
running and that mitigation worked. And I agree with you
relative to the weather and the other things that were
cooperating to make that work.
But, I can assure you that those contracts also serve to
provide stability in the market. If, for example, you look at
what has happened in the financial markets post-Enron, people
who don't have contracts ain't going to build no power plants,
and I say ``ain't'' on purpose, even though I do come from
south central Los Angeles, and I'm just a poor kid from the
'hood, but, even though people may criticize the contracts
today, Mr. Chair, whether it be the CalPine contract, or the
Sempra contract, or the other contract, none of the power
plants were currently on queue, that are not funded in the
California Energy Commission program, are going to get built,
because most of those plants were being built on spec.
Financial markets changed dramatically post-Enron, and there
will be no more spec-built plants. So, if your plant doesn't
have a purchase power contract going in, power plants are going
to function pretty much like building a mall. If you ain't got
no anchor tenant you ain't building the mall. It is going to
pretty much function like that for power plants. If you don't
have a purchase power contract that assures that there's going
to be a return of investment, for both operating and a
reasonable return, people simply won't build the plant.
I would close, and I don't know the time, Mr. Chair, and
I've got a little time I can stay. Going forward, one of the
things that I think that's going to happen is that we are going
to have to separate the two issues of price and supply. The
reason that becomes important is that the solutions to the two
problems are achieved on different roads.
If you believe that the problem is supply, then what you
are going to have to do is encourage the development of new
supply, and in order to do that, you are going to probably have
to pay more. If your concern is that you are paying too much,
then you can do price caps, but you have to understand that
when you cap the price, you inhibit the development of new
supply.
The California Generation Asset Base is almost like driving
around in 1962 Oldsmobiles; it's 30 some odd years old, and
those Oldsmobiles, unless you go to Cuba where they still drive
those old General Motors cars, they are not going to continue
to hold up, and you are going to end up with significant
reliability problems trying to keep those old units running.
So, I think as I look at where we are, I'm afraid that
there's a potential supply problem relative to the constriction
of capital for building new plants. I think that we are going
to end up with contracts that could very well provide for the
fact that the power might cost more than the spot market. But,
I think what people confuse in that, Mr. Chair, and I'll hush
and let my Vice Chair talk, what people confuse about the spot
market price, and the contracted price, is something like
insurance. When you buy insurance you pay a premium, and if you
don't have a loss, some can argue that the money you pay for a
premium was wasted investment, because you didn't get a loss
and you paid money, and you didn't get anything. But, you did.
What you paid for was risk avoidance. The contracts that you
have are going to be slightly more, because what you are buying
is certainty. The equation that we're going to have to look at
in California is a difficult equation of how much risk are we
prepared to absorb, and how much certainty are we prepared to
pay for. The more risk you absorb the cheaper the price, but
the more risk you absorb if the market turns, then you get
burned.
Again, we started off this energy deregulation
restructuring program at 100 percent net short. If you go to
Vegas and you sit at the table, I assure you that if you play
long enough, you are going to lose, because the people who
build casinos are not in the gambling business. They play
percentages.
We have to determine what is an adequate percentage for us
to play. So back to the ISO issue, if you play the percentages
right I think that our position in the spot market today should
be somewhere in the neighborhood of 6 percent, 5 percent. If
the margin of spot market purchase drops to that level, you
could stand market fluctuation in prices and it won't matter,
because in order to get to that level of spot market
participation all the other generating facilities will be
running.
What confuses people when they look at the spot market
price today, is that it's irrelevant, because most of the power
has already been bought. So what you are talking about is a
spot market price, and comparing that to the bogey of the
contract, means that you are looking at people who have already
bought. Much of the power that's in the spot market today isn't
going to be purchased, because the customers, who are the major
buyers, have already bought. You are talking about the residual
power that's left over from power plants that no one needs to
get.
So, I think before we say, whoa, we are buying over market,
no you are not. If you want to find out if you are buying over
market, take all the Governor's contracts, dump them back into
market. Then what you'll see is that the spot price will go
back up substantially above the current market price, because
suddenly you have people competing for what power is left.
I could give you a whole bunch more stuff. You don't want
it at this juncture, but suffice it to say again that we are
going to have to determine if we are going to go RTO or ISO. If
we are going RTO, the ISO really is irrelevant, and we are just
talking interim, and is it worth going through all the effort
to figure that out.
We are going to have a supply problem in the near future,
because there won't be enough capital to finance that. Mirant
is not going to be able to build some of the plants that they
talked about. CalPine is having difficulty getting money to
build some of their stuff. If you void the contracts you'll
bankrupt CalPine, and you'll bankrupt Sempra, and you'll lose
that power as well.
It is not as simple as saying that you rescramble it. Even
if you take our Southern California Edison, and PG&E, who are
currently insolvent, and PG&E is in bankruptcy, and Edison is
insolvent even though they had a settlement. Moody's announced
last week that they ain't going to return credit worthiness to
them until they are assured that the ratemaking process will
prevent what happened to them before from happening again.
So, in this paradigm where we play, it's clear to me that
once upon a time, as policymakers, we could make all of the
decisions. Now, Moody's, Standard & Poors, Smith, Barney,
Solomon Brothers, and all of the other people who provide
capital are going to participate in the decision as well, so we
have to make sure that the decisions we make recognizes how we
deal with capital into the market.
Thank you, Mr. Chair.
Mr. Ose. Thank you, Mr. Wright.
I wish we'd had you at our hearing last April, because
these were the points we were trying to make. Thank you for
coming this morning.
Mr. Pescetti.
Mr. Pescetti. Thank you, Mr. Chair, good morning, and
thanks for the opportunity to address you about the future of
the California ISO.
Before I talk about the ISO, I want to make some brief
comments about some of the broader issues facing the energy
market in California, because the shape of the ISO will be
determined by broader decisions we make about our energy
future. There is a great deal of nervousness in California
about continuing down the path of ``deregulation'' that was
begun in 1996, and some have suggested that instead we should
return to full regulation. If we decide to return to a command-
and-control market as we had before 1998, there will be little
need for the ISO.
I'm not here to advocate for either position. The AB 1890
model of deregulation was so flawed as to be unworkable, and in
many ways places a higher level at risk at the doorstep of
ratepayers, just the opposite of what a functional deregulation
system would do.
Returning to a command-and-control based system, however,
would be an even worse option for California. As our history
shows, California does the worst job of any State in the Nation
of regulating its energy industry. The fact that our
electricity costs were 50 percent above the national average
led the initial drive to deregulate, and our role as one of the
first States in the Nation to take such action led to a boom in
the technology sector here. Pulling the rug out from under
these high-tech businesses would be economically disastrous.
Furthermore, a ``cost-of-service'' based system is not
likely to spur the kind of investment we need to create enough
new power supplies to provide our market with a healthy reserve
margin. The legislature recognized this problem last year and
decide to create a Power Authority to deal with it. The Power
Authority was designed to go into generating business in a
cost-of-service market, to buildup and maintain a publicly
financed reserve margin for electricity. Fortunately, this tool
is not being used. I believe the only impact would be to
``crowd out'' future power plants that would have been built
with private dollars. Taxpayers would have become more and more
involved in the electrical generation business, and I doubt
that's the direction they want to go.
Therefore, I believe a new path must be charted. We must
create a market that is predominantly fueled by private
investment and places the risk for those decisions on
investors, not the ratepayers. But at the same time we must
maintain a key role for government in ensuring stability of
supply, encouraging demand-side efficiency, and stabilizing
rates. In such a scheme, the State would play a strong role,
would be responsible for the ensuring the adequacy of energy
infrastructure, and have the tools and resources to react
quickly and decisively to sudden changes in the market.
This regulatory structure would require an ISO that
maintains as open a market as possible with the other Western
States and with substantially similar pricing mechanisms,
likely including membership in a Regional Transmission
Organization.
The structure and role of the ISO is key to making any
decisions about the future of our energy markets.
As all of us know, markets rely upon open and widely
available methods of transporting goods from the producer to
the consumer. Whether they are highways, rail, the seas, or
transmission lines, those pathways must be open to all
participants and sufficient for the amount of commerce needed.
Californians discovered last winter that the natural gas
pipelines within the State were not sufficient to meet the peak
demand of electrical generators. As a result, California
natural gas prices rose many times higher than in neighboring
States. Likewise, on the electricity side, the San Francisco
Bay Area suffered more blackouts than in other areas because of
insufficient transmission, and is still at-risk.
Plentiful and accessible transmission, therefore, is
fundamental to a workable electricity market.
It is important that our transmission rules allow
California energy companies to compete for energy supplies
outside of California. California must not isolate itself in
the energy market.
I know there has been some controversy about RTOs, but I
believe it is important for California to become part of a
Western RTO. California utilities import up to 25 percent of
peak energy needs from Washington and other Western States. It
is essential that we remain in the market for these resources.
There has been some discussion about making California
``self-sufficient'' for its energy needs, but to do so would be
a waste, in my view. There is a unique opportunity in the
Western electricity market, more so than in most other regions,
to exchange resources, because the seasonal demand patterns of
the Pacific Coast States are exactly the opposite of each
other. California consumers benefit tremendously from the
ability to purchase off-peak power from sources like the
Bonneville Power Administration for their own peak use, rather
than build more peaking plants or keeping old, polluting ones
on-line.
There are some other issues with our market design that
need to be changed. The ISO is now at work creating a new day-
ahead market for spot power, which we have not had since the
California Power Exchange folded last year. This will fill a
huge need for consumers by further reducing the level of
``panic-buying'' at the ISO on the day power is needed.
It was not the legislature's intent, or at least I don't
believe it was our intent, to have the ISO so heavily involved
in energy purchases, which is part of the reason why I also
think the issue of multiple qualified exchanges needs to be
reexamined. In 2000, a statute was passed that banned private
exchanges outside of the ISO and the Power Exchange. The idea
was to keep all spot market power in one place, which in theory
would produce a true reflection of the market conditions. If we
had allowed outside exchanges at that time, perhaps California
would still have a day-ahead market today.
Finally, I have a couple of points to make that are
somewhat external to the business of the ISO, but that I think
are relevant to the discussion. First, the State of California
must get itself out of the power-buying business. It is now
clear that the State is ``over its head'' in dealing with power
producers in the marketplace, and for years to come, ratepayers
in the PG&E and Edison territories will pay billions of dollars
above the market price for spot power and long-term contracts.
Improvements in the spot market will not have the impact for
ratepayers that they can have as long as we are negotiating
poor deals for ourselves. The investor-owned utilities are
simply better equipped to protect the consumer interest in
power purchasing.
The State also needs to give the utilities the tools to buy
the power needed to avoid future calamities such as we saw last
year. Ratepayers would not be in the financial situation they
are today had the Public Utilities Commission acted to allow
utilities the ability to purchase longer-term bilateral
contracts for power. Utilities need the authority to make these
contracts, along the guidelines set forth in Chairman Wright's
assembly bill 57.
Finally, with all of the other reforms that are needed in
terms of market design, there is also need for a fundamental
reworking of the State's energy bureaucracy. I said in my
introduction that California needs more uniform policy with
regard to energy, and the ability to respond to crises like we
saw last year.
I would propose that the way to do this is to create a
State Department of Energy, a Cabinet-level agency that would
be directly answerable to the Governor. Under our present
system, there is too much finger-pointing and too little
accountability. There is too much regulatory uncertainty and
too little coordination of action.
State government must continue to play an important role in
the energy market, but it cannot do so within a regulatory
structure design for yesterday's world. The State should
continue its work with respect to forecasting supply and demand
and evaluating the state of the market, but the same agency
must have the ability to respond to those forecasts by
streamlining the regulatory process or putting emergency
conservation measures into place. Today, doing these things can
require discussion and agreement between three, four, or five
different agencies. And as we saw last year, it's often
entirely ineffective.
I have introduced legislation, assembly bill 2062, to
consolidate all of our various energy agencies into a
department, with the exception of one--the ISO. We've left the
ISO outside in the hopes that it can gain become an independent
agency.
As a legislator who voted to reconstitute the ISO Board
last year and take away its independence, I will say today that
I believe the time has come to undo that legislation. At the
time, in the midst of the energy crisis, the Governor asked the
legislature to remove the stakeholder board with an appointed
board. Many of us thought that this was needed to ensure the
public's confidence in the operation of our grid.
Now that FERC has taken appropriate measures to restrain
energy costs in the West, I do not see a need to hang on to the
appointed board any longer. An independent ISO is key to
reassuring market participants that a stable and less political
environment exists in California.
This will not remove our ability to protect consumers.
Quite the contrary, the State can and should do more for
consumers by taking an active role in energy markets in the
manner I mentioned earlier. If in the future the State sees the
need to impose radical price control measures, it will only be
because it has failed to do its part in ensuring balance in the
energy markets. As I see it, energy price controls are not just
a band-aid solution for market failure, they are a shield
behind which politicians and pertinent agencies can hide the
fact that they are not doing their job.
I hope this gives you a little bit of insight. I think
California has a bright future, but we need to be able to work
in a manner that's beneficial to not only the industry, but to
the ratepayers as well.
That concludes my comments, Mr. Chairman.
[The prepared statement of Mr. Pescetti follows:]
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Mr. Ose. Thank you. Mr. Pescetti.
I want to make sure I understand; I was following your
testimony here, I have a copy of it, and at the top of the
fourth page you used the word ``without'' but your written
statement says ``within.'' You said, ``. . . but it cannot do
so without a regulatory structure,'' and your written remarks
are, ``. . . but it cannot do so within a regulatory structure
. . .''
Mr. Pescetti. You know what, I kind of missed my page here.
Mr. Ose. I think you meant within.
Mr. Pescetti. I probably did, if that's what the written
remarks say.
Mr. Ose. We are going to go with the written ones.
Mr. Pescetti. Yes.
Mr. Ose. We'll correct the verbal statement----
Mr. Pescetti. Please.
Mr. Ose [continuing]. To comply with the written statement.
Mr. Pescetti. Thank you.
Mr. Ose. All right.
Well, thank you both for coming today. I do want to look
prospectively in terms of where we are going.
Chairman Wright, you had mentioned maintenance standards in
your comments earlier, and one of the problems that we
experienced in the immediate past were unplanned outages by
generators. It appears, or at least there has been testimony
given, that the generators contend they bought old plants, that
they proceeded to run them hard, if you will, and that as a
result they experience, subsequent to that, higher than average
outages. Others have testified that the outages were staged in
order to raise prices.
CAISO has been working on maintenance standards for all
generating plants in the State, and yet they've delayed filing
their proposal with FERC in order to allow the PUC to have some
input. It's my understanding that the PUC wants the legislature
to pass 39XX, which would give the PUC authority to do
maintenance checks on all present and future generators who
supply energy into California, including those outside the
State.
Do you have an opinion on that bill?
Mr. Wright. Well, I don't know that we can give the PUC the
authority to inspect anything outside the State. Some of us
question how good a job they are going to do inside the State,
so I certainly wouldn't want to send them outside.
The issue that tied up 39 wasn't inspecting plants; I mean,
the PUC did over 800 inspections so there's not a question as
to whether or not they can inspect. I forget which of the
Federal laws it was, but wholesale generators in California
enjoy an exemption, and it's that exemption that allows them to
even build power plants in the first place on a private basis,
and that was done long before there was a ever a restructuring
or deregulation movement. That was how you were able to get
plants, because the California Constitution specifies that if
you generate electricity you are a utility. As a utility, you
are going to be structured substantially differently.
The law that was drafted by the PUC would have removed the
EWG, or Exempt Wholesale Generator, provision, under current
California law. That dog won't punt in the legislature, and so
what we had to do was say to them that we are not going to
create a situation where we attempt to regulate a private
wholesale generator as a utility, because what that would do is
immediately dry up all of the capital that would have gone to
the people who were trying to do that.
What we are trying to do is grant to the PUC, in statute,
without removing the EWG provision, the ability to inspect
plants, but we have to make sure that we do another thing as
well. The other thing that has to be done is to make sure that,
for example, if the PUC specifies maintenance standards that
differ from those of the manufacturer of the equipment, and the
equipment breaks down who assumes liability? I mean, there are
a number of things that need to be done there to make sure
that's accomplished.
You also have the issue of scheduling, and in some
instances, for example, last year there was this great furor
about the guy at Duke said that during a middle of a shortage
that Duke shut its plant down. Well, what he didn't know--and
it becomes one of the reasons, you know, I guess in the Chicken
Little theory about the sky falling, the fact that an apple
hits you up side the head doesn't mean that the sky is falling,
it just means that an apple fell--this particular plant was
shut down because the ISO needed to do that in order to relieve
transmission congestion.
And so, if you were looking and saying that whoa, you know,
we are in shortages today and this plant is shutting down. If
you didn't know the entire picture then you would provide an
erroneous thing. I mean, the newspaper never----
Mr. Ose. So, they decked the plant, they decrementally had
the plant go down to take the power off the line, to ease the
congestion.
Mr. Wright. Right, see, because if you don't do that then
you'll blow up the whole system. And again, the problem is that
the newspapers were so quick to jump on the testimony of this
idiot that they never were able to get back to the fact that it
was a managed outage. No, it wasn't planned, but it had to be
scheduled so that you didn't crash the entire system.
So, I mean, as you began the question about maintenance, 39
is something that we're going to work with. We are still doing
that. In its initial form, the legislature was not prepared to
grant to the PUC the ability to do that.
And, let me amplify that in the 800 inspections that they
did, they did not find one incidence of outage that they were
prepared to file a grievance against. The one incident that
people discussed was one where a plant in southern California
that was fined by FERC, but the issue there did not have to do
with withholding, the issue had to do with the fact that one of
their units had an RMR contract, the other unit did not have an
RMR contract.
AES brought up the plant first that did not have the
contract; FERC ruled, and I think properly, that they should
have brought up the RMR contract plant first, and fine them the
difference. That's been reported as catching someone
withholding. It's not true, and so, I mean, the difficulty in
all of this is that people take a little bit of truth and push
it in a way that isn't true.
We'll fix 39 to make sure that the PUC has the ability to
inspect plants, without taking away the Exempt Wholesale
Generator, without having the PUC try to determine maintenance
standards for which they have no qualifications to do.
Mr. Ose. I think that's the key point. I think you are
right on the point there in terms of a manufacturer of, let's
say, somebody that makes turbines, says you have to maintain
this turbine in such and such a manner, we've got to make sure
that these maintenance standards that might be adopted align
themselves with the manufacturer's experience on them. So,
that's what I'm trying to get at, is why wouldn't we just
adopt--maybe this is too simple, but why wouldn't we just adopt
the manufacturer's standards for maintenance and tailor those
standards to the specific equipment that's in a plant?
Mr. Wright. Because that makes too much sense.
Mr. Ose. OK.
Mr. Wright. See, part of the problem, I think, that
happened as well, in the year prior to the crisis, Mr. Chair,
the ISO asked a number of the people who were running plants to
exceed their manufacturer's recommendations.
Now again, we are talking about old plants, and so that
meant that by missing standards, or deferring maintenance that
you should have done, you are going to have unplanned outages,
because now you are really going to have to do it for fear of
critically damaging your equipment.
I think where again we have to be particularly careful, is
that in California there's another layer they'd I'd like to put
on top. For example, in Pittsburg, California, not very far
from me, Mirant operates a plant that they bought from Pacific
Gas & Electric. They ran so many hours in the year 2000 that
when we got into the middle of the crisis, the Air Board in
Contra Costa County said, ``Oh, you can't run anymore because
you've already exceeded the amount of time that you can run.''
And, I would remind you, Mr. Chair, that all of the plants
that were purchased actually exceeded the output when they were
operated by the utility by, in some cases, as much as 80
percent. So, it's not a question where you've got less power
out of them.
Now, you could shape that in a way where you could still
manipulate and produce more, but I think it would be a little
bit disingenuous to suggest that people were simply withholding
so that they could drive up the price. If you go back and look
at the incident in totality, it doesn't mean that you couldn't
do it, and it doesn't mean that it didn't happen. That needs to
be investigated, whether more power was produced. But in some
cases you had plants go off line because air boards were
directing. And, that plant in Pittsburg that I just told you
about. I'm not telling you what I heard, and I'm not telling
you what somebody else told me. I went to the plant and saw
them take down a boiler on the largest power plant in
California. They had to take down the boilers on a couple
systems because the air board, not the ISO or the PUC, ordered
that be done.
So, you know, the Governor would later on realize that he
had a problem, because the air board could also come in and
provide fines.
During the energy crisis as well, in Los Angeles we fired
up an old power plant and people said that the DWP gouged when
we did. What people didn't take into account is that DWP paid
several million dollars to the SCAQMD for fines to run the
plant. When you pay those fines, that cost is going to be
incorporated into the cost of the plant.
That plant that I described to you that Williams runs, or
AES and Williams run, they have a totaling agreement with
Williams. I think in 1998 and 1999 the air emissions cost
exceeded the cost of the fuel. In most places in the country,
the cost of the fuel is the largest single operating expense of
a plant, except in those plants in southern California where
the emissions credit exceeds the cost of the fuel.
So, I'm just saying, and it goes back to my original
statement, Mr. Chair, if price is the issue that we're
concerned about, there are a number of things that we can do to
mitigate price.
Mr. Pescetti mentioned, for example, that the prices were
higher in California. The Federal Government helped with that.
When they did PURPA, and they dictated that utilities had to
buy at the short run of what it cost power from somebody else
who built the plant, and they based it on the cost of a nuclear
plant, where the cost of the plant was front loaded, in some
instances Edison, and PG&E and Sempra had to take 3 cent plants
off line to buy power for 8 and 9 cents. But again, at the time
somebody said that gas is going to be--oil is going to be $100
a barrel and it will be scarce. Well, it ain't $100 a barrel.
We guessed wrong.
But now, even if you go back and look at the contract that
people criticized the Governor for, they are a cent and a half
less than the QF contract that utilities are still obligated to
pay for.
So, it's not as simple as saying, well, they screwed up.
There's enough blame to go around where everybody comes away
from this with a little bit of mud on their shoes.
Mr. Ose. Your point on the maintenance standards is that we
ought to listen to the manufacturers, they tend to know what
their equipment can do.
Mr. Wright. And they provide warranties, and if you don't
follow the warranties what happens is, when it blows up you
don't get any money back. It's kind of like you buy a nice new
car and they give you a maintenance schedule, if you don't keep
it you void the warranty.
Mr. Ose. I do take care of my 1989 pick-up.
Mr. Pescetti, on SB 39XX, do you have any thoughts that we
could take into consideration?
Mr. Pescetti. I like keeping things, as well, Mr. Chair,
very simple. I think we should just kill the bill. I mean, we
attempted to kill it last year, personally, I don't think you
can make a bad bill any better. So, I would like to see 39X die
in the assembly.
Mr. Wright and I worked very hard the last night to stop
the bill from getting out, and personally, I think that's the
best thing that would happen for Californians and our energy
market, is to kill 39X.
Mr. Ose. Do these maintenance standards need to be adopted
by regulatory process, is that what you are saying?
Mr. Pescetti. No, what I'm saying, as you and, I think, Mr.
Wright alluded to earlier, is that there are manufacturing;
standards for maintenance, that's what we should adopt. We
don't need any regulatory agency going in and saying we should
change that process.
Mr. Ose. Is it your opinion that PUC's involvement in this
is superfluous?
Mr. Pescetti. Yes. Personally, I think that the PUC would
like to have its hands in more parts of the energy market than
it needs. I don't think we need to increase the scope of the
Public Utilities Commission.
Mr. Ose. Mr. Wright, correct me if I'm wrong; if I
understand your point, it is that if someone buys one of these
pieces of equipment and puts them in their plant and runs it,
and runs it in such a way as to void the warranty--I mean, they
are not going to do that because it's not in their financial
interest, if they screwed it up they wouldn't be able to get
recovery.
Mr. Wright. Right.
Mr. Ose. So, you think, if you will, the manufacturer's
relationship with the buyer is sufficient to handle this issue?
Mr. Wright. Well, I think a couple of things. 39 really
wasn't drafted in conjunction with, but it's now kind of linked
with 28, which is an Assembly bill, that is on the Governor's
desk.
Mr. Pescetti is right. In its current form, the bill should
and will die. If we are able to make 39 work, it needs to be
clear that the ISO, and not the PUC, would be involved in the
scheduling of the power plants when they schedule their
maintenance.
In some instances, for example, the operator, or the
manufacturer, will say you have to shut down this equipment for
maintenance over a period of hours. It becomes an ISO function
to determine which plant in which region, relative to
congestion management, needs to go down for scheduled
maintenance at a given time.
And so, in some instances it might be that you say to the
guy in Pittsburg, we are going to take you down in April so
that when we take someone else down, you can't have them all
down at the same time. So, those maintenance plans, within the
manufacturer's guidelines, also have to be scheduled for the
reliability of the grid, so that everybody doesn't go down at
one time.
One of the problems that did occur before--and this was a
shortcoming of the ISO in part, but again, ISO had the problem
of also keeping the lights on--was that, because a lot of
people blew maintenance schedules earlier on, it meant that as
you got to the crunch time, a lot of people had to go down
because they were now at the critical point of losing the
equipment.
So, I think that the ISO needs to do the scheduling of
maintenance around the manufacturer's schedule, and in
consideration of the congestion management requirements of the
grid. Then the PUC role would be to determine if the plant was
not functioning under the prescribed guideline set forth
between the ISO, the generator, the PGA that they had with
FERC, the generator agreement that they had with FERC. The
PUC's role, in my view, should be much as happens with the PUC,
say, in the telephone business. They become the enforcement
arm, the eyes of FERC on the ground. Because in the event that
there was withholding, you do need somebody to be able to serve
as the cop, so to speak, to say that somebody is gaming the
system.
But, I submit to you that the more efficient way to achieve
that would be by contract, because contracts are much easier to
enforce than trying to figure out at 2 a.m., whether or not a
plant is off line. It becomes a much more laborious task to
figure that out. A contract is much easier to manage, which is
why I get back to my earlier discussion. If you had contracts
for most of the power, and your spot position is de minimus,
then you are not trying to play cops and robbers in the middle
of the night to figure out who is running the plant and who is
not.
Mr. Ose. You are both in agreement that these maintenance
standards are more suited to the ISO then.
Mr. Wright. Yes.
Mr. Pescetti. Yes.
Mr. Ose. OK.
Now, the second subject I want to talk to you about--and I
appreciate your compliment earlier, Mr. Chairman--is the market
mitigation plan that's in effect right now that FERC adopted.
Mr. Wright. At your urging, Mr. Chair. Thank you.
Mr. Ose. I'm sorry?
Mr. Wright. That was at your urging, I understand. Thank
you for your work.
Mr. Ose. Is it working? Is the mitigation plan working, in
terms of bringing power at an affordable price, because if it's
not we need to change it.
Mr. Wright. Well, I think it does. I mean, what it does is
assure that the plants are going to run. And it assures that
the price is going to be within a certain range.
Where you have to be careful with price caps is that, often
times the cap becomes the floor if you are not careful. We saw
that, when there were price caps before, where suddenly you
say, oh, OK, I can charge $2.50, we'll just make it $2.50,
since that's what I'm able to get.
What I think we need to have going forward is, if, for
example, we've got contracts for a substantial amount of power,
so we are assured that plants are going to run and the people
who own the plants are assured that they are going to get paid,
then I think we would be able to begin retreating from the
mitigation measures, because we've got power purchased and the
plants are going to run.
But contrary to what people may have said, that the DWR
bought too much power, the shape of what they bought doesn't
really conform to the load profile of the State. So, we are
going to have situations where we are going to have peak load
times, we are going to have to go out and buy power anyway. We
are going to have to, say, on Sunday afternoons, end up having
to sell power at a substantial loss, or, in some cases, give it
away. That was a function, I think, of not buying wisely, not a
function of having paid too much.
So, yeah, I think that had we not had that, and if we
didn't get the winter, and if you didn't get other things--the
Fortnightly, a utilities magazine, has a great article that
talks about what caused what. I think it was a combination of--
I think most experts would agree--the price mitigation, the
weather cooperating, and we spent a lot of money publicizing
the need for conservation. Californians cooperated with that.
All of those things, taken together, I think contributed to
that. We don't want to be in the position, again, of depending
on good weather, and depending on things we can't manage, which
is why contractual relationships are the best way to go. It's
kind of why a lot of folk get married and quit dating.
Mr. Ose. Remind me never to match wits with you.
Mr. Pescetti.
Mr. Pescetti. Mr. Chair, I'd agree.
I think the market mitigating plan helped us get several
things in order to get to the position where we are, a little
bit more stable as far as price goes, so I'd agree with Mr.
Wright's comments.
I think also we can't undermine the benefits that we've
had, and all Californians have made, with the energy
conservation, because with a plan and with conservation and
with good fortune and with the weather, I think everything
worked out well. So, I think that was a good first step for us,
and I also want to thank the Chair for his help.
Mr. Ose. Now, the FERC's order expires on September 30th.
One of the purposes of today's hearing is to take input about
what we do from there. I mean, is this order a long-term
solution? I hear you saying we need to tweak it to a certain
extent.
Mr. Pescetti. I agree. I think there needs to be some
tweaking, and I think we have between now and before the order
is up at the end of the September to take a look at areas that
we can improve and some areas that we may want to scale back,
take a look at where California has gone.
I think the contracts have helped also with some stability.
I think maybe we may have committed too much in 2003,
especially based on where we've seen the demand go, but I would
hope that between now and the end of September we'll have an
opportunity to look at ways to improve the plan, fine tune it,
and move forward on those areas that are beneficial to
Californians.
Mr. Ose. Mr. Chairman, one of the things you mentioned was
the fact that we've been buying, or at least we were buying, 40
percent of our net short in the daily market, and you hinted at
the percent of the portfolio, if you will, that should be
acquired in the spot market, as opposed to what is being
acquired in the spot market.
The direct implication of that is we need to give these
power generators and power suppliers the opportunity to forward
their contract. Do the power suppliers have the ability right
now to forward their contract under PUC guideline?
Mr. Wright. Well, they do, Mr. Chair, but they do so at
their own peril. Mr. Pescetti mentioned AB 57, which I authored
and it went through the assembly, and God forbid that we inject
politics into the policy process, but 57 is now on the Senate
side awaiting approval.
What 57 did is specify in statute that there would be a new
framework for how the review of the prudency of a plan is done
for the purchase of electricity.
When I say the purchase, I mean what could happen now. For
example, let's say that PG&E bought--well, this would be the
good old days when PG&E bought, since in bankruptcy they can't
buy nothing, but let's say that PG&E bought a contract for 6
cents. If the PUC determined that they should have only paid 4
cents, then what the PUC could do is grant them only 4 cents in
rate dollars, which means that PG&E would eat the 2 cents.
Given that risk, the company won't buy anything that the
PUC won't approve in advance. Since the PUC was not going to
approve contracts in advance, and there still is no procedure
at the PUC to approve contracts in advance, then the companies
are reluctant, and you can't blame them.
Mr. Ose. Wait a minute. We had a hearing in Sacramento last
April, where I took testimony under oath from the person who
runs the PUC, Ms. Lynch, that the PUC had, in fact, adopted
Safe Harbor provisions for forward contracting. Is that not the
case?
Mr. Wright. No. They began working on a 57 framework after
57 was introduced, but that framework is not yet completed, and
it is more important now that it be by statute than by
regulation, because what the financial markets have come to
realize is that the PUC can change its mind on a dime, but they
can't change statute on a dime.
So, it is the ability to purchase forward contracts. In
some respects, the PUC has granted minimal ability for them to
do that, but there is no standard procedure in place in
California today for a utility to go out and buy power without
necessarily facing a subsequent prudence review.
Mr. Ose. No safe harbor provision.
Mr. Wright. Negative, not that exists right now.
They are beginning, at the PUC as a regulatory process, to
look at adopting what was done in 57, but that does not yet
exist to my knowledge.
So, I was with some utility people yesterday who were
urging me to move 57, particularly, with a San Diego company,
because they've got some power contracts that they want to
begin negotiating, and they'll need to do that in January. They
need the protection of 57. San Diego was the San Diego Gas &
Electric/Sempra combination. They need the safe harbor
provisions in 57 to give them a comfort level with their
bankers, to be able to go out and play.
So, it is not currently in effect, that they are able to
have a safe harbor, as you term it, to go out and make purchase
power contracts.
Mr. Ose. Do you share that opinion, Mr. Pescetti?
Mr. Pescetti. I do.
Mr. Ose. This is my last question. I'd be happy to
entertain what further thoughts you might have, but, Mr.
Wright, you had indicated that the percent of the portfolio
that should be acquired in the spot market should be somewhere
in the 5 to 6 percentage, and then you would end up melding
that with what comes off your base generation and what have
you, your long-term contracts.
It is my understanding that we've been buying all in net
short, at least until recent times, in the spot market, but if
I understand PUC guidelines for the past couple years it was
that they wanted a threshold of around 20 percent purchased in
the spot market. You have your native generation, and they
didn't want any generator having more than about 80 percent of
their generation within their own control. So, you'd be forced
to go out and buy around 20 percent of your demand, either in
the forward or in the daily market.
Am I correct in that understanding?
Mr. Wright. OK. Well, the current profile in California,
ball park, is that about 25-28 percent is retained generation
asset by the utility. About 30 some-odd percent is QF or
contracted power, and the balance was what we termed net short.
The problem is that the net short, as a percentage,
fluctuates given the demand. So, the amount you have as
retained generation is a fixed amount of power. The amount
that's contracted is a fixed amount. Now, what you have left as
a percentage is going to vary with how much the demand is. If
the demand goes up, then that means your net short percentage
can go from about 30 some odd percent to maybe 50 percent,
depending on what the demand is for a given day.
The PUC, pre Ms. Lynch, said that because the spot market
was so good, that they wanted all of the purchases to be there,
because the consumer was getting the advantage of the low price
of the spot market at the time.
Mr. Ose. That's the 100 percent.
Mr. Wright. Yeah.
Mr. Ose. OK.
Mr. Wright. But, remember that when we first embarked on
the deregulation effort the surplus of power in the State was
also somewhere in the neighborhood of about 20 percent on an
average day. The demand in California began to grow subsequent
to 1996, and that ate up all of that reserve. As the reserve
was eaten up, that meant that the prices were going to go up
because now the commodity became scarcer. This is Economics
101. If the supply goes down and the demand goes up, then the
price goes up as well.
Mr. Ose. Actually, it's an undergraduate, it's a lower
graduate course, it's Economics 1.
Mr. Wright. Yes.
Mr. Ose. Not 101.
Mr. Wright. This is way, way down, and, you know what? That
still works in this market. Which is why what I mentioned
earlier, the contract in effect with a merchant operator serves
as an insurance policy. What that insures is that if you buy
the contract, that operator is assured that he's going to get
paid. He doesn't have to go out and worry every day whether or
not somebody is going to buy it from him.
You are assured of getting power at a certain price. It
goes back to what I told you, though, about insurance policies.
You pay a premium to get that certainty. If the price goes down
on the other end, you can't look and say, oh, my God, the spot
market is loaded. Because the problem is that, if it had gone
up, then you would have paid the higher price.
And, what you can't try to do is say, ``I want to get the
lower price when it's low, but if the price goes back up, I
want FERC or somebody to come in and rescue me from my own
mistake.''
We've got to determine, and why I say the contract becomes
so important, that the lowest price is not necessarily the best
price. In dominoes, in my neighborhood, they say all money
ain't good money. The fact that you got the low price today
doesn't mean that you are going to get it tomorrow. Since
electricity is something for health and safety that you have to
have, you can't ultimately get the lowest price because that
exposes you, as we now know, to the highest price.
So, let's say that you take the price of, say, 5 or 6
cents, 6.5 as the current, I think, as the current contracts
are. There's a whole lot more risk for you south of 6.9 cents,
than north of 6.9 cents. So, if you chase that 1 or 2 cents
that you think you'll get by playing the spot market, then you
can't complain if it goes to 10 or 11 cents. The reason that
I'd leave some purchase in the spot market is because you have
elasticity in the market. A plant may shut down. Something may
happen that truncates the demand on a given day. But the reason
you'd like to have the ability to reduce what you buy, so that
you are not as wasteful, so that, at the end day, you can
reduce your exposure to risk by ensuring that you have power
delivered to you on a reliable basis.
Mr. Ose. That's the forward contract.
Mr. Wright. And, I want to be careful that we don't say
that they are all long-term. You may have some contracts that
are 6 months and some may be 2 or 3 years.
Mr. Ose. Right.
Mr. Wright. But, you may have a contract like the one you
have with CalPine that's a multiple-year contract, because it
serves as a basis for development. So, the contract portfolio
will actually be a whole lot of little contracts that cover
periods of time.
Mr. Pescetti. Mr. Chair, you have to have some flexibility,
you have to have, you know, 10 percent or less on the spot
market, not only if a plant goes down, but also the demand
shifts throughout the course of the day.
You know, I spent several years, as you know, on the SMUD
board, and we always loved to get businesses to run off of
peak, especially at night, because electricity was floating
anyway. So, you need to have that flexibility and, you know, 5
or 6 percent is probably the ideal amount.
In regards to the contracts, I think those ended up being
advantages for Californians. I think the fact that we have some
stability in the price, we have some that we can buy on the
spot market, helps us as well. I think that also helped us with
some reliability, therefore, the lights haven't been off for a
while. So, I think those are all benefits.
Mr. Ose. I want to thank the two of you for coming today, I
appreciate you taking the time out of your day to come over.
Mr. Pescetti. Thank you.
Mr. Ose. It's been very educational for me. I appreciate
you coming in.
Mr. Wright. Thank you.
Mr. Pescetti. Thank you, Mr. Chair.
Mr. Ose. We're going to take a short break here and then
the second panel comprising Patrick Wood, Terry Winter, Richard
Drom, James Feider, Jan Smutny-Jones and Walter Drabinski will
be here with us.
[Recess.]
Mr. Ose. OK, we are still looking for Mr. Drom and Mr.
Drabinski, are they here yet? We're going to give them a
minute. Tell you what, we're going to proceed, I'm going to
have to swear all of you in; when they come in I'll swear them
in.
Gentlemen, would you rise, please, and raise your right
hands?
[Witnesses sworn.]
Mr. Ose. Let the record show that these four answered in
the affirmative, that would be Mr. Wood, Mr. Winter, Mr. Feider
and Mr. Smutny-Jones.
We'll pick up Mr. Drom and Mr. Drabinski when they come in.
Gentlemen, I know that some of you have a 12 o'clock
schedule constraint. We have your testimony. If you can
summarize in 5 minutes each it would help us get straight to
some direct interaction.
Patrick Wood, the chairman of FERC, welcome.
STATEMENTS OF PATRICK WOOD III, CHAIRMAN, FEDERAL ENERGY
REGULATORY COMMISSION; TERRY WINTER, PRESIDENT AND CHIEF
EXECUTIVE OFFICER, CALIFORNIA INDEPENDENT SYSTEMS OPERATOR;
RICHARD A. DROM, VICE PRESIDENT, GENERAL COUNSEL, PJM
INTERCONNECTION, L.L.C.; JAMES C. FEIDER, PRESIDENT, CALIFORNIA
MUNICIPAL UTILITIES ASSOCIATION; JAN SMUTNY-JONES, EXECUTIVE
DIRECTOR, INDEPENDENT ENERGY PRODUCERS; AND WALTER P.
DRABINSKI, PRESIDENT, VANTAGE CONSULTING, INC.
Mr. Wood. Glad to be here, Mr. Chairman.
The last time that I had the pleasure to visit Sacramento
at the time I was newly appointed to the Commission, as was
Commissioner Brownell, we had the pleasure to meet the
California Energy Commission with a group of experts talking
about the sufficiency of the infrastructure in the California
market, and it's fitting that my second time attending
Sacramento we are talking about the balanced market rule. Those
two aspects of the world, sufficiency of the energy
infrastructure and the presence of balanced market rules to
govern the trade back and forth on that infrastructure, are
really the two prerequisites for a healthy and competitive
market to work, to deliver to benefits to customers.
I am pleased that your focus, as well as the focus of a lot
of the key parties here in California, is on getting the
balanced market rules in place. I think that is such a critical
part of getting this part of of the Nation returned back to
economic health on the energy front, that we really do need to
focus on.
The FERC, for its part, is looking at balanced market rules
on a national scale. We have had a number of instances, and I'm
pleased to see Mr. Drom here from PJM being a good example of
one, but certainly there are others, of instances of energy
markets that are healthy, that have worked, that do survive
stress, that were designed and are malleable enough to improve
as they discover flaws in their mechanisms, and I'd like to
hope that we can get California to that same level, as well as
the rest of the West.
It's important to remember that California, while it's the
dominant player in the West, is part of a bigger electric grid.
The laws of physics dictate where power goes, not the law of
the man, and those laws tend to make power spill over back and
forth between Oregon, and Nevada, and Arizona, and even as far
away as British Columbia, back into New Mexico as well. So,
that interconnectivity of the California Region and, I think,
the gentlemen on the first panel did speak to that,
acknowledging that interdependence is an important part of the
mix here. So, California's solution has got to include the
other players in the Region, and certainly FERC is mindful of
that, as we move forward in talking about market designs that
should work for the whole country.
There is a real urgency, I think, at this point to complete
the transition. This began in 1992, when Congress laid out the
Energy Policy Act and said, we think that competition at the
wholesale level, which is between the wholesale players, is a
good thing for America and we ought to move forward toward
that. That's been 10 years, and with probably the exception of
the Northeast, from maybe D.C. toward Maine, it is really only
a promise, not really an actuality. And so, we'd like to see
that promise be expanded across the country.
This is very separate from the local decision by a
legislature, such as here in Sacramento, to decide to open its
retail market, that is in my mind, and always has been, a State
decision, and it's very separate, it's a political decision as
to whether customers ought to be alcoved to a government
selected utility or be able to pick their own supplier. That's
a political decision, but what we have been about, and always
were about, and what I think the discussions that you have
welcomed here are about, are the economic benefits of having a
market, and having a market work well.
We are committed to that at FERC. We are committed to the
institutions, such as the one that Mr. Winter heads and the
others in the country, that those be good regional leaders for
making these markets work on a regional basis. It's not
necessarily a Federal issue, but often in cases it's bigger
than a single State issue, and that's the difficulty here, we
don't have a government of the region. There's a Federal
Government in the Nation's Capital, and there's a local
government here in Sacramento, but there's not one that kind of
represents where the electric markets really are, which is
somewhere in between.
So, we are doing our best to try to create institutions
that can make that work and work well for the benefit of
customers, and I trust that with discussions like today's, and
the collaboration that can lead from that, among all the
parties here in California and in the broader West, we can get
to a market that is viable for the long haul.
I look forward to any of your questions.
[The prepared statement of Mr. Wood follows:]
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Mr. Ose. Thank you, Mr. Chairman.
Mr. Winter, welcome.
Mr. Winter. Thank you, sir.
Five minutes, I'm not sure I can even get warmed up.
Mr. Ose. I did see your testimony. I've gotten through
about three quarters of it, so if you could summarize that
would be great.
Mr. Winter. I will summarize very quickly.
You asked me to talk on two subjects. One was the market
redesigned effort that we are involved in, and the other was
the operational audit that we underwent.
I'm going to go very quickly and at a very high level, but
clearly in my view the things that have caused the problems in
California have been the lack of generation, lack of
transmission, lack of price-responsive demand, lack of forward
contracting and underscheduling in the forward market, lack of
feasible schedules and the exercise of market power.
In our new design, we have tried to put particular emphasis
on each of those. For generation, we have gone to what we are
calling an available capacity obligation to force the
suppliers, not the suppliers, but the people who supply the
customer, that he have sufficient generation to meet the needs,
which means he's probably going to have to buy more than he
actually needs on any one particular time.
Lack of transmission, in our new design we have put in
locational marginal pricing, which we hope will send better
signals and, therefore, will help the transmission. It's an
area I'm very concerned in, and getting lines built that we
absolutely need, because as the generation comes on, if we
can't get it to the customer, it does us little good.
In the area of responsive demand, we think those are retail
programs that have to be done by others. We are certainly
willing to accommodate them in our wholesale markets, but we do
not take the lead on that.
Forward contracting and underscheduling, again, the
available capacity obligation, and we are proposing in our day-
ahead market that we develop what we call a residual unit
commitment, which is after the day-ahead market we will look at
the shortage that exists and looking at our congestion patterns
actually identify units that have to come on from the available
capacity that is there.
Lack of scheduling feasibility, this in the day-ahead
market will be taken care of through the internal congestion,
and that lack of schedules will then be identified and we'll
handle that with the residual unit commitments that we perform
in the day ahead.
Exercise of market power is an area that in itself would
take considerable time, but let me just say that we have a
three-tiered approach. One is, we think the market structure
with the capacity design is one way of not letting it happen at
the beginning. If we get through that, then we think we do need
a damage control bid cap that many of the other ISOs now have,
and if that fails then we think we need to go to a just and
reasonable safety trigger that would, in fact, avoid prices
getting completely out of control.
Let me just very quickly comment on the audit. You have in
your package a filing of all the items that we responded to the
audit in FERC. I think that, No. 1, I am not happy with the
audit. The ISO has self-audited itself several times, it's not
the quality of the audit or what it says, it's more about I
think that we have done a better job than that, and so I think
people need to look at the circumstances we were operating
under.
I cannot tell you how proud I am of the operators here.
They worked under very, very difficult conditions. We had
bankrupt utilities that were not buying. We had generators that
were not getting paid. The operators, you know, from the time
they begin their training are taught never to drop load, yet
they had to face dropping load in January, and I don't think
people recognize, and some of the criticism we get is, oh, you
took a unit out a few minutes early. It makes a large
difference whether you take units out in the middle of the
night when it's dark or around peak hours. So, we would
actually make decisions to try and get additional power for the
5:30 to 6 timeframe, those we were criticized for. I think the
Commission, or the way the people have performed, was
outstanding, and I would feel derelict if I did not mention
that.
In summary, let me say that the ISO can't do it all alone.
It's going to take the people in California. It's going to take
the regulators in FERC in California. It's going to take the
ISO. It's going to take RTOs. It's going to take regional
planning. All of those have to come together to make this work.
So, I certainly applaud your comments of not looking back, we
must learn from the past but we have to go forward.
And finally, I think that it's going to be extremely
difficult until we get the financial stability developed to
really put in place a lot of the things that are more long
term, and toward that regard I do become a little nervous when
we have an arbitrary date of September 30th, that says I lose
all the mitigation protection and I may not be able to have in
place all the protection that we have in our redesign by that
time.
Thank you.
[The prepared statement of Mr. Winter follows:]
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Mr. Ose. Mr. Drom and Mr. Drabinski, would you please rise
so I can swear you in?
[Witness sworn.]
Mr. Ose. Let the record show that the gentlemen answered in
the affirmative.
Mr. Drom, if you could summarize, 5 minutes.
Mr. Drom. Yes, thank you.
Good morning. I am not an expert on the California ISO
governance, and I am not an expert on the California market
design. However, I think some of the things that PJM has
accomplished in the last 5 years can help to understand what
good governance is and what an effective market design is. So,
I'd like to talk a little bit about governance and market
design in that context.
Governance really has a number of factors, and I mention
them in my paper, I'll just review them. You have to get the
right people in the governance. You have to make sure that they
have explicitly defined fiduciary obligations, and you have to
develop appropriate practices and procedures to govern their
actions. And there is a fourth factor that I didn't mention
that I'd like to also have, because I kind of assumed it, but I
didn't realize other organizations are different than our's.
Very strong stakeholder input is essential to good governance.
We have a members committee that consists of every single
member, we have over 200 members now. They all participate and
they are entitled to participate in all the committees, and
including the members committee, which is our most important
voting mechanism, which endorses or approves all the major
changes before PJM files them. So, those four elements are
critical.
Let me just give you a quick example of how they work
together in reality. Back in 1997, when PJM was approved as an
ISO, one of the conditions was that we form a market monitoring
unit that wasn't part of our original filing. So, we worked
with our stakeholders during a 5-month process, developed with
them effective mechanisms that everyone could buy into. Then at
the last minute our members said you must file the mechanisms
as part of the operating agreement, rather than part of the
tariff.
Now, as a lawyer, I immediately realized that in the
operating agreement members have a two-thirds vote in order to
change it, whereas the tariff PJM has unilateral control over
it to make changes. So, we talked to the board members, and the
board had a real gut check and they rejected the will of the
members. They filed it as part of the tariff, because they felt
that fiduciary obligations of maintaining a robust and
competitive marketplace required that they have control over
the market monitoring unit changes, as it evolved over time.
FERC, within 60 days, approved our filing and agreed that
it should always be in the tariff, not in the operating
agreement. But, that's an example, a real world example, of
where the board has to look at its fiduciary obligations, look
at the will of the members, and then do what's right, not
necessarily what's politically popular.
Our board has made a number of decisions, luckily not many,
about four in the last 5 years, where our members were not in
favor of our steps. In each case, FERC promptly approved our
actions and said we did the right thing. So, we have a history
of working with our members, but also being independent.
One of the phrases that Phil Harris uses a lot is, when the
arrows in the front equal the arrows in the back, you know you
are doing a good job. One thing that PJM's board is very proud
of, is that we look at the arrows from all directions before we
take a course of action.
Second, market design, I'm a lawyer, not an engineer, so I
can't go into detail, but the essential elements in an
effective market design, first of all, is information
transparency. We need real information, under real time, to
create real markets. Phil calls that the three Rs. And, it's
essential to our business, is that information be available to
all the participants so they can make the right business
judgment in the competitive marketplace.
Second, you have to give customers as many choices as
possible. We believe that a marketplace is only effective if
customers can do different things to achieve their objectives,
rather than being forced in a single line to all do the same
thing. We believe in giving people options. For example, when
you meet your load obligations at PJM you can self-schedule
your generation, you can do bilaterals with a third party, or
you can buy and sell on the spot market. On a daily basis you
can change. Because of this robustness, we think the market is
more effective than it would be otherwise if everyone was
arbitrarily forced, for example, to buy or sell off the spot
market, or to do bilateral contracts.
In addition, you have to make sure you have a sufficient
information technology to enable customer choices and make sure
this real information gets to the parties. We are very proud of
our Internet Web site activities, which a lot of the customers
can individually utilize, and PJM can step back and monitor the
process, rather than a command and control mechanism, that
might get involved in too much detail in the process.
Finally, I think in order to have an effective market
design, you have to have the trust of the marketplace, and
that's one thing that our Code of Conduct emphasizes. We work
very hard to maintain the trust of our consumers with
integrity, communication, accountability, respect and
excellence, our five core values.
Thank you.
[The prepared statement of Mr. Drom follows:]
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Mr. Ose. Thank you, Mr. Drom.
Mr. Feider, welcome.
Mr. Feider. Thank you, Mr. Chairman, for the opportunity to
be here.
The Municipal Utilities serve approximately one third of
the electric power usage in California. We are community-based
organizations that are owned by our customers and our mission
is to provide reliable, low-cost, and a stable supply of
electricity.
To do so, we have invested heavily in both transmission and
generation. Our customer-oriented mission makes us risk averse
and, therefore, we procure our supply in forward markets and do
not rely on spot markets to meet our customer demand. We look
for durability in market design.
CMUA members also have a regional perspective, due to the
significant investments that we've made in neighboring States
and, in fact, many of our trading partners are located outside
the State. The Western grid is largely made up of long lines
connecting specific central generation plants to load centers.
There is simply not enough wire in the air to accommodate the
wishes of all market participants. FERC and policymakers must,
therefore, be flexible to allow market design to accommodate
regional and geographic differences.
The audit report that we are discussing here today confirms
the observations of many segments of the electric industry
about what is wrong in California. The most difficult task,
however, is in not identifying the problems, but agreeing on
the correct solutions. We are eager to get down to the business
of fixing the industry so that it once again operates to the
benefit of consumers.
The audit report concludes that the overwhelming view in
the industry is that the existing ISO board is not independent.
Fair or unfair, that perception is a barrier to progress.
Practically speaking, to the extent that market participants
perceive the decisionmaking process as biased, reform efforts
are not likely to succeed. In that instance, the stability
necessary to foster long-term infrastructure development in
both generation and transmission will be jeopardized. For this
reason, this issue must be addressed.
CMUA supports the goals of the audit report recommendations
on governance. There is a need for both real and perceived
independence of the board and formalized stakeholder input to
that board. CMUA also notes that the independence is not
assured simply by installing a disinterested governance board,
there is an inherent conflict in a market structure that places
a procurement obligation on the independent grid operator, thus
placing the operator in a potentially adversarial position to
market participants.
Defining the ISO role properly is, therefore, a necessary
first step to California Independent System Operator
independence. Clearly delineating its mission is, perhaps, the
single, most important issue on which the ISO can make progress
in the near future. Resolution of other issues, such as market
design and cost control would be facilitated by a clear mission
statement.
The California market participants, regulators, and
legislators need to have realistic expectations about what the
ISO can do and what it cannot do. The ISO is well suited to
perform independent grid operation. The ISO is not well suited
in running markets and procuring energy. What began as a model
in the ISO as the air traffic controller of the interstate
electricity grid has evolved to a point where the ISO is the
pilot, the mechanic, the flight attendant, and the caterer, as
well as the air traffic controller.
CMUA would prefer that the ISO do a few things well, rather
than try to do too many things not so well. CMUA has long held
the belief that a minimalist ISO, one that focuses on reliable
grid operation and open access to transmission, and stays away
from markets and resource procurement, would best serve the
interests of California and the West. This model will relieve
complexity, reduce cost, and let the ISO focus on its core
mission of running the grid.
CMUA strongly supports market reforms that require load
serving entities, whether they be municipal utilities or
investor-owned utilities, to procure adequate supply with
associated reserves and ancillary services to meet their
customers' needs.
In the old paradigm, this was called the obligation to
serve. This obligation to serve was retained by our members,
and needs to be re-created for any entity that wants to serve
customers throughout the market.
As noted in the audit report, the California ISO has
relatively high costs compared to other ISOs throughout the
Nation. Even though that report identifies those high costs, it
does not fully capture the myriad of other charges that can
accrue to customers as a result of the ISO operations. These
miscellaneous charges can be significant, unpredictable, and
ultimately dwarf the administrative costs.
The audit states succinctly and accurately that the
economic incentive for municipal utilities to join the ISO has
simply not been there. The core reason is because the ISO
market does not match our business model. We, the municipal
utilities in this State, want to continue to be an integrated
type of utility; we want to operate our generation and our
transmission assets to meet our load.
In conclusion, CMUA agrees with the audit report that the
opportunity exists to solve the problems that have plagued the
California electric utility industry since the inception of
restructuring. Now is the time to redefine the California
Independent System Operator's mission to better serve consumers
in the State of California. CMUA is hopeful that this hearing
and this audit report will be a step in that direction.
Again, thank you for the opportunity to be here today.
[The prepared statement of Mr. Feider follows:]
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Mr. Ose. Thank you for joining us, Mr. Feider.
Mr. Smutny-Jones.
Mr. Smutny-Jones. Thank you very much, Mr. Chairman.
My name is Jan Smutny-Jones, I'm the executive director of
the Independent Energy Producers, and I was formerly chair of
the Stakeholder Board of the ISO.
When I was at the back of the room earlier today, Mr.
Chairman, looking for my colleague's testimony, I came across a
licensing application which was subtitled, ``Lost Dogs and Cats
Find Their Way Home,'' and I hope at the end of the day we
collectively find our way home here. I think that's very
apropos.
Mr. Ose. Mr. Smutny-Jones, that is out of order. I'm going
to gavel you out of there.
Mr. Smutny-Jones. Sorry, Mr. Chairman.
What I'd like to do today is summarize my testimony by
basically pointing out that at the end of the day we need
several things to occur. One is, we need to continue the
reliability of the overall grid. We need market stability, that
is imperative both for a new infrastructure of investment and
to ensure that our utilities become credit worthy, and we need
an independent transmission organization.
I spent a considerable amount of our testimony documenting
how we got here, and I did that deliberately because I think
recently there's been a significant amount of revisionist
history in terms of ignoring the underlying fundamentals of
what happened in California. Those underlying fundamentals are
still there. We were over relying on the spot market, that was
driven by hydro electricity in the Northwest, that hydro
electricity was gone. We had a significant run up in demand. We
had significant increases in gas prices. The point being, while
things are stable now, what we just went through, which was
traumatic and no one's idea of a good market structure or a
good time can reoccur.
I want to commend the committee for taking this step in
terms of looking into this very, very important issue.
The fact of the matter is, we've characterized this as sort
of the perfect storm, which was a convergence of very adverse
market fundamentals of historic proportions. This basic
underlying market force ran into a market structure, which I
think you've already heard a significant amount of testimony
on, that was fundamentally flawed in the fact that it was
basically completely dependent upon a short-term market. I
think we should have learned from that.
I would commend the ISO; they are looking at least with
their market design reform at least trying to open up a
capacity market which would go a long way toward providing some
stability.
The net effect of going short had a significant impact in
terms of the run up of actual prices for the power in the West.
That led to a long, agonizing debate that apparently continues
today on price caps. And, as being the first person to
authorize the use of price caps in the ISO, back in July 1998,
I find it ironic that we are now in February 2002 and this
still seems to be a topic. Price caps is arguing about
bandages, we need to get to the fundamentals of the market
structure and fix that.
One of the key issues that we need out of all of this is a
clear definition of market power, and this is something that
hopefully FERC will be taking up. Right now, market power means
different things to different people. We don't have a standard
under which we know what one means when you abuse market power.
Basically, what we need is the speed limit sign on the front
end of the street so everybody knows what the rules are and
everybody knows what happens if you violate them.
I think that needs to be monitored on a regional basis, not
just sort of that it be the basis from ISO to ISO in terms of
the way it is being done now.
With respect to governance the fact of the matter is, this
is an integrated transmission system that services 11 States,
two Mexican states, two Canadian Provinces. We need a clear
governance structure of an RTO. I'd go that direction. I think
the lack of political independence has undermined the ISO's
credibility and its ability to address real operational issues,
and I'm very much concerned that the lack of needed market
reforms is not moving fast enough because of over deference to,
in particular, the California Public Utilities Commission, and
other political interests.
I am not saying that the ISO should not coordinate with
State agencies, far from that, but I, basically, think that
it's very important to recognize that this is an interstate
organization that needs to interact. I have a very high respect
for the current ISO, I don't believe the Governor calls them on
a daily basis and tells them what to do, but I don't think
there's any question that the ISO board, as it is currently
constituted, is a political board and was designed to do that.
Simply put, I don't believe politics and physics mix.
In closing, I think it's very important, as I said earlier,
that we get to the fundamental market reforms that we need to
do now, before we start seeing a run up once more in demand. We
need a reliable grid. We need market stability, and I mean that
from a political and regulatory sense, and we need an
independent RTO. That will only be accomplished through
significant State and Federal cooperation. So, we welcome
further inquiry on this, and hopefully, will at the end of the
day find our way home.
Mr. Ose. Thank you, Mr. Smutny-Jones.
[The prepared statement of Mr. Smutny-Jones follows:]
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Mr. Ose. Finally, our last witness, Mr. Drabinski, welcome.
Mr. Drabinski. Thank you very much, Mr. Chairman. I
appreciate this opportunity.
I won't take a long time. I think our report speaks for
itself, and I'd be happy to answer all the questions that you
have.
I would like to make a couple points. When we started the
audit, through auditing, using the standards of the tariff, and
very shortly we learned that the causes fell way outside of
tariff, outside the ISO. For that reason, with the agreement of
the FERC, we decided to really address the overall problem, not
the specific little pieces within the ISO, and the results of
that were five global recommendations. I won't repeat them. One
deals with fiscal stability, jurisdictional cooperation,
process for interaction, market design, and the CAISO's role.
They are so intertwined that without solving all of these
problems in some logical sequence it is destined to continue to
have a repeat of problems from the past.
Mr. Winter is correct when he says that he's got a group of
people that have worked very hard, and they've worked on a
difficult situation, and many of the problems came from outside
of his organization, and I agree 100 percent with that. He's
got the finest, brightest people you could ever expect to
assemble. He also has to deal with the problems of them dealing
with their own day-to-day problems, and I think we addressed
them in a fair amount of detail. However, he's correct in
saying that many of the solutions are outside the reach of the
ISO. I think that's why this group and others within government
and regulatory agencies in California need to take action.
The last point I'd like to make, I think everybody needs to
leave this room with, is that the crisis in California still
exists. A group of experts I brought in as part of our team, as
we looked to where we were, we looked at the perfect storm
scenario, and you've gone from the perfect storm to the perfect
calm at this point, but all of the basics are still there and,
in fact, with the implosion of Enron and the concern on the
part of a lot of the major merchants for expending capital, I
fear that a year or two down the road you could see another
major problem occur, and people just need to keep that right in
front of them all the time. With that, I'll just answer any
questions you have.
[The prepared statement of Mr. Drabinski follows:]
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Mr. Ose. Thank you, Mr. Drabinski.
Let me just go through this. Our witnesses, we have the
chairman of the Federal Energy Regulatory Commission, Mr.
Patrick Wood, we have Mr. Terry Winter, who is president and
CEO of the California Independent Systems Operator, we have
Richard Drom, who is the vice president and general counsel for
the Pennsylvania, New Jersey, Maryland Interconnection, we have
James Feider, who is the president of California Municipal
Utilities Association, we have Jan Smutny-Jones, who is the
executive director of the Independent Energy Producers, and
Walter Drabinski, who is the president of Vantage Consulting,
who wrote the audit that we've become so familiar with. I want
to thank you all.
Gentlemen, I did not adequately and appropriately introduce
you prior to your testimony, for which I apologize.
Now, we've had previous witnesses testify and I asked them
a number of questions about the market mitigation plan; some of
you I am going to ask similar questions.
Mr. Winter, did the market mitigation plan work?
Mr. Winter. I think as some folks have said we are now in
the perfect calm and that had a lot to do with it. Did the
market mitigation work? Yes, I think so. It identified a must-
offer component that put in the market units that for whatever
reasons may have not been there before. Clearly in the West, it
forced them to deal with the supply that we needed in
California.
I think probably the threat of hitting different price
levels within their mitigation plan had a lot to do with people
wanting to make sure that didn't occur, because as gas prices
dropped from $15 down to around $60 or something, that trip
wire would have caused the price to drop dramatically.
So, yes, I think it helped. I don't think it was the only
thing. I think the availability of power, more hydro, etc., we
were importing a year ago this time anywhere from 1,000 to
2,000 megawatts, now I'm importing anywhere from 8,000 to 9,000
megawatts. That makes a tremendous difference.
Now, some of that is due to long-term contracting, most of
it is due to available hydro in the Northwest and additional
capacity in Arizona. So, I can't just say by itself it did
everything, but it's something I would want as a back stop as
we move forward, if we do not have a new design completely put
in place and the financial ability of people to protect their
positions is not there.
Mr. Ose. Mr. Smutny-Jones, same question, is the mitigation
plan working?
Mr. Smutny-Jones. I think the market fundamentals had a lot
more to do with driving prices down and stabilizing the market
than did the market mitigation plan.
What troubles me most is that while the market mitigation
plan was designed to be a short-term solution to a problem, we
are still not addressing the underlying problem. And we can
argue about whether or not we need to leave the band-aid on any
longer, but I think we need to be dressing, if you will, the
wound, and we are not doing that. And, that really is at the
heart of the issue.
We, as I said, have spent literally 4 years arguing about
price caps, which was an early form of the price mitigation
measure, and we are having the wrong debate. What we should be
doing is making sure that there's adequate tools that address
the types of price run ups that we have seen, and if you do see
something that's causing the market some trouble, that's
relatively limited in terms of its impact and duration.
Mr. Ose. So, Mr. Winter, you believe that there's some
value to continuing the market mitigation plan, Mr. Smutny-
Jones you think there are limitations to continuing the market
mitigation plan.
Mr. Smutny-Jones. Yes, I do, I think we would be better
spending our time between now and September 30th coming up with
something that obviates the need for the current market
mitigation plan that's in place, and my concern is that times a
wasting and we are not focusing on those issues.
Mr. Ose. Mr. Winter.
Mr. Winter. I would like to respond to that from this
standpoint. One of the things that I think is crucial as we go
forward is what we are calling the capacity, you know, the A-
cap design component. I find it very difficult to justify that
in an arena where I have a bankrupt entity that I'm asking to
now go out and buy capacity, and yet it has no financial
wherewithal to do that.
And so, while I agree totally with Jan, my concern is that
we are not able to get the proper balance until such time as
those entities become financially capable to enter into those
negotiations on an ``even'' basis, so that you have the
supplier with some competition and the buyer with the ability
to shop the market, rather than be held hostage to any one
person.
Mr. Ose. Chairman Wood, would you comment on the reasons
why FERC has set a deadline of September 30th for the market
mitigation plan?
Mr. Wood. Well, quite frankly, the State government in
their pleadings last year asked for two summers, and so rather
than do August 30th we did September 30th, just to get through
the full summer.
So, that was longer than I think we were inclined to do at
the FERC, but we all voted for that, and we supported that
date, and I think we stuck to it, but I think we also, as Mr.
Smutny-Jones just pointed out, made that kind of cooling off
period time so we can get some healing done here, get new
infrastructure on the ground, and get market rules rewritten.
And, I should add some observation that attached to Terry's
was a good chart that he had, that the California ISO and their
staff had put together as a draft for discussion by parties out
here, that I think clearly is a very positive step forward in
getting that done.
Time is short, but quite frankly we do need an incentive to
get this done, and the expiration of that date at the end of
the summer is to me a tight timeline but sufficient to get
going. There's a certain level of detail in this document in
the detail that the Commission is talking about for national
standards, so clearly they've got that going and I think it
needs to be converted into some detail. I certainly envision
that the Commission, through its staff, will be helping to
participate in that effort, but I do think that, really, a lot
of the right things are in the plan here, and I just would
encourage Terry and all the folks out here to really take this
seriously and move forward on that in an aggressive timeframe.
Mr. Ose. Do you think the deadline serves a valid purpose
then?
Mr. Wood. Yes, sir.
Mr. Ose. I want to go on to the independence, the purpose
for which Mr. Drabinski was engaged. Chairman Wood, why did
FERC think it necessary to commission an audit of CAISO? I
mean, is this unusual? Is it unique?
Mr. Wood. It's our first, it won't be our last. I think we
view the ISOs as real extensions of Federal Power Act authority
to the regions. As I mentioned, it's unusual California happens
to be a region contiguous with the boundaries of the State, but
the other ISOs that are up and operating and the new formed
Midwestern RTO cover multiple states, and I expect that we, in
our responsibility, fiduciary and otherwise, to the American
people, want to make sure that these organizations work well.
This is one that clearly was under a significant amount of
stress. Issues were raised in a significant number of pleadings
that when I came to the Commission inherited about the
independence issue that was written up substantially here and
has been discussed today.
And, I really, quite frankly, for me, I know the other
Commissioners might have their own reasons, but I needed just
some objective eyes to look at this, kind of outside of the
policy realm, and tell me exactly what is the implication of
how this organization is running on the effectiveness of that
market.
Mr. Ose. And, I presume that if circumstances arise
elsewhere in the country where you have similar concerns,
audits there will be requested, too?
Mr. Wood. We may not wait for there to be a stress or
crisis there. I think it's probably something we want to do
routinely. In fact, I've set up an Office of Market Oversight
and Investigation that will be kind of continuing liaisons with
the market oversight institutions, which is a part of what the
ISO does, but I expect that we'll use our allocated resources
from Congress to keep good tabs on all the ISOs, up in New
England, New York, Midwest, PJM as well.
Mr. Ose. Tell Mr. Drom, not me.
Mr. Drabinski, I've read the audit, I want to hear in your
own words your description of the level of the independence of
the Board of Governors to CAISO.
Mr. Drabinski. Certainly.
Let me start out by saying, we weren't retained to look at
the independence issue. We were retained to audit the tariff.
Mr. Ose. But, you did get some input on it.
Mr. Drabinski. Well, it was clear from the get-go that it
was a major issue, however, we were taking a much broader
approach. What constantly rose to the surface as we interviewed
management, middle-level employees at the ISO, as we talked
with the various players within California and the major load
serving entities and generators, is that the issue of
independence just came up and it became the linchpin issue that
we needed to address.
Mr. Ose. Now, Mr. Wright earlier today cited an example
where somebody working at Sempra didn't have a comprehensive
view of the whole picture and they, frankly, made some comments
that proved to be inaccurate. To what degree can you satisfy
our concerns that the feedback you received on governance was
not, or lacked knowledge of the larger picture?
Mr. Drabinski. Well, I think by the breadth of our
interview and analysis; we looked at all of the board meetings,
all the decisions from the original stakeholder ISO through to
the existing board. We looked at the types of issues that they
face, the decisions that were made and not made. We interviewed
all of the senior management with specific questions, as to
whether they believed the current board was (A) independent and
(B) addressing the short-term and long-term decisions that
needed to be addressed.
But then, we went out and we talked to every major
generator and every load serving entity. I say we talked with
them, we went to Houston, we had conference calls in Salt Lake
City, L.A., San Diego, San Francisco, Washington; we were
flying all over the country over a period of 2 or 3 weeks. In
each case, we would sit down with a group of as many as 8 or 10
representatives of Reliant, and Mirant, and Dynagy, with people
from--regulatory people right on down to the nuts and bolts
operations people. So, there was such a consistent message from
every level, from every type of organization that we spoke
with, that there was no question in our mind very quickly that
the perception of independence, of lack thereof, existed with
virtually every player that has to deal with the ISO on a
regular basis.
Mr. Ose. Were these interviews--obviously, you kept the
notes, but in reading the audit the identities of the people
participating were kept out of the audit.
Mr. Drabinski. We did that intentionally. We did not want
any individuals to be reluctant to speak freely because their
name would be included in the report. We have the notes that we
took.
Mr. Ose. You took input from all sorts of market
participants, did you visit with Mr. Winter, or did you visit
with anybody who works with Mr. Winter?
Mr. Drabinski. We interviewed 25 people at the ISO,
including, I believe, we interviewed every officer, most of the
department heads, the chairman of the Board of Governors, one
of the other members of the board. We submitted numerous
information requests with specific questions that needed to be
answered in detail.
We had a number of meetings with the entire management of
the ISO.
Mr. Ose. So, it was full-scale, it was comprehensive.
Mr. Drabinski. Oh, absolutely.
Mr. Ose. I mean you didn't just take one side, or this
side, or that side.
Mr. Drabinski. We met with representatives from the
Electric Oversight Board. I met with Mr. Smutny-Jones as a
representative of the industrial generators. I met with a
representative of CDWR. We had a number of meetings with the
CPUC.
Mr. Ose. Right. My concern was the comprehensive nature of
who you met with.
Let me ask you a question. From your interviews, what types
of operational problems arose that the people you interviewed
attributed to a lack of independence?
Mr. Drabinski. There was a general consensus that while the
operational people at the ISO would oftentimes reach a one-on-
one consensus of what needed to be done, but then it got around
to the legal and regulatory flagpole and went to the board, and
somehow things got changed and stopped, and the view was that
all the people in the pits at the ISO were trying to do the
right things, oftentimes there was direction from the Board of
Governors that precluded them from implementing what they would
have liked to have implemented.
Mr. Ose. Well, how is that unusual? I'll give you an
example; I get all sorts of suggestions from my staff about
what I should or shouldn't do. Sometimes I do it and sometimes
I don't. I mean, why is that unusual?
Mr. Drabinski. I think the difference here is that we
operate an electrical system; it's done on an instantaneous,
minute-by-minute basis. Typically, once the rules are set the
people in the field work out deals, they are cutting deals,
buying and selling, making sure that the lights are on. When a
deal is cut, and the details of the transaction are agreed
upon, that's pretty much what they are.
And there's very seldom a legal representative or some
senior management person then coming back and saying, no, we're
not going to do it that way, or we're changing the way we
interpret the rule, and the view of many of the participants
were that often times there were people in the back room who
were stepping in.
Mr. Ose. The interviews you conducted indicated there were
people in the back room?
Mr. Drabinski. That's correct.
Mr. Ose. All right. Thank you.
Mr. Smutny-Jones, your members are independent energy
producers, they deal with this on a day-to-day basis. Can you
give us some examples of how this lack of independence is
hampering either your operations or the function of the market
as a whole?
Mr. Smutny-Jones. I think the best example, actually, you
talked about previously with Mr. Wright and Mr. Pescetti, which
is this maintenance standard issue.
Last year, the Governor actually issued an Executive order
that there become a maintenance coordination and maintenance
standards be set. The ISO went to work doing that; my members
spent a significant amount of time and energy in the
stakeholder process to put together both a coordination
protocol and some standards.
The coordination protocol was filed at FERC. They did adopt
it. The standards, basically, were adopted by the Board of
Governors of the ISO on November 7th of last year, and my
understanding, with the instructions that staff solicit input
from the members.
Mr. Ose. November 7, 2001?
Mr. Smutny-Jones. Correct, and solicit opinions from the
Public Utilities Commission, which by the way, could have, and
maybe did participate in the promulgation of the standards in
the first place.
That was on November 7th. We had been involved in this
battle with regard to the proper role of the PUC with respect
to inspections of power plants throughout last year and into
the beginning part of this year. We still do not have those
standards filed at FERC. Let me be very specific, I have no
evidence that anybody has told Mr. Winter do not file those
documents, but I think that there is the concern about, and
this is what I meant by an excessive deference to the Public
Utilities Commission. Those standards need to get out there so
they can be approved and we can get on with making sure that
these power plants are operated according to standards that
everybody understands.
Mr. Ose. Let me make sure I understand. The November 7th
document you are talking about, were they draft standards?
Mr. Smutny-Jones. My understanding was these were standards
that were voted upon by the Board of Directors. Our opinion is
that they are ready for prime time, and that the staff was
asked to coordinate with other agencies, which is fine, but
again, we are now at the end of February and it's time to get
down to the business of getting those maintenance standards in
place.
Mr. Ose. So, give me some examples of how the lack of these
maintenance standards is impacting you.
Mr. Smutny-Jones. Well, right now there's a significant
amount of a grand conspiracy theory, that somehow people are
breaking their power plants to adjust prices in the wholesale
market. I think the facts do not demonstrate that at all, in
fact, these power plants run significantly higher in 2000 and
2001 than previously. But that aside, people do take their
power plants out for specific maintenance requirements, and
what would be nice is a set of standards where people could
basically say, we took our plant out according to a schedule
that we submitted to the ISO for the following reasons to
address the following issues, and there's no question that the
power plant needed to go down for maintenance.
We don't have that right now. As Mr. Wright indicated
earlier, the PUC has apparently conducted about 800
inspections. To date, we don't believe they've found anything
because they haven't reported in the public record any problems
they found with the maintenance of power plants. But, this
still hangs over the overall ability of generators to take
plants out when they need to, basically, provide basic
maintenance.
Mr. Ose. All right.
Mr. Winter, is Mr. Smutny-Jones accurate in the sense that
the ISO board did adopt maintenance standards on November 7th?
Is that accurate?
Mr. Winter. I do not remember whether we had a board
meeting on November 7th. I thought it was near the end of the
month.
Mr. Ose. But, they've been adopted.
Mr. Winter. I could be wrong.
Mr. Ose. OK. So, let's say on or before November 30th.
Mr. Winter. OK.
Now, what you have to understand is, what we bring to the
board is a program, and I would like to go into the maintenance
standard because I think it's an example of a lot of things
that can happen, but just very quickly, our process is that we
develop a program and go to the board and say, ``board, we
would like to have your approval to prepare the documents to go
to FERC.'' And so, the board--and again, I'm sorry, Jan, I
don't remember exactly which day it was, but the board, at that
time, said that yes, they really liked the program we had put
together, but would we please get with the PUC and the
regulatory EOB and others and discuss what changes they would
like in them.
At the same time, we began to prepare what we call the
final language that we then have to file at FERC. At the time
it's a program, it is nothing but a program, then we have to
prepare all the legal language that then makes it acceptable
where FERC can look at it and say, yes, that's in your tariff,
or it's not in your tariff, or it's in your protocol.
So, between November the--let's say the 28th, we began
preparing that; we call it FERC language for short cuts, and
during that time we met with the PUC. They wanted some things,
and we could not come to an agreement of whether or not we were
going to put in some of the requests that they had.
In the meantime, we had the stuff going through the
legislature. Coupled with that, I was given some very strong
instructions from the board that we had to start cutting our
cost. Generator maintenance was not a program that the ISO
looks at as part of its core business, and the reason it
doesn't is we are very, very concerned about the scheduling. We
schedule with transmission lines and generators almost 38,000
outages a year, and have to combine all of those. So, up until
last year we didn't have authority to do the scheduling.
We filed at FERC, they gave us that authority. We now have
the authority to handle the schedules, but the maintenance of
the generation, all I am really concerned about is an
availability factor. If the unit is available 92 percent of
time, that's a good standard, that's what people do. I don't
necessarily have to go in and inspect the plant and work on it,
but because the Governor had asked that we develop this plan we
went ahead and did what we call a preventive maintenance plan,
and to do that we involved the generators and everyone else and
we felt that was a good way to go.
Who does it did not matter to the ISO, whether it's the PUC
or ourselves.
Mr. Ose. I think you bring up an excellent point. You are
responsible for scheduling.
Mr. Winter. Right.
Mr. Ose. How can you schedule if you don't also align the
schedule with the maintenance programs?
Mr. Winter. OK. The way we do that is, the generator comes
to us and says, ``We want to schedule an outage for such and
such a timeframe.''
Mr. Ose. Right.
Mr. Winter. What normally happens is, they all want to
group around different periods of time, in other words, 2001,
after we had run the units hard all summer, October, everybody
wanted to go out, and that's what brought us to filing to FERC
to allow us to schedule those.
What we do when we get that request is, we ask why are you
taking it out? And, they will give us several reasons. One is,
boiler tube leaks. Some will be, I split the tubes and I'm
taking it out no matter what, because it's not operational.
Some will be for preventive maintenance or annual maintenance
on a unit, and they will ask for 4 weeks. Others will say air
quality modifications that we have to put on. So, we take all
of those, put them on a large scheduling chart, and then we
start calling the generator and say, OK, you want preventive
maintenance, you need 3 weeks, we agree everybody needs 3 weeks
once a year, can you shift it to December instead of October
15th?
So, I don't have to know all the details of their
maintenance program to actually schedule them, all I am is a
big clearinghouse that's trying to make sure that they get
their time for maintenance, that they get their time for
whatever happens.
Mr. Ose. OK, so you don't need to know why they need to go
off, you just need to know whether they need to go off.
Mr. Winter. And when they want to.
Mr. Ose. And when, right.
Mr. Winter. And then, I try to work with them to make sure
that they get the time they need, at the same time not letting
everybody go at once.
Mr. Ose. You are responsible for scheduling----
Mr. Winter. That's correct.
Mr. Ose [continuing]. When the plants are up or when they
are coming up?
Mr. Winter. I have to maintain that authority, because I'm
balancing it with transmission line outages, and, you know, we
do several hundred a day that we're switching out.
Mr. Ose. So, why are we waiting on the PUC on the
maintenance standards?
Mr. Winter. Because they are really not an issue that I
have to have before the FERC. I mean, I have the authority to
do the scheduling now.
Mr. Ose. But, you can't schedule without knowing what the
maintenance schedules are.
Mr. Winter. Well, they will tell me, the generator will
come in and tell me what the maintenance schedules are.
Now, the question is, do we, as either the PUC or the ISO,
need to get in and determine whether these are appropriate
maintenance issues.
Mr. Ose. You need their authority to make that decision.
Mr. Winter. That's right.
Mr. Ose. But, apparently, the PUC is electing to make the
decision.
Mr. Winter. Correct.
Mr. Ose. As to whether or not to supercede, for instance,
the manufacturer's recommended run rate and what have you.
Mr. Smutny-Jones. And, that's a problem.
Mr. Ose. I'm sorry?
Mr. Smutny-Jones. That would be a problem. That would be a
serious problem.
Mr. Ose. Well, why wouldn't the PUC be able to dictate to
the manufacturer what the run rates on the equipment should be?
Mr. Smutny-Jones. I think you'll end up with a lot of
broken equipment. I do not believe that the PUC has any
fundamental basic expertise in that area. I think what is
important about all this is that we have a commonly understood
set of standards, so if someone takes their plant out to fix a
boiler tube everybody knows why that's important.
Mr. Ose. OK.
Mr. Smutny-Jones. And it is coordinated. Believe me, we
believe that coordinating the schedule of outages is a very
important thing. It's a positive thing, but we need one set of
standards, not two. We don't want a set of standards that the
ISO has in place, and then a second standard that the Public
Utilities Commission has in place.
Mr. Ose. All right, let me cut to the chase. How do we--
quit the mumbo jumbo and get it to the point where he can
schedule and you can run?
Mr. Smutny-Jones. We have a schedule and what we would like
to see is the tariff amendments that we understand have already
been adopted by the board filed. If the PUC has comments that
they want to make on those, they are perfectly capable, just
like we are, to make them in front of you.
Mr. Ose. You just said you haven't adopted tariffs, you
have adopted scheduling only.
Mr. Smutny-Jones. There's two sets of issues here, Mr.
Chairman, let me see if I can clarify this. There is a
coordination protocol, which I believe was filed some time
earlier last year, April/May timeframe. I may have these dates
wrong, but don't hold me to that, but that coordination tariff
the FERC has already given Mr. Winter the authority.
The second sort of prong here is maintenance standards, in
other words, an identified sort of understanding of how plants
will be maintained, to assure their availability to the ISO.
That is what is in dispute here.
There is, as I said, a separate political effort in
legislative to give what we view as an extraordinary power to
the Public Utilities Commission to adopt maybe even different
maintenance standards, and we can't live in a world where
you've got two different maintenance standards. That's the
issue.
Mr. Ose. Mr. Drom, how do you handle this at PJM?
Mr. Drom. All the generators are required to coordinate
their schedules in advance with us, and we approve the
coordination. As Terry was saying, they do it with the CAISO,
to ensure that there is reliability at all times.
We do not need the authority to force people to maintain
facilities at particular times, because we have a collaborative
model where we get everybody in the room together and say, OK,
everybody wants to do it October 15th, how can we solve this
problem? People volunteer for different times and then we work
it out voluntarily.
Mr. Ose. So, from your perspective, do you or do you not
think there's any reason to go ahead and file this scheduling?
Mr. Drom. I think that's beyond my level of expertise. I
mean, the issue of whether generators should have specified
criteria seems to be a hot issue in California, because, as Jan
has said, there are allegations that people are doing it
improperly.
In our area, there's no allegations like that, we have a
very effective market monitoring unit which verifies issues
like that and does studies, and we have not found any instances
where any generator in PJM has intentionally withheld like that
because of alleged maintenance problems.
So, our situation is different than California.
Mr. Ose. All right. Well, I have to admit there's some
confusion as to why it is we can't move this ball forward.
Mr. Drabinski, again, I've read your audit. You have at
least passive familiarity with the many challenges we have here
in California. Is the Board of Governors of the ISO effective?
Mr. Drabinski. No.
Mr. Ose. How do we fix it?
Mr. Drabinski. Well, I think the fix is to implement a
board of Governors, and I say no for the long run, for the
long-term solution, the answer is no. I think over the last
year they've faced a challenge that they had to do, going
forward you need a board of Governors that, first of all, is
perceived to be effective, by all the players, so that you then
get input and involvement on an active basis by the players,
not strictly to legal challenges.
You need a board of Governors that begins to look at long-
term strategies, long-term capital, budgets, market reform
issues, with the expectation that they are going to be there
for some years.
Mr. Ose. How do you ensure that occurs? I mean, the PUC
guys, they serve specified terms.
Mr. Drabinski. Well, I think, let's look at the existing
board. All of the existing board thought that they were brought
on in a stop gap measure until the crisis was solved.
Mr. Ose. Is that what they told you?
Mr. Drabinski. The chairman told me he didn't expect to be
there more than a few months. And, I think I read something
recently where after reappointment Mr. Flosio made a comment
that even criminals are paroled occasionally, and I'm
paraphrasing that.
So, I mean----
Mr. Ose. You are not saying anybody is doing anything
inappropriate.
Mr. Drabinski. Oh, no, no, no.
Mr. Ose. OK.
Mr. Drabinski. Their point was, they expected to be brought
on for a short period of time, while the crisis was resolved,
and then they could go on to their normal lives.
When you bring in a professional board, you are bringing in
a group of people who are brought on, they are receiving some
compensation, they have specific expectations. The firm that
does the selection are selecting people who know that they
are----
Mr. Ose. Describe the characteristics of a professional
board. We know what the characteristics of the existing board
are; describe the characteristics of a professional board.
Mr. Drabinski. Well, it typically would be individuals who
have a general level of professional expertise in the areas of
banking, whether it be legal banking, financial, engineering,
education, energy.
Mr. Ose. Why would you put a banker on the board of
Governors for the CAISO? Why wouldn't you put an energy person,
either on the consumer side or----
Mr. Drabinski. Well, I think you would want one of each.
Mr. Ose. Do we have that now?
Mr. Drabinski. No, without looking at the resumes of the
existing five, I don't believe--first of all, you would not
have anybody on the board that probably has a vested interest
in, oh, industrial activities in California. So, most boards
generally have people who are either from outside the State or
if they are within the State they are academic experts or
retirees.
Mr. Ose. Let me interrupt here.
Mr. Drom, how do you deal with this at PJM, your Board of
Governors?
Mr. Drom. Yes, our board was established by an independent
consultant based upon the protocols in the operating agreement,
page 3 of my testimony lists that corporate leadership is one
of the elements, professional disciplines of finance or
accounting, engineering, utility laws and regulation,
transmission dependent utility experience, experience in
operation, planning of transmission systems, commercial
markets, trading, risk management. We don't have a single
category for each individual board member. We just have a group
of characteristics and we try to fill a board that has all of
those traits. And, our current board actually does demonstrate
every one of those traits.
Mr. Ose. OK. There's a chart on the podium right behind Mr.
Drom and Mr. Feider; can we go to the overhead please? You just
need to move it right down in that white square. There you go.
Does this accurately reflect what you are talking about in
terms of skill sets and the like?
[The information referred to follows:]
[GRAPHIC] [TIFF OMITTED] 82667.116
Mr. Drom. I'm sorry, but my eyes aren't good enough to read
that.
Mr. Ose. Use this.
Mr. Drom. Yes, we have independent members. We do have
seven members. Members were selected by an independent
consultant and then approved by the members committee. We have
a very strong stakeholders committee, and all members,
including ex-officio members from the States, are entitled to
be on it.
Mr. Ose. Well, as I look across that top line, every single
one of them is an independent, made up of independent members,
and there's six, seven, eight, nine. On that second line, you
have different membership and the source of the selection is
based on the skill sets they bring to the table, is that
correct?
Mr. Drom. I can't vouch for the lines except PJM, but I do
believe that a board like the PJM board does demonstrate the
characteristics of independence that lead to success.
Mr. Ose. The members of the board that you are familiar
with, are they subject to legislative confirmation?
Mr. Drom. Not at all.
Mr. Ose. Who appoints them?
Mr. Drom. An independent consultant selects a slate of
candidates, and then the members approve them. They have
staggered 3-year terms.
Mr. Ose. So, let's say the six of you currently serve on
PJM, and one of you wants to retire, you would engage the
services of an independent consultant, they'd give you a list
of potential candidates, and then you'd decide who it was that
you were going to select.
Mr. Drom. The board issues to the members a slate of
candidates for the members' approval, and either two or three
have gone up each year for the members' approval, yes.
Mr. Ose. When you say the members' approval, you are
talking about the participants in the industry, would that, for
instance, involve Mr. Winter? I mean, explain to me how it
works.
Mr. Drom. Yes, I'd be happy to.
The members committee that PJM has, it's a two-tier
governance that FERC has endorsed in the past. The Board of
Governors are at the top, and a very vibrant members committee
is below. It's composed right now of four sectors: generators,
transmission owners, end users, and load serving entities. All
the members, the 200, fall in one of those four categories, and
they divide up the vote for each category.
So, if there are 25 generators, each gets 1/25 of a vote in
a sectoral voting arrangement. It takes a two-thirds sectoral
vote to pass anything at PJM, and in this case to approve the
board it takes a two-thirds sectoral vote. So, we have a very
vibrant input by our stakeholders, and if our board members are
not achieving their goals, the stakeholders have a very easy
way, when their terms expire, to just replace them with someone
else.
Mr. Ose. Now, Mr. Smutny-Jones and Mr. Feider, FERC
proposed a similar formula for California, for choosing a
board, and I perceive from your written testimony that there's
some discomfort you have, the two of you, in terms of the
current board. Would this new formula, if the Board of
Governors were based on the FERC formula, would it satisfy the
concerns you have?
Mr. Feider. I would have to take a look at the formula
proposed by FERC, but from the Municipal Utilities perspective
we support the model that PJM has for independence, independent
board members are put forward.
Mr. Chairman, you may or may not be aware of the evolution
of the Western Systems Coordinating Council that has been
changed into the Western Energy Coordinating Council, and a
similar board approach by member class is being used. And,
although the Municipal Utilities haven't agreed on a specific
model, those types of models are the ones that we'd like to
see.
Mr. Ose. Where you have some stakeholder participation.
Mr. Feider. Yes, we think independent board members with
strong stakeholder participation is an important element.
Mr. Ose. Mr. Smutny-Jones.
Mr. Smutny-Jones. We would agree with that completely. I
think I have to publicly admit Mr. Drom and I used to have a
public debate over whether or not independent boards or
stakeholder boards were a superior way of going. He won the
debate.
The stakeholder board, while in its inception the ISO did,
I think, a phenomenal job of creating the ISO, putting together
a staff that is second to none, basically, started falling
apart when we were put into a rule of quasi ratemaking, which
is what we were basically doing in the summer of 2000.
And, in that process, I think we lost the confidence of
FERC and we lost political legitimacy here in California. It
was replaced by the current board. I don't think there's a
debate that in the current board independence was the watch
word.
In terms of going forward the stakeholder process needs to
be reinvigorated, because I think we end up with a better
product and we need an independent board.
We also need an independent board that has political
legitimacy, not only in California, but throughout the rest of
the West, and this is where it gets tricky, because California,
rightly or wrongly, has a persecution complex right now, and
the concern about who runs the ISO is obviously a significant
political issue, and we need to kind of figure out how we
transition to a board of professionals that can actually
operate the system.
It shouldn't be that--I have to believe that the political
leadership of Pennsylvania, your colleagues in Congress, the
Governor, the Pennsylvania Legislature, worry as much about
their constituents as the political leadership here in
California. Yet, somehow Pennsylvania has their transmission
system operating in a multi-state, with an independent board.
So, I think it is doable and it's the preferred model.
Mr. Ose. Mr. Winter, any feedback?
Mr. Winter. I was going to just say I didn't want to
respond to any questions on the board. Holding that thought
that I made later, if you continue to question me, take the
fifth, I would like to make a couple of comments.
No. 1, I served under two boards in this corporation now,
and I think both of them met a tremendous need at the time. The
stakeholder board, when we were starting up, it was a way to
get a lot of buy in. It had very knowledgeable people right
down to, you know, how I should write my memos.
The new board clearly came in with a mandate, and I'm not
so sure one of them wasn't to get rid of me, but, nonetheless,
they did not do that, and I have to say that on day-to-day
operations clearly that is--I have been given the leeway to do
what I thought was required.
I get along with the new board just like I try to get along
with everyone. I think the biggest issue that I see is the
perception, that it is not what people want in
``independence.'' And, I think clearly there the State and FERC
have to work together to determine what is the proper structure
for ISOs.
While I'm on this subject, there seems to be the idea that
if you form an RTO the ISO isn't necessary. I think whether you
call it a control area or an ISO, that to get the local, and I
won't call it regional because to me regional is the Western
United States, but to get local input you are going to need
local ``ISOs'' or some forum that allows for the immediate
constituents to get their input into how the system operates in
a bigger scheme. Then I think once you go multi-state then
clearly you've got to have an independent board that is made up
of people that are from the industry, or independence there of.
Mr. Feider. Mr. Chairman, I'd just like to add one further
thing to my comments.
We believe that designing the board, the independent board
that we all are striving for, will be made easier by first
establishing the mission of the independent system operator,
that if their mission is confined to grid management, grid
operations, that board will be easier to form and easier to
design.
Mr. Ose. Well, you did make clear that you thought that was
the appropriate role of the ISO, as opposed to running the
markets and procuring electricity.
Mr. Feider. Yes, that's correct.
Mr. Ose. OK.
I do want to, Mr. Drabinski, I want to go back to
something. You've made extensive recommendations in terms of
improving the cooperation among the regulatory agencies, and
you held what I would call a special role for FERC. Could you
describe those recommendations for us?
Mr. Drabinski. Certainly. One of the recommendations, let
me read it, for improving the cooperation, is to develop among
FERC and the various California regulators and agencies formal
policies committed to enhancing cooperation in the design, the
subsequent oversight of the California electric industry.
When we looked at the players, and there are a myriad of
them just within California, would be the legislative, the DUC,
the Energy Commission, CERS, power authority, you know, then
you've got FERC, you've got Congress itself, and one that I
left out, I can't believe it since my background is finance,
certainly is Wall Street, because without the capital markets
buying in to what's going on in California you are not going to
get the development that's required, or the credit readings
that Terry needs in order to have offices that are a suitable
size for the employees.
I think that our point, and we've made some specific
comments in the report, that it's time to put politics aside,
it's time to put the blaming individual groups or parties
aside, to sit back and say what is the correct overall
solution. What role should everybody be playing on a long-term
basis, you know, get through the crisis, get the system set up
right, and then look to see what you need to go forward in the
long term.
I think someone made the point that in other parts of the
country they've been able to do this, gotten away from the
politicizing of the decisions role. FERC has to be the leader.
FERC, ultimately, is the one that controls the interstate and
the transmission elements of the ISO, and they've got the
greatest leverage for getting things done. Unfortunately, they
don't have the opportunity to make 100 percent of it, the CPUC
and the other parties that I mentioned also have to play, and
if they are at odds, I'm one of the parties to going forward,
and I guess what we tried to express in the report is that
California citizens, billions and billions in the last few
years, and if you want to avoid it in the future it's time to
put the politics aside and a real solution. We think FERC is
the natural focus point. I think someplace in our report we
have a triangle that shows the ISO, the customers and FERC,
they are the natural point of authority here. And, to the
degree that the State legislature has to come to some
agreement, or some acquiescence, I think it's time for that to
occur.
Mr. Ose. Mr. Wood, that's quite a load.
Mr. Wood. We're up for it. I mean, that's partly what we
asked for, managed to do the audit, we expected there would be
some recommendations coming out that we were going to have to
do, and that's why it's helpful sometimes when you are trying
to think through a new process that we are not particularly
adept at to have somebody come in and make a suggestion. We've
asked parties, ISO a couple days ago, and then all the other
interested parties, to respond to his audit, and particularly
we asked them to prioritize the 19 things that he suggested be
done, a big part of which is the role of FERC in being the
facilitator or convener of the multilateral process, to really
get back to the table and negotiate this stuff back out,
because it is, I mean, I heard from the first panel there's a
strong State interest here of, you know, we could do a lot of
things on the wholesale level, but if the State doesn't have a
corresponding retail match up to it, which we heard about 18
months ago, it doesn't work.
And so, as much as FERC has to do to set up the wholesale
market, it is integrally connected to the rest of the picture.
So, without question, we do have to work in a bilateral or
multilateral mode, and we are up for it. I'm getting staffed
for that effort. We have to also include the non-California
parties in the West in that effort as well. So, it is--yes,
sir, to answer your question, we are up for it.
Mr. Ose. It is not going to be easy. I want to shift here a
little bit. We've talked a lot about the governance issue.
Ultimately, when rubber meets the road it's the market design
piece of this.
Now, Mr. Drom, you've talked about locational marginal
pricing, can you explain that to us in English?
Mr. Drom. As an attorney, I can give you a very simplified
explanation. But when you dispatch a system, you try to keep
the lights on at all times; you have a multitude of generation
sources that you can rely upon. At PJM, over 75 percent of the
time when we dispatch more generation in an economic order the
prices rise everywhere at the same time. That's our normal
situation, because if we only need, you know, 20,000 megawatts
we'll have like $15 power, but as we ask for more megawatts
they charge more. It's just the nature of the way generation is
scheduled into our system.
Occasionally, and in some places it's frequent and in some
places it never happens, we have congestion. Where there's
congestion, it means that----
Mr. Ose. Congestion on the transmission lines.
Mr. Drom [continuing]. On the transmission, the wholesale
transmission system. I'm not talking about retail or low
voltage lines, I'm talking about the big lines.
Mr. Ose. The 500 kilovolt lines.
Mr. Drom. We control down to 69 in some areas, up to 500
for sure.
Mr. Ose. OK.
Mr. Drom. At some times during the system you can't do
that. In order to serve a particular load you have to dispatch,
meaning tell a generator who is higher than the normal cost, to
go out of order and generate.
Now, there's two solutions to that. One is you spread the
costs among everybody, and that's what many organizations do,
and the other is locational marginal pricing. And that simply
means the area where the higher cost generation is produced
pays more than everyone else. So, there's disparity within the
system.
Now, we have got it down to like 1,700 different points in
our system, so we have very fine granularity over a five-State
area, and with those 1,700 points in theory they can all be
different on a given hour. They rarely are. Most of the time
it's about 75 percent generally are all the same price, but in
certain areas, like peninsula areas, the Delmarva Peninsula for
example. It's a radial area and it's more prone to congestion
because you can't get power from the East through the Atlantic
Ocean, for example.
So, in simplicity, all LMP is, is pay the actual cost of
dispatching the system in order to have congestion borne by
those who caused the congestion. In essence, if a load in a
pocket has to have higher cost generation, they should pay more
than the one who is not in a pocket.
Mr. Ose. Conceptually, what you are talking about is
pulling it to time of day pricing, in other words when the
demand is really high you charge more, as a conservation
measure or something.
Mr. Drom. There's an analogy to that time. Obviously, our
prices are calculated every 5 minutes and integrated over an
hour, so the locational marginal prices, the LMP, which we post
on our Web site in real time, may vary constantly. We have a
tool called E Data that anyone can subscribe to for free, and
you can see the LMPs at any point over 4 hours, 12 hours, 24
hours, and it's graphed. So, people can immediately see the
prices.
The advantage of LMP in my mind is very simple. It sends
very powerful real time price signals to the load that
experiences the problem and encourages them, encourages new
generation in particular, to locate in those areas.
Mr. Ose. But what you are doing is quantifying transmission
costs.
Mr. Drom. The congestion costs, exactly----
Mr. Ose. Right.
Mr. Drom [continuing]. Quantified and allocated to those
areas where they occur, rather than being socialized over
everyone.
Mr. Ose. So, if you route it through one point and that
point gets congested, you price it in such a manner that,
perhaps, the person producing or the person receiving might
choose to wheel it a different way and ease that congestion.
Mr. Drom. That analogy is a little off, because it assumes
contract path. In reality, in a network grid, our power flows
everywhere simultaneously. There isn't a path that's congested.
But, our engineers, monitor particular facilities if they go
out--if a generator goes off, or a transmission line goes down
or something, we manage the grid reliably. That's when we have
to dispatch certain generation off cost, namely, everybody else
has one cost, and you are at a higher cost in this particular
area.
If you look at the facts, you'll see in the last 3 years
since we've had LMP we've had tremendous generation joining our
area and building steel on the ground. We had over 3,000 new
megawatts in the last 12 months alone, and the reason is, is
because they can get these higher LMP prices. So, the price
signals directly affect the market price, and guess what, when
the generator locates there, the LMP goes down, which is great
for everybody, because we not only have reliability, but we
have supply.
Mr. Ose. You end up with distributed generation.
Mr. Drom. In a sense the generators are like distributed
generation, and that's a separate initiative that PJM is
pursuing now, because we strongly believe we have to encourage
demand side management more than we have in the past. We have a
proposal on March 4th for the members that we hope will pass
and send on to Pat Wood for approval, a 3-year program.
Mr. Ose. Now, Mr. Winter, I know in your Market Design 2002
you've looked at locational marginal pricing, and you're
proposing to adopt it, if I understand correctly.
Mr. Winter. That is correct.
Mr. Ose. What kind of an impact do you think that will have
on overall prices?
Mr. Winter. Well, first off, I think it's always kind of
interesting to note that we, in fact, our model runs on 3,000
points, which was what Mr. Drom was referring to. However, what
we did at the beginning is, we broke it into zones. We picked
those areas that we felt were going to be constricted, and
rather than make all the calculations and go to all the
different generators we jumped to the zones.
Now, I personally was not that concerned with that, because
I always felt that the real model would eventually migrate. I
thought PJM's model, and if I understood him right, they
started with several points, many of which they don't look at
anymore because they find there is no congestion there. On
others, they find there is. So, we had gone from four, then we
added a couple more zones.
When we go to the LMP, we are going to get much more
defined. The result of that is going to be that there will be
areas which have much higher costs than others within a zone.
For instance, there's no use ducking it, in northern California
San Francisco is a very restricted peninsula area.
Mr. Ose. Much like Delmarva.
Mr. Winter. Yes. So, when you go to an LMP the residents of
San Francisco are going to see an increased cost. That will be
met with some, probably, opposition.
Mr. Ose. Now, Chairman Wood, from your perspective is the
LMP a good model? What are the benefits or the problems? I
think Mr. Winter just highlighted one, when you have an
isolated peninsula clearly you have a problem because there's
obvious congestion unless you are extremely lucky, but are
there benefits or particular problems that you foresee?
Mr. Wood. Well, I was slow coming to LMP, too, mostly
because it moves from a level of simplicity to complexity
really fast. I mean, there's not really a fading to grey there,
it's kind of cut No. 2, a more complicated system.
So, when I was at Ercot, and we set up our wholesale market
in Texas, we favored more of a zonal model like he just laid
out, Terry, that California had, and it became clear right as I
was leaving to come to FERC that model could be gamed, and
people could play that congestion, because the costs were not
borne by the people who caused them, they were kind of spread
over everybody else. So, one of the benefits is that you are
allocating--you are removing a big gaming opportunity from a
trader, or market, or generator, or load, to kind of,
basically, game the system to make some money and then spread
the cost to the rest of the system, because those costs then
under the new system come back to you. So, you cause a problem,
you pay for it. So, that's actually a very positive thing.
I mean, generally, regulators like to have the cost causer
be the cost bearer, and so if you can align those incentives
then I think some of the things Mr. Drom was pointing out about
where new generators decide to build, if the load takes
advantage of demand side reductions, or puts small-scale
generation on their site or nearby, distributes generation,
those kind of things where people start to say, hey, I don't
want to pay this excess cost, I'm going to do something about
it.
That's not a spatial problem, that's a problem that's their
problem, they have a much greater incentive to fix it, so it's
really hard to improve on that.
I guess my only lament is that it is complicated, and the
administration of an LMP model is not something you do with a
GED, I mean, it's for the big league. And, I mean, that's OK.
Mr. Ose. That leaves me out.
Mr. Feider, how do the munis feel about this?
Mr. Feider. Well, as a director of the electric utility for
the city of Redding in Shasta County, in the shadow of Shasta
Dam, where there's probably 2,000 plus megawatts of generation
in the county compared to 500 megawatts of load, it would be
easy for me to say I don't care about this problem. But,
several of our members live in the Bay Area, the city of Palo
Alto, Santa Clara, and Alameda, and they are faced with this
congestion issue.
We prefer a market that is simple, not complex, and so we
are concerned about moving to this complex model. And, as I
said in my remarks, we don't believe that there's enough wire
in the air. If we had enough wire in the air, we wouldn't have
as much a problem. So, that issue really needs to be taken head
on as a part of this.
In the meantime, we think we need to be able to protect the
existing rights that we have on the transmission, what we term
physical rights, and we appreciate the fact that FERC rules in
our favor in many cases to protect those pre-existing rights
and those arrangements, because it's all about cost to our
consumers. If we move to this model quickly, or too quickly,
our rate payers are going to incur increased costs, and I don't
think that's the right thing to do when we made the investments
we think that needed to be made.
Mr. Ose. OK.
Mr. Smutny-Jones, how about you, any ideas on LMP?
Mr. Smutny-Jones. Well, I used to have a very strong
religious conviction that LMP was very problematic. The events
of the last 2 years have sort of worn me down.
My members do function in PJM, we believe it can be
modified in a way that actually can work. I think the issues
with respect to complexity is an important consideration, and
the debate in terms of whether it should be put into the
California market, or how it would work, I think the ISO's
market reform forum is the proper place to discuss that.
I think that there are several things, though, that I would
like to point out. The problem California faced in 2000-2001 I
don't think would have gone away with LMP. If I'm correct, I
think PJM has, you know, 90 percent of the power prescheduled,
in other words, it's purchased, you know, it's not in real
time.
Mr. Drom. No, that's actually not true. We have the option
of self-scheduling, bilaterals and the spot market, and at any
given day the spot market may be 5 to 25 percent and the
bilaterals may be 10 to 35 percent, and the self-scheduling
would be the difference.
So, there isn't just 10 percent.
Mr. Smutny-Jones. Well, the point is that there are
mechanisms there which allow for a significant amount of
bilateral trading, whether it's 10 percent or 25 percent.
Mr. Drom. Yes.
Mr. Smutny-Jones. Or whatever. We did not have that there
for our load serving entities, and that was a fundamental
problem.
The second area is that load really needs tools to be able
to adjust. Here again this is a problem if you have entities
within a node, that's what it's called, that can respond either
by shedding load, or by cranking up generator. But we found in
2000-2001 often times we saw a run up in prices where people
couldn't respond, load couldn't respond, consumers, let's not
call them a load, customers couldn't respond because they
didn't have the tools to respond. So, sending them a price
signal that they couldn't respond to didn't make anyone
particular popular. We need to address that issue with respect
to having those kind of tools.
And last but not least is the issue that Terry addressed,
which is that at this point in time you do have certain areas,
San Francisco is the clearest one, of where, for lack of a
better definition, San Francisco is being subsidized by the
rest of northern California. The costs are higher to run power
in San Francisco, and you are constrained with respect to
transmission generation on the peninsula. We just need to get
that out on the table and have a discussion about how you
address that or how you segue into a program where you are not
picking winners or losers, more importantly, is this a huge
problem or is it a relatively small problem, because it may
turn out at the end of the day that the actual ``cost'' to the
end use customer is so de minimus that no one cares. I don't
know that anyone has done that analysis, but that would be an
area that I think needs to be looked at very closely as we
migrate into more of an LMP model.
Mr. Drom. If I could just respond to that last point.
Historically, LMP costs do vary tremendously, congestion costs.
When we were designed in 1997, a lot of opponents of LMP said,
hey, $5 to $10 million, why are we going through all this
trouble for LMP congestion? They opposed LMP.
FERC, in its wisdom, approved LMP, and when we entered it
the first year congestion was only about $5 million. The next
year it was about $35 million, and then it was about $100
million. So, the amount of congestion varies dramatically
depending on what generating sources are available, what the
day of the week is, and what transmission is available. So it's
very complex, and you are very right, Jan, that it's not a de
minimus problem, though some make it out that way.
Mr. Ose. Well, if I understand your testimony then, Mr.
Feider and Mr. Smutny-Jones in particular, confirmed by you, is
that there is a transfer going from those who have efficient
distribution systems, for whatever reason, to those who have
inefficient distribution systems, for whatever reason. There's
a financial transfer going on under the current rules, am I
correct?
Mr. Drom. Yes, I would say, I would describe it simply as
socialization of these costs. They are inevitable. In order to
run a grid Terry has to turn on high and low cost generators,
but the question is, do you allocate those costs just to the
area where you turn them on or do you spread the costs among
everybody? That's the basic issue before you.
Mr. Wood. Well, I think it also minimizes the costs.
Mr. Ose. It quantifies what the expense is.
Mr. Wood. And then, the person who----
Mr. Ose. You supply the power to come in.
Mr. Wood [continuing]. Right, so the gaming opportunity,
which is another part of the California Market Design 2002
addresses and some call it an ink and debt game, and that's
more than we need to talk about, but there is an incentive
there to take behavior that would make costs go up for
everybody. So, the overall amount that's being socialized is
also higher than the sum of all the different amounts in the
current market structure out here.
I don't know if that's true of the pre-LMP PJM, but----
Mr. Drom. I think that's exactly what our history was,
because our first year we didn't have LMP, and our next year we
did, and we found the congestion was actually lower when we had
LMP because any free rider principle tells you that people will
use it more knowing they are not going to pay the full costs.
So, I think there is not only an equity element, but there's
also an actual reduction in congestion as a result.
Mr. Ose. Mr. Smutny-Jones.
Mr. Smutny-Jones. I was just going to respond. I think
there's no question that the signals, in terms of the cost of
congestion, are very clear in that model, and actually the
question that I'm raising is once you've established the fact
that the costs are higher it's a ratemaking question. Does PG&E
take the cost of serving people in San Francisco, and does the
PUC basically say we are going to spread it out through
everybody at PG&E, OK, we are going to encourage PG&E to build
local generation, or transmission, or something, to basically
lower that cost, or are we going to leave it the way it is,
which is basically spread over all the PG&E's customers.
So, this is kind of where we got, you know, LMP will result
in a need to sort of have a State and Federal discussion of,
OK, as congestion costs we know will rise in the San Francisco
peninsula, what are we going to do about it, and that actually
would be a State issue, and I would, you know, venture to guess
that the PUC would have some opinion in terms of how they would
address such an issue.
There's no question that the market signals are pretty
crisp.
Mr. Ose. Do you confirm?
Mr. Drabinski. I was just going to say, from a long-term
standpoint, what LMP does is essentially collect market
signals, generators and transmission builders, as to where they
should be putting the ark.
Mr. Ose. So, we would have to address the embedded or the
stranded cost issues, if you will, the stranded revenue issues
that the munis have at the very least to move toward this
model.
Mr. Feider. Yes.
Mr. Ose. Now I want to go to the RTOs, I know our time is
evaporating here, and I'm trying to be respectful of people's
desire to be out of here by noon.
The FERC has been trying to establish RTOs throughout the
country, Chairman Wood, can you give us a status report on your
progress?
Mr. Wood. Yes, Mr. Chairman, the 1999, December 1999, the
FERC has put forth the standards for setting up regional
transmission organizations. The point of an RTO, was the basic
knowledge that there was a regionality to the power business,
and that we needed to basically treat it as if it were, and set
up an organization that would be the equivalent of the air
traffic controller at the Sacramento Airport for the
transmission grid of a given region of the country.
And, as a result of that, it was voluntary, but they put a
very strong suggestion that RTOs be up and going in 2 year's
time. Well, that time period came and went last December, and
we did approve the first RTO in the country for the Midwest. It
covered about 16 States, ranging from Ohio over to, oh, gosh,
part of Manitoba, and then down south toward Missouri and
Kansas, so that whole swap is now the Nation's first RTO.
PJM has applied for one. We are encouraging them and the
two parties in the Northeast to consider joining forces. We are
also working with parties in the Southeast, but it's pretty
much a work in progress. Our hope is that, really, there is
clarity to all the grid in the country by the end of the year,
that we do have these organizations set up.
Out here in the West, it appears there's kind of a pretty
strong, at least political, meaning not necessarily at your
level, but political at the parties levels across the West,
that the California, the RTO West, which is in the Pacific
Northwest, and then West Connect, which is from the Desert
Southwest up to Wyoming, that those would be three RTOs that
would encompass the whole Western grid.
Mr. Ose. So, what are the benefits in cost to California of
joining such an RTO?
Mr. Wood. Well, we've actually done, and we've got coming
out Wednesday of next week our cost benefit analysis that we
have a consultant to do for us, again, that broke it out region
by region for the whole country, because it's certainly helpful
for us to discuss in the context of why we are doing this, to
look at if there are benefits or not.
So, we've asked that be done, and I don't know exactly what
the details are, but assuming that there are some benefits, the
benefits certainly on the financial level of integrating the
system together, to take advantage of the fact that rather than
California having to build 100 percent of the power plants
needed to serve California, it's recognized that weather and
resources are different across the whole grid, it might be
useful, as California has done for many years, to use hydro in
the winter--or, to use hydro in the summer when there's a lot
of it, power from the Northwest outside of California to
supplement California's needs, and then use, when California is
not using so much power in the winter, to export power off the
grid to the Northwest. It's been kind of a natural back and
forth relationship that I think has worked and benefited the
West pretty well.
This, quite frankly, would not be plowing tremendous new
ground, it's just to kind of institutionalize what has been
kind of an informal practice for many years, and it gives some
coherence, some long-range planning, some standardization of
how commercial practices are done around the grid.
So, I would consider it an evolutionary step, not a
revolutionary step, of trying to set up an RTO out here.
Mr. Ose. Here in Sacramento County we have a public utility
governed by a seven-member board. Mr. Feider, I'm kind of
interested in how the munis react to the proposal of California
being part of an RTO.
Mr. Feider. We're very supportive of California joining a
broader regional RTO to take into account the regional aspects
and dynamics in the West, including making sure that the
operation and scheduling protocols are consistent across the
West.
Mr. Ose. When you say geographically, how big of an area
are you talking about, California?
Mr. Feider. California, and actually the entire Western
Interconnected Grid, we think, ultimately, could be one large
RTO, but we would acknowledge that there are regional
differences, and so an intermediate step that we see as a
minimum is the Pacific Northwest as an RTO, the Desert
Southwest, and the Rocky Mountain Region. Whether or not
California could move to that RTO quickly is maybe
questionable. We certainly would like to see it sooner rather
than later.
Mr. Ose. All right.
Mr. Winter, how about from the ISO's standpoint on this
RTO, any feedback?
Mr. Winter. I'd say I believe 1999 was when I proposed that
the Western Region ought to be one large RTO, right after that
came out. Tomatoes, a few rocks, things were thrown at me for
proposing that, but I still believe it.
And so, however the State of California recognized that,
passed a law saying that I could not become a member of an RTO.
Mr. Ose. So, you were statutorily prohibited from it?
Mr. Winter. Yes.
Mr. Ose. OK. So, I'm not going to ask you to break the law.
Well, gentlemen, I do want to thank you for coming. Given
the constraints of time--I know what time the county told us we
had today--I will leave the record open for 10 days for any
comments you wish to include.
First of all, let me thank you all for coming, as well as
the two members of the legislature. I learned a lot today
regarding the market design and reform that is, frankly,
essential, to ensuring that Californians pay only reasonable
prices for power.
I think we are all in agreement that markets don't work
well if they aren't designed well, that they'll collapse of
their own weight, and consumers will pay more than they should
if they aren't properly designed.
I will say, in my opinion, we have a market that has
significant design flaws in it today, and I know we are all
trying to work on it. I appreciate your efforts accordingly.
I do think that the independence of the CAISO Board is a
critical step. I've served on corporate boards. Frankly, they
serve a valuable role here, and their independence is at the
heart of their ability to do their job. The establishment of
that independent board of directors needs to take place sooner
rather than later. My people don't want to be paying high
prices because of inaction on this question.
I thank you all for coming, look forward to working with
you in the future. Have a great day.
[The hearing was adjourned at 11:58 a.m.]
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