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July - Duke Energy Employee Advocate

Deregulation - June, 2001 - Page 1

"Ye shall know the truth, and the truth shall make you mad." - Aldous Huxley

Deregulation Will Increase Power Costs
Associated Press - June 8, 2001

Oklahomans will pay more for their electrical power if the electric utility industry is deregulated in the state, according to a report delivered to the Oklahoma Corporation Commission Thursday. The report, prepared by the Oak Ridge National Laboratory, concludes that electricity costs will rise an average of one cent per kilowatt hour under a restructured market, from about 6 cents to 7 cents per kilowatt hour for residential customers.

The report also concludes that deregulation will result in higher earnings for electricity generating plants, especially low-cost coal-fired plants whose prices will rise along with those of more expensive gas-fired plants. "Prices will rise so these plants will recover their marginal costs," the report states. The report does not offer an opinion on whether the electric utility market should be restructured to meet the state's long-term power needs.

"It depends on a lot of things like monitoring and marketing practices," said Jim Palmer, spokesman for the commission.

"If they are not handled just right, it can go berserk. When you're dealing with a free market, anything can happen - and usually does," Palmer said.

Supporters of electricity restructuring maintain it will increase competition and lower energy prices for Oklahoma consumers.

"This was the best way to move into the future to keep rates as low as possible," said Paul Renfrow, spokesman for OG&E.

Renfrow said he had not studied the report and had not had a chance to analyze its conclusion that rates will rise under deregulation.

"We've said all along there was a possibility rates would go up," he said. Rates eventually will eventually go up anyway as producers build additional generating plants to keep up with demand, Renfrow said.

The Legislature this year passed a bill to delay electricity deregulation for two years while a task force studies the issue.

Plans to implement deregulation were shelved because of concern that it might lead to skyrocketing electrical costs and rolling blackouts like those that followed deregulation in California.

The study was performed by the energy center at Oak Ridge National Laboratory, which is owned by the U.S. Department of Energy, Palmer said. The center studies energy issues worldwide.

The report developed a model for electricity deregulation in Oklahoma based on data from 1999, the earliest available, Palmer said.

The report says Oklahoma is already a low-cost power state. "In a regulated market with prices based on average costs, the costs of all production are combined to provide relatively low costs to consumers," the report states.

But in a restructured market, prices will largely be defined by the price of the highest cost plant, it says.

"In Oklahoma, this will be gas-fired capacity most of the time," the report states. A second phase of the study due to be released in August or September will examine consumer demand as well as new sources of power generation in the state over the next 10 years.

Deregulation again gets focus
High Point Enterprise - By Paul Johnson - June 6, 2001

The miles of power lines that stretch through the medical facility provide the electricity that keeps machines and devices operating 24 hours a day. Electricity also creates a substantial expense item.

High Point Regional Health System on average spends $100,000 a month on electricity, said Director of Facilities Management Jim Morton. So with an overall expense that can reach $1.2 million on an annual basis, High Point Regional Health System maintains a keen interest in how local and state officials address the issue of power costs, Morton said.

On Tuesday, leaders with the city of High Point and the municipal trade group ElectriCities updated several dozen business leaders on the status of the electric industry in North Carolina. Morton was one of those attending the forum at the String & Splinter Club.

A year ago at this time, the state seemed poised to wire up to the electric deregulation grid that was multiplying across the nation. Two dozen state legislatures had either decided to move toward deregulation or institute programs.

Then the energy industry in California, one of the first states to deregulate, started to implode last summer.The resulting energy crisis has led to skyrocketing customer rates, insolvent utilities and rolling blackouts in California.

This summer, California power customers could have to cope with 15 hours a week of blackouts because of the energy crunch, said Jesse Tilton, president of Raleigh-based ElectriCities.

The power crisis in California has shifted the climate for deregulation, said Tilton, who spoke at the city-sponsored electric industry forum. States such as North Carolina that had been considering deregulation have put deliberations on hold, Tilton said...

Panel OKs Subpoenas for Energy Companies
L. A. Times - By C. INGRAM, M. BUSTILLO - June 5, 2001

Special state Senate committee will demand pricing information in inquiry into whether California has been gouged.

The Senate Rules Committee agreed Monday to issue subpoenas to eight out-of-state power generating companies demanding documents on pricing, bidding and other aspects of electricity sales in the state.

Sen. Joe Dunn (D-Santa Ana), chairman of the special Senate committee that is investigating whether power wholesalers are illegally profiteering from California's energy crisis, said he expects the companies to resist. That would set the stage for a court fight, he said.

In addition to subpoenas aimed at the private generating companies, the committee also put the Los Angeles Department of Water and Power on notice that unless it voluntarily provides information on its power sales to the state, the data will be subpoenaed as well. And the panel threatened to subpoena records of the state Department of Water Resources unless it turns over information on how it has spent more than $7 billion to keep electricity flowing in California.

Under Senate regulations, Dunn's panel needed approval of the Rules Committee to issue the subpoenas. Industry executives deny that they have broken any laws in selling electricity at premium prices to California's financially strapped utilities and the state water department.

The subpoenas will be issued to Reliant Energy, which Gov. Gray Davis has publicly accused of price gouging, Dynegy Energy Services Inc., Williams Energy, Enron Corp., NRG Energy Inc., Duke Energy, Mirant Inc., and AES Corp.

Dunn said executives of the generators seemed cooperative when the investigation was launched two months ago. Since then, he said, they have raised barriers, including demands that the confidentiality of their documents be protected.

The demand for information from the Los Angeles DWP and the state's water resources department were pushed by Sen. Ross Johnson (R-Irvine), vice chairman of the rules panel…

The big energy companies also took a hit Monday from a leading advocacy group for the poor.

The Pacific Institute for Community Organization, a coalition of faith-based groups that has pressed for California to cover more of the millions of working citizens without any health insurance, voiced concern that the energy crisis is hitting the poor hardest.

The group, which scheduled a Capitol rally today, plans to urge political leaders to use the economic power of the state's huge pension funds to leverage the companies.

The two pension funds own at least $1.2 billion in stocks and bonds in most of the major firms involved in the state energy crisis, from Enron of Texas to Duke of North Carolina, the advocates said.

"They could bring the voice of stockholders into the debate, as a major stockholder, and take a more enlightened view of what is happening to California," said activist Jim Keddy. "We really have no voice inside those companies right now."

Activists accused of favoring cash over mission at Moss Landing
San Francisco Chronicle - By S. Winokur, C. Berthelsen - June 3, 2001

Eager to placate environmentalists, the Duke Energy Corp. agreed to pay more than $12 million to Monterey Bay area groups whose objections could have scuttled the controversial expansion of its Moss Landing power plant, destined to be the state's largest.

Most of the groups are now being accused of taking financial advantage of the situation and betraying their mission as environmentalists to defend the Monterey Bay area's fragile harbors, sloughs and wetlands. The environmental groups protested until Duke put up money, then dropped their opposition.

The result, opponents say, is that the very things the groups originally protested, including the discharge of heated water into fragile aquatic environments, will still happen.

Donna Solomon, co-owner of Solomon Live Fish in Moss Landing, fears that the heated exhaust water will shrink catches of two commercially important fish, cabezon and bolina.

"They say they are environmentalists, but they are not -- they are frauds," Solomon said of the groups.

The funds include $8 million for "monitoring" environmental quality and for land acquisition -- an amount dwarfing the nonprofit groups' budgets, in some cases.

The fighting that broke out at the local level over Moss Landing, energy- industry critics say, is an inevitable consequence of authorities' failure to establish a broad, coherent energy policy and their desperate search for quick fixes to the crisis.

The deals, critics add, were a predictable corporate response to a situation that invited financial exploitation.

"Local groups quickly succumb to corporate money," said Doug Heller, a consumer advocate with the Foundation for Taxpayer and Consumer Rights in Santa Monica. "When we become dependent on them to take up statewide issues, the corporation is given the upper hand."

Two prominent Monterey County politicians took part in behind-the-scenes negotiations involving the 239-acre plant, sources who participated in the talks told The Chronicle.

Assemblyman Fred Keeley, D-Boulder Creek (Santa Cruz County), brokered a $1 million deal between Duke and the four environmental groups. Keeley, who plans to run for the state Senate in 2004, has accepted donations from the energy industry in the past, but says he stopped accepting the industry's contributions in January, after assuming a leadership role in dealing with the crisis.

County Supervisor Louis Calcagno pressed regulators to approve the power plant and held a meeting called to devise a way to transfer $3.4 million from Duke to the Moss Landing Chamber of Commerce. Calcagno is a Moss Landing dairyman with substantial agricultural, commercial and residential properties. He acknowledges that those holdings could grow in value as a result of Duke- funded projects in the area.

"There was money all around," said Gary Shallcross, chairman of the Central Coast Regional Water Quality Control Board.

Environmentalists who negotiated with Duke say they made the best of a bad situation. Rather than fight a project they believed likely to get speedy approval regardless of what they did, they accepted money from Duke. They contend that the funds will be used to benefit the environment.

"The bottom line is, we were looking at a locomotive coming down the track, " said Steve Shimek of the Otter Project in Marina, one of the groups that negotiated with Duke. "We made the decision to do the best we could. Do I wonder if we did the right thing? I question myself."

The three other groups that opposed Duke, then made a deal with the energy company, are Save Our Shores and the Center for Marine Conservation, both in Santa Cruz, and Friends of the Sea Otter in Pacific Grove.

Although fierce initially, key opposition to Duke vanished between the late summer and Nov. 6 -- when a document laying out the company's agreement to pay for "monitoring" and additional "mitigation" was finalized.

The environmental groups agreed by that date that they would "not participate in any lawsuit, regulatory challenge, regulatory appeal or any other action . . . that might obstruct, delay, or prevent Duke's construction" of the plant.

This contrasted with a Sept. 22 letter to the Regional Water Quality Control Board in which they said they were "deeply concerned" about impacts; had "serious reservations" about the amount of money Duke agreed to put up, to that point, to offset damage; and "strongly" believed the company should do more.

The Moss Landing plant will be the state's largest after its completion next summer. With an output of 2,538 megawatts, it's expected to account for 30 percent of all new electricity generated in California next year, serving about 2.5 million households in the Monterey, Santa Cruz and southern Santa Clara County areas, including San Jose.

At issue for the environmentalists is Duke's intention to use a relatively cheap "once-through" cooling system as part of the modernization and expansion project.

The cooling system would suck up to 1.2 billion gallons of salt water a day out of Moss Landing Harbor and two of the state's ecological gems, Elkhorn Slough and Monterey Bay. This amount would cover nearly 3,700 acres of land to a one-foot depth.

Duke contends that "once-through" is cleaner than lower-impact alternatives costing tens of millions of dollars more. The company also says studies show its impact on marine organisms won't be unacceptably high. Environmentalists uniformly disagreed.

About two things, however, there has been no dispute.

The "once-through" process will exterminate a substantial portion of the aquatic food chain, chiefly the smallest organisms, before the slightly chlorinated water is returned to Elkhorn Slough, nearby Moro Cojo Slough, Moss Landing Harbor and Monterey Bay.

Moreover, the process will allow the discharge of large amounts of water 600 feet offshore in Monterey Bay at temperatures up to 20 degrees warmer than natural water temperatures.

For some of the delicate organisms that survive the previous stages of the process, this may mean the equivalent of death by boiling. As one environmentalist told regulators, " 'Cooling water' is a euphemism . . . 'Heated exhaust water' is a more accurate description."

Duke spokesman Tom Williams said the company did nothing wrong and contended that the expanded plant will be better for the environment than the current one. He said Duke had gone "the extra mile" to address community concerns.

Madeleine Clark, a Prunedale environmentalist, disagrees. "In Monterey County, Duke can waltz in and buy everybody off, and everyone looks the other way," she said.

A last-ditch challenge to the project by Clark and other protesting environmentalists will be heard by the State Water Resources Control Board in Sacramento on Wednesday.

Duke acquired the 30-year-old, 1,478-megawatt gas-fired plant from Pacific Gas and Electric Co. in July 1998 as part of a half-billion dollar package, including plants in Oakland and Morro Bay (San Luis Obispo County).

Five months later, the Charlotte, N.C., energy company announced plans to spend $475 million modernizing Moss Landing, a figure that would rise to $525 million. This was followed by an application to the California Energy Commission for permission to add 1,060 megawatts.

Despite environmentalist opposition, the project generally had an easy time of it in hearings before the Regional Water Quality Control Board and the state Energy Commission. When Duke broke ground on Nov. 16, about three weeks after the commission gave its final approval, the company had made the following side arrangements, totaling $12,435,000:

-- $1 million, in five annual installments, to the Monterey Bay Sanctuary Foundation "to monitor water quality in the Elkhorn Slough."

This is the deal that sparked the controversy. The funds were obtained for the foundation by the four environmental groups that opposed Duke, then dropped their opposition when the company put up the money.

An additional $425,000, in three annual installments, will be given to the foundation "to monitor the power plant's heated seawater discharge in the ocean." Most of the money will be used, the groups say, to pay experts to take water and marine-life tissue samplings for five years.

-- $610,000 to local agencies for air-pollution control, marine mammal care and trail building.

-- $7 million to the Elkhorn Slough Foundation for land acquisition and management.

Foundation Director Mark Silberstein said the money would be partly used to add to the 1,700 acres under the foundation's control and to pay for conservation chores such as removing weeds and planting native grasses.

Some environmentalists don't consider Silberstein's plan genuine mitigation.

Carolyn Nielson of Aptos, a foundation docent, quit in September after the $7 million deal was announced.

"The groups made a cynical decision that never again would there be an opportunity for such financial benefit," Nielson said.

Supervisor Calcagno also could benefit from the Elkhorn Slough deal by selling property or property easements to the newly enriched foundation.

He owns MoonGlow Dairy, a 110-acre farm adjoining the slough and the power plant. The farm includes a 22-acre pond frequented by bird-watchers.

As chairman of the Monterey County Board of Supervisors last year, Calcagno went on record in state hearings supporting Duke. He also said he had confidence in the Elkhorn Slough Foundation's ability to use the company's money to benefit the environment (Calcagno had been one of the organization's founders).

There's no indication that a transaction involving Calcagno and the foundation is imminent. But Silberstein didn't deny the possibility of an eventual deal.

"You need a willing seller, and Lou Calcagno owns that property," he said. "The door is open."

Calcagno said he would consider a transaction.

"That will probably be in a long-range plan. There is no doubt about that," he said.

-- $3.4 million to the Moss Landing Chamber of Commerce, in 20 annual installments, for "infrastructure improvements," including power-line undergrounding, storm drains and street lighting.

Here, too, Calcagno could benefit.

Since the late 1980s, he has been planning a large commercial project on Highway 1, not far from Elkhorn Slough. The project has been dropped, but Calcagno still owns the land on which it would have been built, as well as stores and apartments nearby.

Calcagno held a meeting at his office in Castroville last July to discuss how Moss Landing businesses would deal with the money Duke was offering, according to Jim Stillwell, harbormaster of the Moss Landing Harbor District.

Stillwell -- who opposes the plant and contends that it will increase toxic sedimentation in the harbor -- said at the meeting that he believed the district was best suited to handle the money because it is authorized to undertake public works.

He offered the district's services. He was rebuffed.

"We proposed this," Stillwell said. "Next thing I know, they give it to the chamber."

Calcagno confirmed the meeting and acknowledged that his properties could grow in value as a result of the Duke-funded projects chosen by the chamber, to which he belongs. He said, however, that he didn't care about the potential gains.

"The Duke project in no way benefits me," he said. "I can't get out of my driveway when the traffic is coming in the morning."

The four groups that made the deal with Duke insist they won't benefit. But the Monterey Bay Sanctuary Foundation, which will benefit, has connections to at least two of the groups.

Sanctuary Foundation President Warner Chabot of San Francisco is also regional director of the Center for Marine Conservation, which led the way in making the Duke deal. The Sanctuary Foundation, additionally, has accepted cash grants from both the Center for Marine Conservation and another party to the Duke accord, Friends of the Sea Otter, tax records show. Chabot said the links are of no significance.

"The great conspiracy does not exist," he said.

Vicki Nichols of Save Our Shores and Kaitilin Gaffney, Central Coast program director for the Center for Marine Conservation -- both parties to the Duke accord -- echoed Chabot.

But Gaffney admitted that there had, in fact, been much coordination between the groups before reaching an agreement with Duke. Gaffney's group and the Otter Project demanded $3.75 million -- $750,000 a year for five years -- within a week of each other in late October. Gaffney said this had been planned.

Duke countered with offers no higher than a few hundred thousand dollars, according to people who participated in the talks. As negotiations between Duke and the groups bogged down in early November, Assemblyman Keeley was asked to intervene.

"Fred prevented what could have been a bloody negotiation," Nichols of Save Our Shores said. "When he came in on behalf of the environmental community, Duke listened."

Keeley was no stranger to the energy industry. As speaker pro tem of the Assembly, he has been prominent in attempts to deal with the energy crisis. And state records show that he has received nearly $50,000 in campaign contributions from energy companies since 1998, including $5,500 from the Duke subsidiary running the company's power plant in San Luis Obispo County, Duke Energy Morro Bay. According to Keeley, the total amounted to less than 10 percent of all the political contributions he received.

"The things that drive me as a legislator are environmental protection, higher education and social justice," Keeley said, "and so when I get a call from two well-established environmental organizations saying we need help to get a better deal for the environment, I'm pleased to help."

A Duke California plant is included in the article linked below:

Nuclear Watchdogs Eye Duke's Salvage Operation

Watchdogs Take a Hit in California's Power Ills
L. A. Times - By J. PASTERNAK and A. C. MILLER - June 3, 2001

Ex-federal officials say oversight of California's deregulation suffered due to a push for free-market competition.

WASHINGTON--California was the first test, and right from the start economists at the Federal Energy Regulatory Commission saw trouble coming. Their bosses were worried too. In hindsight, some admit they could have done better.

But five years ago, when California officials were rushing to deregulate electricity, the federal watchdog charged by law with overseeing the process and guarding against runaway prices decided not to bark.

In their zeal for free-market competition and their ideological commitment to shifting authority away from Washington to the states, FERC's commissioners brushed aside their qualms and let the process roll forward. "There were a lot of issues that got swept under the rug," said economist Carolyn A. Berry, who headed FERC's analysis of the California plan. "We were trying to point out the ugly warts, but it wasn't our job to set policy." Former FERC Chairman James J. Hoecker, who presided over the approval, said the agency "should have been far less deferential." John Rozsa, a state legislative analyst who played a key role in the deregulation law, laughed when he heard that. "FERC wanted it badly," he said.

Today, FERC stands accused of failing to exercise its oversight, enforcement and political muscle just when they were needed most. The agency, critics on the inside and outside agree, helped launch a radical economics experiment without sufficient preparation, adequate staff or a clear sense of how to carry out its mission. With fully half the states considering deregulation, the story of what a previously obscure federal agency did not do has become more than a case study in regulatory shortcomings. It has become a warning shot across the bow of the whole country.

FERC has approved deregulation plans in New England, New York and the mid-Atlantic states. At stake is a reliable supply of a commodity that fuels virtually every home and workplace in America. California's example is hardly encouraging: months of blackouts and an electric bill that has rocketed from $7 billion in 1999 to as much as $50 billion this year.

Now the commission is caught in what some see as an identity crisis, divided and uncertain as politicians in California and Washington call for mutually contradictory action. "I think the commission needs to decide what it wants to do when it grows up," said Hoecker, who headed the agency during a critical period ending in January. His own leadership, he concedes, was not always all it might have been.

Without question, there is ample blame for everyone, not just FERC. Certainly in California, state officials devised a flawed deregulation scheme and then insisted on carrying it out. Some power company executives have extracted windfall profits. Politicians have wilted when things went awry.

And, as FERC officials continually point out, its authority is limited to wholesale markets. State officials are responsible for the local utilities and other retailers selling power to consumers.

Nonetheless, it is FERC that Congress charged with overseeing electricity markets and assuring "just and reasonable" prices.

How did FERC choose the course it took? What factors influenced its decisions?

Certainly energy companies, consumer advocates, lawmakers and others lobbied the agency.

Yet even FERC critics say such influence was not dominant. FERC is not insulated from lobbying, but David Nemtzow, president of the Alliance to Save Energy, a coalition of business, consumer and environmental leaders, said: "They are less sensitive to those forces than a lot of other players."

Rather, this seems to have been a case of government decisions driven by ideology. The commissioners, both Republicans and Democrats, were wedded to the idea that deregulation at the wholesale level would lead to lower retail bills. The market, they believed, would inexorably produce greater competition, greater efficiency and falling prices.

To Mark Cooper of the Consumer Federation of America, the primary problem was "their excessive faith in the market."

Even after price spikes occurred across the Midwest and in California as early as 1998, FERC officials dismissed suggestions the surges might reflect market instability or manipulation.

And as California's situation worsened, FERC's response was shaped by a continuing commitment to market forces with a minimum of government intervention--witness its April order allowing temporary price caps but only in narrowly defined emergencies.

In the last few months, under enormous pressure, FERC has ordered a dozen companies to justify high prices or refund $124.5 million to California utilities for January and February. It won an $8-million settlement from Williams Cos. of Tulsa, Okla., which it had accused of shutting power plants last spring to drive up prices. Williams did not admit guilt.

Detractors, including California officials, howl that FERC's actions are too little too late. They have called for a range of solutions, from flat-out price caps, as in the old days of full regulation, to much higher rebates from generators caught price-gouging, to retractions of individual firms' permission to charge market-based rates. If the agency chose to wield all of its authority, it also could force witnesses to testify under oath and subpoena tapes of phone calls among power traders, and even force the state to change the way the market operates.

Curtis L. Hebert Jr., the free-market champion who succeeded Hoecker as chairman, insisted "FERC is being vigilant in its efforts to ensure just and reasonable rates, while at the same time ensuring" that it fosters new energy supplies.

"I would vehemently disagree with anyone who says otherwise," he added, noting he transferred 75 attorneys--half of the agency's litigators--into market oversight.

Still, a consensus that it's time for aggressive action seems to be forming among commissioners, including two nominees confirmed by the Senate last month: Patrick H. Wood III and Nora M. Brownell.

Wood, a Texas utility regulator nominated by Bush and probably FERC's next chairman, said the agency needs to evolve into a "market cop with a great big old stick," adding: "There is a role that only the federal government can take. . . . The free market ain't a free and full market yet."

Already named FERC's special liaison for California, Wood remains dedicated to market principles but vows to take a fresh look.

Commissioner Linda Breathitt, a Democrat, also talks of change. And commissioner William L. Massey describes agency officials as naive in their past actions, in contrast to what he calls the "very sophisticated players" on the industry side.

If some commissioners are starting to sound more like watchdogs, that's partly because they feel the tug of two conflicting ideas in their mandate to open markets while assuring fair prices.

Americans have always loved the way capitalism gives opportunities to the shrewd and energetic. At the same time, the country has repeatedly turned to government regulation when it thought particular industries, such as the railroads, waxed too powerful.

How well FERC deals with this intrinsic conflict and meets its challenges may have a sizable effect on the country's energy future.

Frightened by events on the West Coast, some states have slowed their progress toward deregulation. Others have decided not to try at all, at least for now.

"If the commission wants to have competitive markets," Hoecker said, "it's going to have to pull the bacon out of the fire."

Though it traces roots back to the Federal Power Commission and development of hydroelectric power in the 1920s, FERC began its present incarnation in the 1980s, with the Reagan administration's deregulation campaign.

FERC undertook to deregulate natural gas, then, spurred by a Democratic Congress and the first President Bush, it moved on to electricity.

The problem is that electricity and its markets differ significantly from natural gas. Electric power cannot be stored to meet future shortages, as gas can. Its markets are more volatile. And the effect of shortages or price spikes cascades through the economy much faster.

Without anyone quite realizing it, FERC was sailing into uncharted waters.

Moreover, as FERC's staff took up the original California deregulation plan, it faced a significant constraint: The commissioners had made a conscious call to let the state have its way most of the time.

As state officials saw it, so much power was available for the Western electrical grid that prices would surely come down. FERC economists, on the other hand, saw myriad problems.

For example, the state's scheme called for generators to submit blind bids with a separate quote for each hour of the coming day. With any power plant, the unit cost is highest when a generator is started up and declines as it runs. So the price charged for later hours should be lower than for the first--but only if the operator can sell both the beginning and the later hours.

Under the California blueprint, though, bidders could not be sure which hours the purchaser might buy. That meant bidders would have to load the higher start-up costs into each hour throughout the cycle to make sure those costs were recovered. By contrast, the mid-Atlantic market requires the power purchaser to add separate payments to cover start-up costs.

Other issues were deferred rather than solved before FERC granted approval, including such questions as how to manage congestion on the grid and what the transmission rights should be for municipalities that generated and sold power.

State legislative aide Rozsa argues that such matters were not crucial and that the biggest flaw in the plan--the insistence that the system operator not have any generators of its own--was conceived with FERC guidance. Both FERC and the state, he said, had "an exaggerated sense of their knowledge and ability."

As the California launch, originally scheduled for January 1998, drew near, FERC's nervousness increased. As late as the Christmas holidays, the state was still tinkering. The agency ordered the state to provide two weeks' written notice before taking the final step, even though FERC had already approved the plan.

When California finally "went to market," FERC analysts snickered at the timing: The first electricity auction was held March 31 for power to be delivered the next day--April Fool's Day.

As for the commissioners, "We were somewhat naive," Massey said. "The commission believed there was so much inefficiency built into the old-fashioned . . . regime that any new market would be better."

With the nation's largest state deregulating, FERC began blessing plans on the East Coast. Hundreds of companies lined up for permission to charge market rates in various open trade zones.

FERC, according to its rules, was supposed to reject any firm that held a big enough share in a market--generally defined as about 20%--to influence prices for a sustained period. But doing the necessary market analyses proved impractical.

For one thing, the rising workload was overwhelming the staff, which had shrunk by more than 25% from its 1980 high of 1,600 employees. The agency, as critics see it, simply buckled.

"Once it got going, it took over," Berry said of the momentum behind deregulation. "FERC was handing out [permission] to anybody who walked in."

FERC economist Steven A. Stoft was infuriated. He wanted to start cautiously, opening one small market, testing before expanding nationally.

"To put in markets everywhere, to affect a lot of people, to just wait and see how it turns out, that's completely irresponsible," said Stoft, who now lives in California and is writing a book for regulators about how to design markets.

At first, the staff Cassandras seemed wrong. Prices generally headed down.

But during the summer of 1998, prices spiked twice--once in the Midwest, once in California.

In the Midwest, several aging nuclear plants shut down for maintenance just as a heat wave sent air conditioners into overdrive. Wholesale electricity rose past $7,000 per megawatt-hour, 100 times normal. Consumers and politicians screamed.

The weather cooled and new supply came in fast. Prices ebbed.

To consumer groups and several FERC economists, the sudden increase suggested the worst can happen. Hoecker and FERC member Vicky Bailey drew a different lesson, as did a staff investigation: The market worked to correct an unusual confluence of events that was unlikely to recur.

About the same time, a strange thing happened in California's reserve market, where the state's independent system operator pays generators with extra capacity to stand ready to meet unexpected surges in demand.

So few companies offered to sign such contracts that the ISO sometimes had little choice but to accept whatever bid came in. It was just a matter of time before someone took advantage. One day in that summer of 1998 someone did: The only offer to provide reserve power was an astronomical $9,999 per megawatt-hour.

To some, it was proof that the California market could--and would--be manipulated. "I was horrified," Berry said.

FERC quickly granted California's request for permission to cap prices in the reserve. The authority quietly expired in November. There was no outcry about this spike because reserve costs are spread around to the states' utilities, thus diffusing their effect.

"Of course, it should have been a warning that the sellers were several steps ahead of us," commissioner Massey says.

In a memo last June, Ron Rattey, a senior FERC economist who has been with FERC since 1975, complained that the staff was "impotent in our ability to monitor, foster and ensure competitive electric power markets." He added in an interview: "FERC doesn't want to discover that the policy changes it's making aren't working."

Commissioners at the quasi-judicial agency are forbidden by law from privately discussing pending cases. So companies and Congress must officially content themselves with filing briefs, writing letters and testifying at hearings.

No such restraints apply to the issue of who sits on the commission. There, the jockeying for influence can be intense.

Commissioners are appointed by the president and confirmed by the Senate to staggered five-year terms, with a limit of three members of a political party on the panel. The president can also designate at any time which commissioner serves as chairman, a position that bestows broad authority over the FERC's agenda and staff.

When Bush took office, he picked Hebert, then the lone Republican on the commission, to the chairmanship and named his choices for the two vacancies. It was unclear whether Hebert would keep the chair once Bush's nominees were confirmed.

Soon afterward, Hebert talked by telephone with Kenneth L. Lay, who heads Enron Corp., a Houston-based energy marketing giant that recently saw its profits triple in a year. FERC policy decisions could have a huge influence on its future.

Enron spokesman Mark Palmer says Lay, whose friendship with Bush is well known, was returning a call from Hebert. Palmer says Hebert wanted Lay's support for remaining chairman.

Hebert told a FERC official, who heard the new chairman's end of the conversation, that Lay offered support but only if the chairman changed his views in ways that would aid Enron. The official says he heard Hebert decline and characterizes him as offended. The discussion was first reported in the New York Times. Lay has never been shy about offering advice, nor about courting political access. He golfed with President Clinton, and Palmer wrote a letter to Clinton's personnel chief touting Hoecker for chairman. The Enron executive's ties with Bush bind especially tight; Lay raised and donated hundreds of thousands of dollars to Bush's campaigns and related efforts.

Power companies also scouted candidates for the two slots. Enron went so far as to send the White House a list of a dozen people Lay considered qualified (the two new commissioners were on it). In the end, however, the evidence suggests that such lobbying mattered less than the faith in free markets and less federal intervention shared by two presidents and just about every recent FERC member. "FERC is filled with true believers," Rozsa said.

The agency's recent California orders underline the point. In December, FERC concluded the market was dysfunctional and ordered a limited version of the price caps that free marketers abhor.

Still, prices remained above $300 a megawatt-hour--10 times the pre-crisis average. So in April, FERC concluded it had to take further action.

But the new version of price caps, approved 2 to 1, actually narrowed the circumstances under which they could be imposed, though it gave the state more flexibility. Even temporarily, the commission would not abandon its market principles.

"I was reluctant to stop in my tracks," said Breathitt, the swing vote. She didn't want "to go back to a form of regulation that this commission and I had departed from five or six years ago."

Deregulation Failure in New York
Duke Energy Employee Advocate - June 2, 2001

The New York Times reported on the failure of deregulation in "A Failed Energy Plan Catches Up to New York." Things are not as bad as they are in California - yet. But things are not good.

Ten small generator are quickly being installed to prevent blackouts and price spikes this summer. Their power rates were high before deregulation. Now they are much higher, and projected to go even higher.

Now, the mayor and the State Public Service Commission want more government control. It is noteworthy that the State Public Service Commission drafted the deregulation plan! But it is to their credit that they realize that they have made a mistake and want to correct it.

“Statewide, suppliers manipulated prices on the wholesale markets about 10 times last year, according to the Independent System Operator, which runs the state's power grid. Just one of those instances, it says, cost utilities about $100 million.”

One power generator CEO said "I don't believe there is a lot of gouging taking place…" Oh, Well. Everything must be OK, as long as there is not a lot of price gouging going on!

Duke Calif. rates spike in emergency
The Charlotte Observer - By S. M. HOPKINS, P. WALLSTEN - June 1, 2001

Last-minute sale pushed charges to nearly 30 times average, firm says

As Duke Energy faces accusations of price gouging in California's escalating energy crisis, the Charlotte company acknowledges it has sold power to one wholesale customer for more than twice the highest previously reported price.

For several days in January, Duke Energy charged the California Independent System Operator $3,880 per megawatt hour. That's about as much electricity as the average Duke Power residential customer in the Carolinas uses in one month. That average Duke Power customer pays about $73 a month.

Duke's $3,880 charge is twice the $1,900 rate that brought another power generator harsh criticism in May from California Gov. Gray Davis, who is battling President Bush to impose caps on the state's skyrocketing wholesale energy prices.

The ISO sale came to light during an Observer analysis of federal documents that provide a rare public look at closely guarded pricing in California's convoluted energy market. After that analysis, Duke also gave The Observer pricing data it has previously refused to release.

Duke says its average wholesale price in California last year was $76 per megawatt hour.

For the first three months this year, which includes the high ISO sale, Duke said its average sales price was $136 a megawatt hour.

"On average, Duke's prices are not `gouging prices,'" said Nancy DeSchane, a vice president with Duke Energy's trading arm in Salt Lake City.

Wildly gyrating energy prices are the product of California's effort to deregulate its electric industry. Legislators intended the move to foster competition and lower prices. Instead, prices soared - sometimes to unheard-of extremes. Duke Energy, whose Duke Power unit is the largest Carolinas utility, is a key player in California, where it is one of five generators accounting for 30 percent of power production.

In the past year, Duke's highest-priced sales seesawed, then rose sharply. Last spring, Duke's top charge was $1,100 per megawatt hour.

During the summer, the high dropped to $554, then rose to $1,021 last winter and topped out at $3,880 during the first three months of this year.

Duke said its rate for the ISO sale reflected higher fuel costs, the cost of running an extremely inefficient unit of one plant and a poor-credit surcharge representing up to 80 percent of the total charge to a buyer that hadn't paid its bills. The sales came during times of extreme power shortages, including two days when the ISO called blackouts, Duke said.

Duke's total sale to the ISO at $3,880 was 5,000 megawatt hours - $19.4 million. The sale represented less than 1 percent of the 10 million megawatt hours Duke sold in California during the first three months of the year.

Most wholesale rate increases hadn't been passed on to Californians, but starting today, residential consumers begin receiving bills reflecting the largest rate increase in California history. Depending on use levels, consumers will pay two to three times the rate Duke Power charges its Carolinas customers.

The Observer's analysis of Duke's quarterly reports filed with the Federal Energy Regulatory Commission led the company to identify significant errors in reports. The reports, for example, listed one sale late last year for $4,845. Duke said the actual charge was $758. The company volunteered the $3,880 transaction, which had been reported as $250.

Duke will file amended reports.

"We have a number of erroneous items," DeSchane said. "It was not intentional."

The commission is required by federal law to assure "just and reasonable" prices, and the reports are one mechanism for monitoring prices.

Despite errors, the reports remain the best publicly available source of pricing information that Duke and other generators have fought to keep confidential.

The demands for pricing data come as the generators face lawsuits and state and federal investigations into claims of profiteering and price manipulation. The companies are resisting subpoenas from a state Senate committee investigating their business practices. The companies say price disclosure hurts their ability to compete.

"The fact that they are so insistent on confidentiality is very disturbing to me," said state Sen. Joe Dunn, the Orange County Democrat chairing the committee. "If (the allegation of market manipulation) isn't true, then why are they insisting on secrecy?"

In its quarterly federal reports, Duke lists the total power sold and the lowest and highest price for each customer. But Duke doesn't have to say how much power was sold at what price, so there's no way to calculate Duke's total California sales from the report.

The documents also show about 10 percent of Duke's sales volume came in what's called the spot market, a highly volatile, daily trading market.

The ISO sale at $3,880 was a last-minute sale, similar to those on the spot market, driven by heavy demand. The $1,900 charge that angered the California governor was a last-minute sale by Houston generator Reliant to avert blackouts.

In releasing the confidential pricing, Davis called Reliant's price "obscene."

He has called generators "the biggest snakes" and warned plant seizures could be the ultimate penalty.

For January and February trades - which includes Duke's $3,880 sale to the ISO - the Federal Energy Regulatory Commission has ordered generators to refund $124 million in overcharges, including $20 million from Duke. The company has said it will gladly refund those fees - if it ever gets paid.

Duke stands by the credit surcharge policy it developed as cash-strapped utilities stopped paying mounting bills. When the utilities stopped paying the ISO, that agency couldn't pay traders such as Duke.

The ISO, created under deregulation, oversees the state's electrical transmission system and is charged with ensuring the system has enough power to meet demand.

When the system runs short, the ISO buys power at what are typically high, last-minute prices. If there is no power to buy, the ISO calls for blackouts. Generators must sell available power to the ISO.

"We were forced to sell (to the ISO) and had an obligation to our shareholders to assess the risks," Duke's DeSchane said of the decision to levy a credit surcharge. "Nobody has paid bills yet."

The company has set aside $110 million to cover anticipated refunds and unpaid bills.

The federal reports also show Duke sold 90 percent of its power this year and 70 percent last year on contracts ranging from a few days to more than a month.

Duke says most of these contracts actually range from one to four years.

Pre-selling power means Duke forgoes the chance to make potentially larger profits selling that power on the spot market. If a plant shutdown or other problem prevented the company from producing power, Duke could be forced to buy on the spot market to fulfill the contract.

Duke says it wants the stability of long-term contracts. When Duke agrees to sell power, it also buys fuel to produce that energy. That means Duke locks in sales and its largest cost.

Duke entered the California market in 1998 by buying three power plants for $501 million. In 1999, the company signed a 10-year lease on a fourth plant. The company expected tight supplies, which likely meant strong prices, because California hadn't seen a major power plant built in 10 years. But, like much of California's leadership, Duke didn't forecast the severe shortages that have led to blackouts.

The result is a market in which sellers can charge prices far higher than elsewhere in the country.

Duke readily admits California profits have exceeded its expectations, although the company won't say how much money it has made in California.

This year, profits quadrupled in the unit that includes Duke's California plants as well as plants outside its regulated Duke Power territory in the Carolinas.

Duke calls the unit's earnings rise to $348 million from $82 million "stellar."

The unit accounted for 27 percent of the Fortune 100 company's pre-tax earnings, compared with 10 percent a year ago. Duke stock closed at Thursday at $45.72, 62 percent above its 52-week low.

Critics say generators' profits come on the backs of Californians.

Some economists and California politicians say generators' prices violate federal requirements that electricity prices be "just and reasonable."

"The generators are charging whatever they can get in the market," said Frank Wolak, a Stanford University economist with access to confidential pricing data.

"In economics, when there is a financial incentive for something to happen, it usually does."

The criticism haunts Duke veterans, sent from the Carolinas to make a go of the company's California gamble.

"We're out here on the new frontier, where they don't know Duke from Adam," said Randy Vigor, who helped build Duke's nuclear plants on Lake Wylie and Lake Norman and now heads a $500 million expansion at one of Duke's California plants. "We're getting blamed for a lot of things that aren't Duke's fault."

In July - before the big run-up in prices - Duke offered Davis the chance to buy enough electricity to power 2 million homes at $50 a megawatt hour. Davis did not act on the offer.

"At that point, prices were still lower than that," said Steve Maviglio, Davis' press secretary. "No one in a million years expected prices to rise as much as they have since then.

"Where is that offer today is the better question."

The answer, Duke says, is that the power has been sold.

"We feverishly attempted to provide a set of solutions to all the California folks," said Duke Chief Executive Rick Priory.

He includes in those attempts the offer Duke lawyers sent this spring to Davis, saying it would forgive millions in utility debts in exchange for an end to investigations. The move backfired when the offer became public May 2, dragging Duke into a harsh spotlight.

"They were clearly trying to call off the dogs," Maviglio said. "They realize this a public relations nightmare."

In similar past exchanges, Duke has said the "dogs won't find anything."

Priory says he doesn't regret making the offer, that it was an attempt to settle disputes and get on with building desperately needed power plants.

He says California remains important - and welcome - in Duke's portfolio.

"Our experiences in California have generally been positive. The one negative is the political rhetoric, but we know this problem will be solved, and that will be toned down," Priory said.

Meanwhile, he added: "We're just focused on producing every kilowatt of electricity we can." "We're out here on the new frontier, where they don't know Duke from Adam. We're getting blamed for a lot of things that aren't Duke's fault."

Energy Probe Winding Up
Duke Energy Employee Advocate - June 1, 2001

Yesterday the San Francisco Chronicle reported that the energy price manipulation probe is winding up. Rates were raised $5.7 billion in one year! The price tag for the bailout bill is $13 billion!

"Attorney General Bill Lockyer is offering multimillion-dollar rewards to power plant workers and energy traders who provide the state with inside information about wholesaler's decisions." If there is any evidence out there, this should flush it out!

One company has already refunded $8 million. Other companies under investigation include: Houston-based Enron Corp., Dynegy Inc., and Reliant Energy, Charlotte, N.C.-based Duke Energy and Atlanta-based Mirant Corp.

Deregulation - May 2001