<DOC>
[107 Senate Hearings]
[From the U.S. Government Printing Office via GPO Access]
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                                                         S. Hrg. 107-27

                    CALIFORNIA'S ELECTRICITY CRISIS

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                      ENERGY AND NATURAL RESOURCES
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION

                                   on

     CALIFORNIA'S ELECTRICITY CRISIS AND IMPLICATIONS FOR THE WEST

                               __________

                            JANUARY 31, 2001


                       Printed for the use of the
               Committee on Energy and Natural Resources

                                 ______

                    U.S. GOVERNMENT PRINTING OFFICE
72-191 DTP                  WASHINGTON : 2001
_______________________________________________________________________
            For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 
                                 20402




               COMMITTEE ON ENERGY AND NATURAL RESOURCES

                  FRANK H. MURKOWSKI, Alaska, Chairman
PETE V. DOMENICI, New Mexico         JEFF BINGAMAN, New Mexico
DON NICKLES, Oklahoma                DANIEL K. AKAKA, Hawaii
LARRY E. CRAIG, Idaho                BYRON L. DORGAN, North Dakota
BEN NIGHTHORSE CAMPBELL, Colorado    BOB GRAHAM, Florida
CRAIG THOMAS, Wyoming                RON WYDEN, Oregon
RICHARD C. SHELBY, Alabama           TIM JOHNSON, South Dakota
CONRAD BURNS, Montana                MARY L. LANDRIEU, Louisiana
JON KYL, Arizona                     EVAN BAYH, Indiana
CHUCK HAGEL, Nebraska                DIANNE FEINSTEIN, California
GORDON SMITH, Oregon                 CHARLES E. SCHUMER, New York
                                     MARIA CANTWELL, Washington
                  Andrew D. Lundquist, Staff Director
                      David G. Dye, Chief Counsel
                 James P. Beirne, Deputy Chief Counsel
               Robert M. Simon, Democratic Staff Director
                Sam E. Fowler, Democratic Chief Counsel
             Howard Useem, Senior Professional Staff Member




                            C O N T E N T S

                              ----------                              

                               STATEMENTS

                                                                   Page

Bailey, Keith, Chairman, The Williams Companies, Inc., Tulsa, OK.    85
Bingaman, Hon. Jeff, U.S. Senator from New Mexico................     5
Boxer, Hon. Barbara, U.S. Senator from California................    11
Burns, Hon. Conrad, U.S. Senator from Montana....................    38
Campbell, Hon. Ben Nighthorse, U.S. Senator from Colorado........    33
Cantwell, Hon. Maria, U.S. Senator from Washington...............    49
Craig, Hon. Larry E., U.S. Senator from Idaho....................    35
Crisson, Mark, Director/CEO, Tacoma Public Utilities, Tacoma, WA.   112
Dorgan, Hon. Byron L., U.S. Senator from North Dakota............     4
Feinstein, Hon. Dianne, U.S. Senator from California.............     6
Ferreira, Richard, Executive Advisor, Sacramento Municipal 
  Utility District, Sacramento, CA...............................    87
Fox-Penner, Dr. Peter S., Principal, The Brattle Group, Inc......    19
Frank, Stephen E., Chairman, President & CEO, Southern California 
  Edison, Rosemead, CA...........................................    61
Gale, John R., General Manager, Pricing and Regulatory Services, 
  Idaho Power Company, Boise, ID.................................   104
Hildebrand, Curtis A., Vice President, Project Development, 
  Calpine Corporation, Pleasanton, CA............................   119
Johansen, Judi, Executive Vice President, Regulation and External 
  Affairs, PacifiCorp, Portland, OR..............................   116
John, Frederick E., Senior Vice President, External Affairs, 
  Sempra Energy, San Diego, CA...................................    67
Karier, Dr. Tom, Council Member, Northwest Power Planning 
  Council, Spokane, WA...........................................    95
Kean, Steven J., Executive Vice President & Chief of Staff, 
  Enron, Houston, TX.............................................    72
Kline, Steven L., Vice President, Federal Governmental & 
  Regulatory Relations, PG&E Corporation.........................    64
Konolige, Kit, Managing Director, Morgan Stanley Dean Witter, New 
  York, NY.......................................................    24
Landrieu, Hon. Mary L., U.S. Senator from Louisiana..............    54
Makovich, Lawrence J., Ph.D., Senior Director of Research, North 
  American Electric Power, Cambridge Energy Research Associates, 
  Cambridge, MA..................................................    12
Murkowski, Hon. Frank H., U.S. Senator from Alaska...............     1
Nickles, Hon. Don, U.S. Senator from Oklahoma....................    55
Perkins, Joe Bob, President and Chief Operating Officer, Reliant 
  Energy Wholesale Group, Houston, TX............................    76
Schumer, Hon. Charles E., U.S. Senator from New York.............    58
Thomas, Hon. Craig, U.S. Senator from Wyoming....................    43
Wilcox, Brett E., Chief Executive Officer, Golden Northwest 
  Aluminum Inc., The Dalles, OR..................................   109

                               APPENDIXES
                               Appendix I

Responses to additional questions................................   149

                              Appendix II

Additional material submitted for the record.....................   169

 
                    CALIFORNIA'S ELECTRICITY CRISIS

                              ----------                              


                      WEDNESDAY, JANUARY 31, 2001

                                       U.S. Senate,
                 Committee on Energy and Natural Resources,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 9:40 a.m. in room 
SH-216, Hart Senate Office Building, Hon. Frank H. Murkowski, 
chairman, presiding.

         OPENING STATEMENT OF HON. FRANK H. MURKOWSKI, 
                    U.S. SENATOR FROM ALASKA

    The Chairman. Let me welcome you to the Energy & Natural 
Resources Committee hearing. The hearing today is on the 
California electric crisis and its effect on other Western 
States.
    In view of the lengthy number of witnesses that we have, 
with the exception of Senator Bingaman and myself, and we have 
agreed upon this, we are going to defer opening statements and, 
as we all know, Senators can abbreviate their opening 
statements in their questioning period. However, we are going 
to make an exception and allow the two Senators from California 
to make statements relative to the significance of what this 
crisis has done to their State and Senator Bingaman and I have 
agreed that is probably the best way to expedite this hearing.
    We are certainly aware of the seriousness of the problems 
in California, and I am not going to go into that today. 
However, I think it is fair to say that those that characterize 
the California deregulation as a failure do not fairly evaluate 
deregulation. California really does not have a deregulation in 
the strict sense of the word. With the capping of retail 
prices, why, clearly that changes the structure.
    I think Chairman Greenspan has indicated in his statement 
before the Budget Committee that that type of deregulation 
really is questionable. I think he noted that power can be 
supplied in a regulated market or a deregulated market, and I 
quote, ``but if you try to mix the two it is clearly, as 
evidence demonstrates, not the desirable way to go.'' I think 
that's an understatement.
    In any event, we have what we have, and the California 
problems affect nearly everyone connected to the grid, the 
entire West. The Idaho Power may have to raise their rates as 
much as 24 percent. Tacoma Power in the State of Washington has 
already raised their rates 50 percent. Utilities serving 
Arizona's Tahonaho Indian Reservation will have to raise rates 
an additional $1 million collectively on top of a 30-percent 
rate increase last summer.
    We are seeing other States--Governor Leavitt of Utah said, 
``what is at stake is the economic competitiveness of the 
West,'' and we have seen Chairman Greenspan's analysis of the 
situation.
    Having come from the bankruptcy community I have seen what 
a bankruptcy judge can do in a bankruptcy in dictating the 
rates the consumer may have to pay to restructure the utilities 
if, indeed, it should come to that.
    Now, so far California has had 12 days of stage 3 emergency 
electric reserves of less than 1.5 percent, or prevalent 
margins that should be in the range of 15 to 20 percent are not 
there. It will be interesting to see what happens when the 12 
days are up, whether California will actually have a workable 
plan that has the confidence of the investment community, or 
whether they will come back into the Federal Government for an 
extension of time.
    We have seen statements from the administration that they 
do not intend to extend that sales order, but as bad as the 
trouble sounds, many of us on this committee fear the worst is 
yet to come. It is anyone's guess what is going to happen this 
summer when the air conditioners are turned on. Given the 
reservoir levels in the Northwest even less power may be 
available to California.
    Now, some of us feel that California created this problem 
by betting that it could rely on electricity produced in other 
States to meet the growing demands in California. The 
realization that no major powerplant has been built in a decade 
is a reality, and the fact that 25 percent of California's 
electric energy comes from outside the State I think sets a 
parallel.
    It sets a parallel, if you will, on the reliance that our 
Nation has on imported oil. We're 56 percent dependent on 
imported oil. See what happens to a State that is 25 percent 
dependent on electricity coming from outside the State, and the 
exposure of the Federal Government and the United States in 
relying on 56 percent of oil coming from outside this Nation.
    We also have inconsistencies. Take the case of Cisco, which 
fought the construction of a new powerplant near its office 
building in California. The irony of an electricity-dependent 
high-tech company locking the construction of an electric 
generator is simply--well, it is not-in-my-backyard mentality.
    Again, this crisis was a result of California's scheme of 
partial deregulation. I have already covered that. The Governor 
and the State legislature are struggling with the immediate 
crisis, but I think California needs to look at the future, the 
long term. It needs to recognize that electricity does not 
appear magically at the plug, as some seem to suggest. Somebody 
has to produce it. It has to come from the power of nuclear, 
the power of coal, clean coal, hydro, natural gas, wind, and 
other renewables.
    I think some in the California environmental community 
forgot where it came from. Now there is a credit problem here 
and the ability of California to pay for its power, as well as 
an energy problem. If California expects to achieve a 
meaningful solution to the problems, the path is clear. It is 
going to have to allow and encourage new generation and 
transmission to be built. The question of the State taking over 
the industry is something that we can explore today, so I am 
not going to comment on that, but the reality is, somebody has 
got to pay for it. There is no free ride.
    I think there is a lesson here for the other States both in 
the East and the West, and there is also a lesson here for the 
Federal Government, Congress and the administration. For far 
too long we have not had a workable, functioning energy policy 
in this country.
    What California has taught us is, we cannot rely upon 
others to provide our energy security, so what we have today is 
a number of expert witnesses, but we do not have FERC, and we 
do not have the Secretary of Energy. Some of us see this in 
spite of our sympathy and recognition that we all have to do 
something about the problem, that this initially in this stage 
is a California problem, and it is appropriate that we have 
primarily California witnesses.
    We will explore whether, indeed, there is a legitimate role 
for FERC and the Federal Government. Again, some of us are 
almost of the opinion that the government of California was 
trying to protect the consumer, the consumer ratepayer from 
themselves. Now, I do not know whether you can do that. Maybe 
we can find that out in this hearing today.
    So what we have in these three panels is an effort to try 
and find factual information and gain an accounting of what is 
really occurring, and what it is going to take to fix the 
problem, not fix it temporarily with a band-aid, but fix it so 
it will work and progress.
    The first panel consists of industry experts and a Wall 
Street analyst. I hope that the Wall Street analyst will call 
them as he sees them from the standpoint of what Wall Street 
sees going on in California, whether they're going to step up 
and finance new energy in California, or whether they feel that 
corrective action is sufficient or not.
    The second panel is going to consist of three California 
investor-owned utilities, followed by those in the generation 
of electricity in California, and the marketers who sell power, 
and lastly, the second largest municipally owned utility in 
California.
    We had invited the California independent system operators 
and the Los Angeles Department of Water & Power, but they 
declined the opportunity to testify.
    Finally, the third panel consists of public and private 
utilities and others who are located outside of California, and 
they can testify as to the impact California is having on them.
    Senator Bingaman.
    [The prepared statements of Senators Murkowski and Dorgan 
follow:]
Prepared Statement of Hon. Frank H. Murkowski, U.S. Senator From Alaska
    Today's hearing is on the California electricity crisis and its 
effects on other Western states.
    California has serious problems. Shortages. Blackouts. Families 
sitting in the dark. Traffic lights out. People stuck in elevators. 
Production lines shut down. Utilities on the brink of bankruptcy. 
Stockholders and pension funds suffering major losses.
    California's problems are affecting everyone connected to the 
grid--the entire West. Idaho Power may have to raise rates 24 percent. 
Tacoma Power has already raised them 50 percent. The utility serving 
Arizona's Tohono Indian reservation will have to raise rates an 
additional $1 million on top of a 30 percent rate increase last summer 
despite a 20 percent unemployment rate on the reservation.
    Utah Governor Leavitt said that ``what is at stake is the economic 
competitiveness of the West.'' Federal Reserve Chairman Greenspan 
warned that California's crisis threatens the Nation's economic 
expansion.
    So far California has had 18 days of a ``Stage 3'' emergency--
electric reserves of less than 1.5 percent--margins that should be in 
the range of 15 to 20 percent. As bad as that sounds, I fear that the 
worst is yet to come. It is anyone's guess what will happen this summer 
when the air conditioners are turned on. Given the reservoir levels in 
the Northwest, even less power is going to be available this summer for 
California to import.
    California created this problem by betting that it could rely on 
electricity produced in other States to meet its growing needs. No 
major powerplant has been built in California for more than a decade.
    Take the case of Cisco which fought the construction of a new 
powerplant near its office building in California. The irony of an 
electricity-dependent, high-tech company blocking the construction of 
an electric generator is simply too much. No wonder there is little 
sympathy in other states.
    This crisis is also the result of California's scheme of partial 
deregulation--deregulate wholesale sales and continue to regulate 
retail sales. As Chairman Greenspan noted last week--power can be 
supplied in a regulated market or a deregulated market--``but if you . 
. . try to mix the two . . . it is clearly, as evidence demonstrates, 
not the desirable way to go.''
    In this connection, I understand that the California public utility 
commission has claimed that FERC has approved California's retail 
rates. I would observe that under the Federal Power Act, FERC has 
exclusive jurisdiction over wholesale rates, but that States have 
exclusive jurisdiction over retail rates. It is well settled law--the 
so-called ``Filed Rate Doctrine''--that States may not deny the 
passthrough of Federally approved rates, such as FERC-approved market-
based rates. Nine days ago, a Federal Court held that the State may not 
deny California's utilities the passthrough in retail rates of 
prudently incurred wholesale power costs. If the State of California 
acts promptly to comply with this Federal court decision, that could 
help address the financial stability of California's utilities, which 
is a major element of the California crisis.
    Governor Davis and the State legislature of California are 
struggling with the immediate crisis. But California also needs to look 
to the future--the long-term. It needs to recognize that electricity 
does not appear magically at the plug--it comes from generators. 
Nuclear, coal, hydro, natural gas, wind and other renewables.
    If California expects to achieve a meaningful solution to their 
problems the path is clear--allow new generation and transmission to be 
built--not have the State take over the industry and try to run it.
    There is a lesson here for other States--both in the East and the 
West. You too must look to the future. You too must make sure that 
energy is available for homes and businesses.
    There is also a lesson here for the Federal government--Congress 
and the Administration. For too long, we haven't had an energy policy. 
What California has taught us is we can not rely upon others to provide 
our energy security.
    It is high time we have one so that consumers and industry have the 
energy needed to sustain our economy and way of life.
                                 ______
                                 
       Prepared Statement of Hon. Byron L. Dorgan, U.S. Senator 
                           From North Dakota
    Mr. Chairman, I am pleased that we are holding this hearing. The 
California energy crisis is significant, and it is important for us to 
learn what is causing this crisis, and what we can do to solve it. We 
also must learn from this experience and avoid similar problems in the 
future.
    I have long said that deregulation of industries such as the 
airlines, railroads and telecommunications have ended up hurting rural 
states like North Dakota. The California experience is reinforcing my 
belief that electricity deregulation, or restructuring, could cause 
similar harm.
    I am very concerned about the energy problem the U.S. faces. I held 
a hearing in North Dakota on Monday to learn first-hand about some of 
the problems my constituents are facing as a result of high energy 
costs, particularly of natural gas. Natural gas supply is an issue in 
the California market, too, and I know this will be examined during the 
course of today's hearing and beyond.
    Some will argue that ``the free market'' will take care of 
problems, such as those being experienced in California and elsewhere. 
However, when a dysfunctional and only partially deregulated market is 
created, it is a recipe for failure, and the free market will not solve 
the resulting problems.
    National Public Radio and other media have been reporting profits 
in the hundreds of millions of dollars for some companies selling into 
the California market. This is wrong--especially at a time when 
blackouts are occurring and the California companies are going 
bankrupt.
    In addition, the California companies also reaped billions of 
dollars in profits in the early years of California's electricity 
restructuring. The issue is what happened to these funds that made them 
unavailable when the recent crisis hit? Reports indicate that the 
profits went to the parent companies, and to pay dividends, pay off 
debt, reinvest in capital, and more. Thus, the funds weren't available 
when power supply shortages occurred and prices rose dramatically.
    Mr. Chairman, I do not have the answers to all of these questions--
it's unlikely that anyone does--that's why we're here today. However, I 
do know that the California system does not work. The Power Exchange 
has contributed another layer of bureaucracy and complexity that has 
contributed to California's problems.
    I believe that some of the recent federal actions and state actions 
in California have been appropriate to begin to alleviate the crisis 
that State is facing. For example, elimination of the requirement that 
power be purchased and sold through the Power Exchange seems practical. 
The imposition of the ``soft price cap'' ($150 per megawatt hour) on 
wholesale power sales also appears not only appropriate, but necessary, 
at this time. The cost-based rates may also be a solution, at least in 
the near term. Cost-based pricing has enabled federal power facilities 
to recover their investment and power supply costs, while keeping the 
cost of electricity affordable for commercial and residential 
consumers. North Dakota benefits from cost-based rates and will 
continue to benefit, at least until real restructuring legislation that 
creates true competition is enacted into law.
    We need to look at longer-term steps, too, however.
    For example, California's retail price caps means that there has 
not been any market responsiveness so, consequently, there are no 
incentives for consumers to respond to the current crisis.
    We need to provide incentives for consumers to conserve energy. We 
need to look to renewable and alternative measures, not as entire 
solutions in and of themselves, but as part of an overall, long-term 
solution.
    Let me also point out that utilities' claims that environmental 
regulations are prohibiting construction are not altogether plausible. 
Information from the California Energy Commission indicates that delay 
in the construction of new power plants in the state during the past 
decade was due largely to plans that were underway to deregulate the 
State's energy market. Until the deregulation plan was completed in 
1996, generating companies were reluctant to invest in new plants due 
to uncertainty over future profits in a deregulated market. Unusually 
low demand for electricity during the mid-1990s, and historically low 
prices for power, led companies to shun new plant construction. When 
the prospect for large financial returns improved, however, 
construction of substantial quantities of new generating capacity 
actually began in California--apparently uninhibited by any 
environmental regulations.
    I look forward to hearing from our witnesses and to working with 
all of the relevant stakeholders to craft a national energy policy that 
corrects past mistakes, and that works for all of us in the future.
    Thank you, Mr. Chairman.

         STATEMENT OF HON. JEFF BINGAMAN, U.S. SENATOR 
                        FROM NEW MEXICO

    Senator Bingaman. Thank you very much, Mr. Chairman. What 
is happening in California is extremely serious. It is serious 
not just for the people of California, but for people 
throughout the West, and, of course, throughout the rest of the 
Nation. California is not an island unto itself. Its electrical 
system is inseparably connected to the western power grid. Its 
economy is inseparable from our national economy.
    The roots of California's problem may or may not hinge upon 
California's restructuring plan, and I think we will hear a lot 
of testimony about that today, but the effects of the problem 
extend to the rest of the West and to the Nation.
    To his credit, President Bush has recognized that 
California has a problem, and that the problem is spreading 
beyond California's borders. Unfortunately there seems to be, 
at least from some statements made by the President and the 
administration, there seems to be a perception that this is 
California's problem and should be left to California for a 
solution.
    About the only solution I have heard so far from the 
administration is the opening of ANWR. Many factors seem to 
have contributed to the California electricity crisis, but the 
ban on oil drilling in ANWR is not one of them. Less than 1 
percent of California's electricity is generated by oil-fired 
plants, and all of the oil in Alaska will not fix what is wrong 
with California's electricity market.
    I look forward to hearing from our experts as to what they 
think the best solution is to this electrical power crisis. It 
may be to impose some sort of price caps or cost-of-service 
rates on wholesale sales. It may be something else. Whatever 
the answer is, I believe the administration and the committee 
have an obligation not just to California but, of course, to 
the entire Nation to try to find a solution and put that 
solution into effect before the crisis worsens.
    Sixty-six years ago, when our predecessors here in the 
Congress passed the Federal Power Act, they asserted Federal 
jurisdiction in that act over interstate power and the 
interstate power grid. They said they wanted the Federal 
Government to be ``ready to do all that can be done in order to 
prevent a breakdown in electric supply.''
    Clearly, the Federal Government has not done and is still 
not doing all that can be done and needs to be done to fix this 
national crisis. I hope we get some insights into what steps 
need to be taken in today's hearing.
    Thank you.
    The Chairman. Thank you very much, Senator Bingaman. I 
would call on Senator Feinstein, who is a member of the 
committee, and then we will hear from Senator Boxer.

       STATEMENT OF HON. DIANNE FEINSTEIN, U.S. SENATOR 
                        FROM CALIFORNIA

    Senator Feinstein. Thank you very much, Mr. Chairman. I 
want to thank you and I want to thank Senator Bingaman for 
holding this hearing. I think it is a very good list of 
witnesses, and I am hopeful that we can learn a great deal.
    I would also like to extend my thanks both to Secretary 
Richardson and Secretary Abraham. Both Secretaries have gotten 
fully involved in the California problem. Secretary Abraham has 
carried that out, I am very pleased to say, and I frankly am 
very grateful to him for extending the emergency order both on 
electricity and natural gas.
    As he said, it would have to take some very compelling 
circumstances to continue to extend that, particularly for 
electricity. The natural gas crisis appears to be looming in a 
very serious manner, and I believe his comments did not extend 
to natural gas.
    Mr. Chairman, I have prepared a rather lengthy formal 
statement which I would just like to enter in the record.
    The Chairman. It will be entered in the record.
    Senator Feinstein. I would like to summarize, and let me 
begin by quoting from the letter that I just handed you dated 
January 30 from the Governor of California addressed to both 
Senators Murkowski and Bingaman, and I would ask that this full 
letter go into the record.
    The Chairman. Without objection.
    Senator Feinstein. The Governor points out that a number of 
steps are being taken, and I would like to just quote a few 
parts. We are now focusing our efforts in the following four 
main areas, 1) increasing the energy supply through expedited 
plant construction and other sources of power generation; 2) 
decreasing energy demand and increasing efficiency; 3) 
expanding the use of long-term energy contracts, rather than 
relying on the volatile and expensive spot market, and 4) 
maintaining the financial viability of California's public 
utilities.
    The Governor goes on to say that supply clearly has not 
kept pace with demand. In the 10 years prior to my taking 
office, there was no significant powerplant construction. To 
address this imbalance we are rapidly siting over 20 new 
powerplants, including 9 that have been permitted and 5 that 
are currently under construction. By year's end, California 
should have 2000 megawatts in new power production online. He 
submits an attachment which details that.
    We are also streamlining the process to approve new 
powerplants, cutting the time by one-half in some cases. In 
addition to plant construction, we are looking at creative ways 
to get substantial megawatts online for the coming two summers 
through a variety of alternative and innovative technologies. I 
might add that six new powerplants should be online prior to 
the end of 2002, but not before then, and that is why this part 
is important.
    In addition, we are finding flexible ways to allow for 
power generation while continuing to protect our environment. 
We are also coordinating powerplant maintenance schedules 
through the ISO and legislation recently passed, I might add, 
has reconstituted the ISO, has changed the mid-1900 
deregulation law to require that utilities no longer divest of 
their generating facilities, but hold those facilities at least 
through 2004.
    Legislation is now pending--it did not pass through the 
Senate yesterday, but hopefully by the end of the week--to 
permit some bilateral contracting and the auctions that have 
been held have resulted in more than two dozen additional 
contracts at about $74 a megawatt hour. That is not as low as 
was hoped, but my understanding, these contracts vary between 6 
months and 10 years. I think there are 39 of them in total.
    He goes on to say that I announced the results of the first 
Internet-based auction for long-term electricity contracts, and 
then he goes on to speak about maintaining the financial 
viability of utilities.
    I must say this. I think people in California are confused 
between the power generation role and the utilities' role of 
distributing power, because this morning's newspaper carried an 
article about Southern California Edison selling its generation 
facilities, which were required under the California law, and 
paying off the loans on those facilities, and then taking $4.5 
billion and putting it in the holding company.
    There is a great deal of criticism emanating because of 
that. I am not going to enter into that debate. I am going to 
say that it is probably sort of standard practice for privately 
owned or investor-owned companies to provide for their 
shareholders. I mean, I think almost any company would do this. 
The question of whether in an electricity situation this is the 
right thing to do remains to be seen, but up to this point, 
what has happened is, the utilities have had to buy power at 
rates that increased 1,000 percent in this crisis, 
extraordinarily volatile purchases.
    If you can pass through 64 megawatts per hour, or $64, and 
you have to buy megawatts at $1,000, or $3,000, you can see 
what happens in terms of the accumulation of debt and, in fact, 
these utilities have been acquiring debt at about $3 million a 
day. That is inordinate.
    Now, let me just make a couple of recommendations. What can 
the Federal Government do in this crisis until additional power 
generation gets online? The first thing is, provide some 
stability in the marketplace. To that end, I have introduced a 
bill which I hope the committee will consider.
    FERC has the authority to grant, to put on a cap or to do 
cost-based rates if the rates are found to be unjust and 
unreasonable. FERC has made that finding, but it has refused to 
go the next step. My legislation would give the Secretary of 
Energy the ability that if FERC finds rates unjust and 
unreasonable to, 1) do cost-based rates which allow for costs, 
which allow for a margin of profits, or secondly to put forward 
a temporary wholesale regional price cap which the Governor of 
a State can opt out of if they do not want to be in it, and I 
would like just quickly----
    The Chairman. Could you summarize the balance of your 
statement?
    Senator Feinstein. Yes. Could I just indicate and enter 
into the record a letter from the Governor of California to the 
Governor of Arizona and Nevada, Wyoming, Montana, and Utah 
essentially saying that one immediate solution to protect our 
customers from skyrocketing prices may be for the FERC to 
implement a temporary cost-plus-pricing requirement?
    The Chairman. Without objection.
    Senator Feinstein. I will terminate now, and thank you.
    [The prepared statement of Senator Feinstein follows:]
    Prepared Statement of Hon. Dianne Feinstein, U.S. Senator From 
                               California
    Thank you, Mr. Chairman.
    I appreciate your holding this hearing. There is a lot on today's 
agenda, and I will try to be brief.
                             current status
    Today, California is in its 16th straight day of a Stage 3 energy 
emergency. This means that California's energy reserves have remained 
below 1.5 percent since the middle of January.
    Fortunately and miraculously, California has only had two days of 
rolling blackouts.
    With the help of the President's Emergency Order requiring out-of-
state generators to sell energy into the California market, California 
ISO has managed to keep the lights on.
    Nevertheless, California cannot maintain the status quo 
indefinitely. The fact that there are extremely low reserves places 
incredible stress on our electric infrastructure and the financial 
underpinnings of that system.
                         keeping the lights on
    California's peak demand during the winter is approximately 30,000 
megawatts per day.
    The State is meeting this demand through various strategies--
including implementing its interruptible load contracts, purchasing 
surplus power from out-of-state suppliers, and even waiving permits for 
smog-causing pollutants (such as NO<INF>X</INF>). The State, however, 
cannot keep up this juggling act.
    This has been one of the driest years on record in Northern 
California and the Northwest. As a result, reservoirs are low. And 
because much of our power in the summer comes from Hydro-Power, it is 
likely that there will not be sufficient supply to meet the increased 
summer demand of approximately 42,000 megawatts.
    Unless the State and Federal government take action now, I fear 
that we will have widespread and debilitating outages in California 
and, possibly, other areas of the west.
                            financial crisis
    Because of the way the electricity market was restructured, this 
energy crisis is causing a financial crisis as well. The cost of 
constant peak power has ruined the credit ratings of our two largest 
investor-owned utilities, PG&E and Southern California Edison and has 
them poised on the brink of bankruptcy.
    Consequently, the State has had to step in and buy power itself. In 
fact, the State has already spent $500 million dollars to secure power 
supplies. Furthermore, the State is suffering from lost productivity as 
a result of this crisis.
    A recent study by the Los Angeles County Economic Development 
Corporation has concluded that California's rolling blackouts and 
interrupted service have taken an estimated $1.7 billion toll in direct 
and indirect costs on the economy. This figure includes costs to big 
businesses, small businesses, and institutions. When the lights go out, 
we suffer from lost wages, lost sales, and lost productivity.
    If nothing is done, the 6th largest economy in the world is put at 
risk.
    Two questions arise: How did California get into this mess, and how 
will we get out of it?
                            state situation
    In 1996, California passed a badly flawed electricity deregulation 
bill. It was problematic on several fronts, but the biggest problem 
with the bill was that it forced California to rely on the ``spot'' 
market and ``day ahead'' market for 95 percent of its electricity.
    At the time, supplies were high and prices were low, in large part 
because the State was still recovering from the 1990-1991 recession. 
Legislators assumed that deregulation would spur an increase in new 
generation and that demand would stay low and energy efficiency would 
improve. All those assumptions turned out to be wrong. In the past four 
years, demand has skyrocketed and little has been done to improve 
energy efficiency.
    Demand for energy increased, but the supply of energy has remained 
constant. Inexorably, wholesale prices went up, and now we face 
shortages.
                     solutions to the energy crisis
    In theory, the solution to the energy crisis is simple: either 
increase supply or decrease demand or do some of both. In the real 
world, however, that is much more difficult to accomplish than it 
sounds. Power plants take 3-4 years to get sited and built, and people 
need energy to run their daily lives.
    Nevertheless, California is taking steps to address the crisis. 
Already, the State has approved 9 major power plants, which will 
generate enough energy to power 6 million households (6,278 Megawatts).
    California has also implemented a conservation plan, which cuts 
energy use across the State by 7 percent. In addition, the state has 
taken steps to fix the market which has caused this crisis. California 
has:

  <bullet> Conducted an energy auction to cover up to one-third of the 
        State's energy demand;
  <bullet> Expedited siting of new generating facilities;
  <bullet> Eliminated environmental obstacles to in-state energy 
        generation.

    Through these efforts, I am hopeful that California will be able to 
avoid further blackouts in the next few weeks.
                              federal role
    The most important thing that the Federal government can do is 
provide stability and prevent price gouging. To that end, I have 
submitted legislation to give the U.S. Secretary of Energy the 
authority either to impose an interim Western regional price cap or to 
set reasonable cost-of-service-based rates for power generators if the 
Federal Energy Regulator Commission (FERC) finds there are ``unjust and 
unreasonable'' rates being charged.
    You can't have a situation where California is buying power 
averaging $300 per megawatt hour, but can only pass it on to consumers 
at an average of $75 a megawatt hour. Under the Federal Power Act, FERC 
holds the exclusive authority over energy generators and marketers. But 
despite this authority and despite FERC's finding that rates in 
California are ``unjust and unreasonable,'' the Commission has refused 
to take action.
    [I would like to enter into the record the November 1, 2000 FERC 
Order Proposing Remedies for California Wholesale Electricity Markets. 
The yellow tabs indicate where FERC refers to ``Unjust and 
Unreasonable'' rates.]
    Thus, I have this introduced legislation to provide the Secretary 
of Energy the power to impose a temporary regional price cap and 
thereby prevent the price gouging or to set cost-of-service-based 
rates, allowing a reasonable profit for the power generators. If, 
however, a governor does not believe that the rate cap is in his or her 
state's best interest, that governor would be able to ``opt out'' of 
the cap.
                       working with other states
    For those who say that this is just California's problem, don't kid 
yourselves. This crisis will not be confined to California. Ultimately, 
it will have an impact on Washington, Oregon, Idaho, and the other 
western states--either directly with regard to power supplies or 
indirectly through its impact on the regional, national, and 
international economy.
    I strongly believe that the only way to address this problem is for 
our States to work together. Already, nine governors of western states 
have indicated that they are open to some sort of rate cap, and I hope 
that this Committee will be, as well.
                              natural gas
    In addition to the electricity crisis, natural gas supplies and 
prices are presenting another troubling problem for the region. Stocks 
of natural gas are low everywhere and because of the cold winter, the 
demand has been much greater than usual.
    Low stocks and high demand have driven up prices across the 
country. It has been especially troubling in California on two fronts.
    First, because of the economic uncertainty surrounding PG&E, 
California has had to rely on another Emergency Order from the 
President requiring natural gas suppliers to sell to PG&E. Without this 
order, it is possible that 3.5 million homes in northern California 
could be forced to go without heat. And unlike rolling blackouts which 
typically end in 60-90 minutes, if there is a natural gas crisis, if 
3.5 million pilot lights go out, it would be weeks before PG&E would be 
able to turn them all back on.
    The second concern lies in Southern California where natural gas 
prices have remained at nearly double the national average. Last 
Friday's spot prices for natural gas were $12.99 per million British 
Thermal Units (BTUs) in San Diego compared to $7.14 in Chicago, $6.88 
in Katy, Texas and $6.31 at the Canadian border.
    [I want to also submit for the record a copy of a December 20 
request I made to FERC asking for an investigation of the natural gas 
prices in southern California.]
    Mr. Chairman, I know that you held hearings about the natural gas 
situation in the last Congress and I urge you to take another look at 
this problem.
                               conclusion
    Clearly, the energy crisis is a complex problem. I know the 
Governor and the legislature have been working tirelessly to find a 
solution to these problems, and I believe that they are on the right 
path. But the Federal government has a responsibility as well. I urge 
my colleagues to listen to the testimony that you will hear today, and 
consider the legislation that I outlined above.
    As I said a moment ago, California has the world's sixth biggest 
economy. It simply cannot function without reliable sources of energy 
at reasonable prices. This crisis may have originated in California, 
but I guarantee it won't respect State boundaries. We all have a 
crucial stake in working together to resolve it.

    The Chairman. Senator Boxer.

         STATEMENT OF HON. BARBARA BOXER, U.S. SENATOR 
                        FROM CALIFORNIA

    Senator Boxer. Mr. Chairman, if you can tell me when I have 
gone 3 minutes, I will wrap it up. Thank you so much, and I 
know you would rather do 2 minutes, but Mr. Chairman, thank you 
for your graciousness in allowing me this opportunity, and the 
same to Senator Bingaman.
    My purpose for being here today is really threefold. It is 
quite--I think the simple points I want to make, No. 1, I want 
to also thank the past Energy Secretary and the current Energy 
Secretary for ensuring an adequate supply for California while 
we have been in these stage 3 alerts. I cannot tell you what it 
means to all of us, and we are very, very grateful.
    Second, I want to expose a myth, that environmental laws 
are responsible for the electricity crisis in California, and 
third, I want to expose the myth that the Federal Government 
has no role in this crisis.
    So my first point, I have already thanked them, and I think 
I would certainly hope that Secretary Abraham would continue to 
be vigilant on short-term help to our State.
    Now, we have heard that California is in this situation 
because of strict Federal and State environmental laws, and the 
fact show it is not true. I ask unanimous consent that a New 
York Times editorial from January 16 be placed in the record at 
this time.
    The Chairman. Without objection.
    Senator Boxer. Let me quote from it. ``Some politicians 
blame the State strict air rules which they say deterred 
construction of new powerplants and shut older ones down, but 
the real reason for the energy shortfall is that no new plants 
were built in the nineties because prices were low, supplies 
were plentiful, and producers wanted to wait.''
    Mr. Chairman, this editorial is right on target. It is not 
the fault of the environmentalists that California lacks 
generating facilities. Let me give you the facts. The history 
of the crisis demonstrates this. Before deregulation the 
public, California PUC ordered the utilities to build more 
generating facilities. The utilities did not want to.
    In fact, the utilities, not the environmentalists, actively 
worked to halt powerplant-building in California, and the 
utilities argued that no new capacity would be needed until 
2005. They were wrong, but the California PUC kept on pushing 
the utilities and they took them to court, and the utilities 
said to the State administrative law judge, do not force us to 
build these plants. We do not need them. The court ruled 
against them.
    However, they took that turn-down and they went to FERC, 
and FERC sided with the utilities, and no plants were built, 
and so as a result we do not have enough in-State generation. 
If the construction had gone forward as the PUC wanted, the 
State would have an additional 1,000 to 2,000 megawatts of 
power, enough to prevent the almost daily stage 3 alerts and 
the rolling blackouts.
    I will not get into the shielding of billions of dollars. I 
think Senator Feinstein is right, there is going to be a lot of 
analysis of that, and I will leave it up to you and many 
others, and myself I will look at these, but today I do not 
think it helps to raise that question.
    The Chairman. Your 3 minutes are up.
    Senator Boxer. I will conclude in 1 minute. FERC says in 
its own words, its responsibility is to regulate the 
transmission and wholesale sales of electricity in interstate 
commerce. That is its mission, and so for us to say that they 
have no role does not even make sense. In fact, last November 
FERC found the electricity rates in California were, quote, 
``unjust and unreasonable.'' That is why I support Senator 
Feinstein's bill. I have my own bill with Bob Felner on the 
same subject in terms of wholesale prices.
    My final point, you are right, Mr. Chairman, when you say 
that deregulation that was pushed in California by Pete Wilson 
and the legislature, Democrats and Republicans together, did 
not fully deregulate. It said, you cannot pass the cost on to 
consumers. However, Mr. Chairman, I would say to you, if, in 
fact, they could, prices could go up 1,000 percent, 600 
percent, so I ask you whether in the real world consumers would 
accept that kind of increase.
    So I hope we learn from California. I hope we can work 
together, Mr. Chairman. I know you and I do not see eye to eye 
on a lot of things, but I am ever so grateful to you for 
focusing attention on our problem. Thank you.
    The Chairman. Thank you, Senator Boxer. We now move to the 
panel, and we have got a lot of witnesses and we are going to 
try something that I am going to kind of insist on, and that is 
the colors of the clock here. I know you do not have one in 
front of you, but the green means you are running, the yellow 
means to wind up, and the red suggests stop.
    The first panel, we are going to try to give you about 7 
minutes each, and then the second and third panel we are going 
to try 5 minutes. That way we might be through about 5 or 6 
o'clock tonight.
    With that, let me introduce Larry Makovich, senior director 
of research, North American Electric Power, Cambridge Energy 
Research Associates, Cambridge, Massachusetts, for an overview, 
followed by Peter Fox-Penner, principal of the Brattle Group, 
Washington, D.C., and Mr. Kit Konolige, managing director, 
Morgan Stanley Dean Witter, New York, and we trust you will 
call them as you see them. That is what we want to hear. We do 
not want any pussy-footing around here.
    All right, Dr. Makovich.

 STATEMENT OF LAWRENCE J. MAKOVICH, PH.D., SENIOR DIRECTOR OF 
   RESEARCH, NORTH AMERICAN ELECTRIC POWER, CAMBRIDGE ENERGY 
               RESEARCH ASSOCIATES, CAMBRIDGE, MA

    Dr. Makovich. Good morning, Mr. Chairman and members of the 
committee. I will try to summarize my prepared testimony in 7 
minutes.
    When California started its deregulation in 1996, it did so 
because it had some of the highest electricity prices in the 
country. There was a lot of optimism that what they were doing 
in California would provide a model for the rest of the West to 
follow, as well as other electricity markets around the world. 
Well, what has happened today is, we have a severe shortage of 
electric supply in California, and that has caused skyrocketing 
prices, rolling blackouts, financial distress, and political 
turmoil.
    In fact, right now I think the biggest problem with 
California is, no one can agree on what went wrong and, of 
course, we are trying to formulate a solution. That is a big 
problem. Although it is tempting, it would be incorrect to 
blame this problem on deregulation itself. California has set 
up a market with serious flaws, and these flaws prevented 
supply from keeping up with demand. 5 years ago, when 
California passed its legislation to restructure this industry, 
it had a surplus of electric generating capacity. The economy 
grew 32 percent over those 5 years, and electric energy 
consumption grew 24 percent, so even with increased electric 
efficiency in the California economy, we reached a point in 
1998 when supply and demand was in balance. We went passed that 
in 1999 and 2000 into a period now where we have a shortage.
    Urgent action is needed right now to address this shortage 
crisis in the short run to avert an even more serious problem 
this summer, and we also need to fix the problem in the 
California market that created this shortage in the first 
place.
    Now, the crisis in California arose because people believed 
that an electric energy market was just like any commodity 
market. When supply and demand would tighten up, prices would 
gradually rise, stimulate investment, and supply and demand 
would stay in balance. This assumption was wrong. Power markets 
are not like other commodity markets. They are complex and have 
unique characteristics, and the real lesson in California is 
that there is a right way and a wrong way to set up power 
markets.
    California's restructuring law involves sweeping changes 
that did many but not all of the things that were necessary to 
set a market up properly. Customers could choose among 
alternative suppliers. Divestiture created a large number of 
independent rival generators. There was a formal power 
exchange. The ISO provided a traffic cop on the transmission 
system that hooks buyers and sellers together.
    They had a plan to deal with their stranded costs, but the 
structural flaws in this plan were that the market was set up 
to make it impossible nor profitable to build new powerplants. 
These flaws were right there from the start of deregulation, 
which has made this shortage both inevitable and, sadly, 
preventable.
    Now, the first problem is, the State does have an approval 
process for new powerplants that creates significant obstacles 
to building new power supplies. These hurdles have made 
California one of the toughest places on earth to build a new 
powerplant. Year after year, the State has failed to approve 
the amount of new capacity that has to be brought on to keep 
supply and demand in balance.
    Now, even without these siting obstacles, California also 
set up a market that was guaranteed to deliver prices that were 
too low to provide a timely signal for the amount of capacity 
that was needed to keep this market in balance.
    Now, setting up a power market properly means you have to 
pay for two things, capacity and energy. California set up a 
market that only paid for energy, the utilization of 
powerplants. When you turn on a 100-watt bulb, you have to have 
a capacity in an electric system to meet that demand, and then 
you also have to pay someone to utilize that capacity to burn 
the fuel over time to produce the watt hours.
    Now, unlike other commodities, electric energy is not 
stored in inventory. It thus requires this capacity to be 
there. Unlike other nonstorable commodities like 
telecommunications services, there is no equivalent of a busy 
signal in the power business, unless you consider a blackout a 
busy signal.
    Now, most of the time in the power business there is plenty 
of capacity to meet customer demand, so the typical problem in 
a power system is to figure out which power units ought to be 
running, and that is what the energy market that was set up in 
California did so well. But to figure out the best plants to 
run want an energy market that clears on short-run costs only. 
You want the cheapest plants from a short-run basis to be 
running at any point in time.
    So as we look at the record, whether the California market 
had a surplus of capacity, a balance, whether we look at the 
years when it was in shortage, the California energy market was 
doing its job of clearing on the basis of short-run costs.
    Now, of course, the problem is no one is going to move 
forward and build powerplants on the basis of short-run cost 
recovery alone, and in fact when the market dipped into a 
severe shortage, of course, any short market of any type, price 
runs up dramatically. The price run-ups that we have seen right 
now are far higher than what is needed to bring forth new 
supply, and they are too late. If it takes 2 or 3 years to site 
new powerplants, the price signal had to occur years ago to 
avert this kind of shortage.
    What California lacked was a requirement that if you are 
going to sell people electric energy you also have to have 
enough capacity, either owned or under contract by the 
suppliers, to meet their needs, plus a reserve to cover for the 
variances that we see from weather and hydro availability and 
so forth.
    Now, if this requirement were in place, there are 
mechanisms, the right type of long-term contract, or a formal 
capacity market that could create the payment mechanism that 
would provide the timely price signal to show that it is 
profitable to invest in powerplants at the right time in a 
market like California.
    Now, when we look around other deregulated power markets 
like Texas, New England, Pennsylvania, New Jersey, Maryland, 
they have these capacity requirements. Texas is a great 
example. It is a fairly isolated power market, so it has energy 
independence. Texas is roughly the same size as the California 
power market. It started its deregulation after California. It 
had less of a surplus capacity cushion to work with, but 
because it set up both the capacity requirement and energy 
market, and it sited enough powerplants to keep supply and 
demand in balance, Texas added 5,000 megawatts of new supply 
last year, and it's got another 8,000 coming over this year.
    California is about 5,000 megawatts short. Had they done 
what Texas did there would be no shortage right now. Was this 
an honest mistake in California? The problem in California 
comes down to this. There was a belief that you could set up 
the rules for the power market with a stakeholder democracy. 
Instead of an expert independent governance structure for the 
power exchange and the ISO, there were large committees of 
stakeholders. It is no surprise that when they organized this 
market with a surplus, the majority opinion was, why pay for 
capacity when the liability is free, and so today we need to 
embark on emergency actions to create lower demand and greater 
supply, and the West, being so interconnected with California, 
the citizens and businesses throughout the West now have an 
enormous bill that reflects the cost of this costly mistake in 
the power market setup.
    Thank you.
    [The prepared statement of Dr. Makovich follows:]
 Prepared Statement of Lawrence J. Makovich, Ph.D., Senior Director of 
  Research, North American Electric Power, Cambridge Energy Research 
                       Associates, Cambridge, MA
          california power crisis: what are the real lessons?
    When California passed its electric power restructuring law in 
1996, it prided itself with being on the leading edge of deregulation 
in the United States. when the state passed its power restructuring 
laws in 1996. At that time, the state took on the daunting task of 
power deregulation for good reasons. The state's power prices were 
among the highest in the country, and the industry was mired in a 
complex regulatory system that promised to lead to still higher prices 
because the inefficiencies of traditional regulation made California's 
power prices among the highest in the country. The hopes were that 
deregulation would deliver lower prices and that California would be a 
model for other power markets to follow. That's not what happened. The 
results, instead, are today's power crisis: stand in stark contrast to 
the shortages, skyrocketing prices, induced prices run-ups rolling 
blackouts, financial distress and political turmoil.
    Today, one of the biggest problems in California is that no one can 
agree on what went wrong. Customers, regulators, politicians and power 
producers are all pointing a finger at each other to assign blame. 
Although tempting, it would be incorrect to blame the problems in 
California on deregulation itself. Indeed, there is a grave danger of 
drawing the wrong lessons. If this crisis drives California back to the 
heavy-handed regulation and control that launched power restructuring 
in the first place then the state is likely to find its electric sector 
becoming increasingly inefficient and expensive--and very much 
disadvantaged compared to regions with properly structured power 
markets. California is now at a critical juncture--the state can go 
backwards by reregulating--or even taking outright ownership--or the 
state can fix the flaws in its power market. The latter is the way to 
go.
    Urgent action is needed not only to meet the current crisis but 
swift and dramatic steps are needed to avert an ever more severe 
shortage in the coming summer.
                            the real lessons
    The real lesson of the California power crisis is that there is a 
right way and a wrong way to set up and run a power market. 
California's electricity crisis is the result of three critical 
failures:
    1. California set up its power market with serious structural flaws 
that made timely investment in new power supply neither possible nor 
profitable. These flaws were part of the California market design right 
from the start of deregulation. Consequently, the current power crisis 
was both inevitable and yet could have been prevented.
    2. It has been enormously difficult to site and build new plants in 
the state. California has perhaps the most daunting power plant 
approval process in the nation. This process and the inability to site 
have thwarted efforts by companies to build the new power plant 
facilities that could have averted the supply shortfall.
    3. Although described as ``deregulation,'' the California system is 
only a partial deregulation. Customers remain under controlled prices 
(retail) that are well below the prices paid by utilities to generators 
(wholesale). This is a fundamental misalignment between the two parts 
of the market that creates a liquidity problem for utilities and 
disconnects the demand side from the market.
    The crisis in California arose because people believed that 
electric energy markets were just like other commodity markets--when 
demand and supply tightened up then prices would gradually rise, 
stimulate investment and keep supply and demand in balance. That 
assumption, however, is wrong. Power markets are not like other 
commodity markets. The power business is complex and has unique 
characteristics. Research over several decades pointed out that power 
markets are far more challenging to set up properly than most other 
markets. The system that was set up in California could have taken 
these realities into account--and come out with a good result. The 
system that was set up did not take these realities into account--with 
the results that we now see.
                       what triggered the crisis
    The flaws of the market design prevented supply from keeping up 
with demand. Five years ago, when California passed its power 
restructuring legislation, the state had a surplus of power generating 
capability. Since that time, the California economy grew a phenomenal 
32 percent, fueled by a 24 percent increase in electricity consumption. 
The fact that electricity use increased less than overall economic 
growth meant that the state was becoming more efficient in its use of 
power. Yet conservation and greater efficiency could not stem the need 
for additional supply. By 1998, demand growth had ended California's 
power surplus. The record of the past five years is clear--California 
failed to approve the siting and permitting of anything near the 1,200 
Mw needed each year to keep demand and supply in balance. As a result, 
far too few new power plants were added to California's power sector 
over the past five years. Moreover--and this point needs to be faced--
not enough power plants are currently under construction to end this 
shortage in the near term.
    Why was new generation not added? That is the heart of the matter. 
The California power market was simply not designed to add enough 
generating capacity at the right time.
                           the market design
    California's restructuring law involved sweeping changes that did 
many--but not all--of the things necessary to make a power market work 
properly. The legislation unleashed competitive forces: customers could 
choose electric service providers (ESPs); utilities were required to 
divest at least 50 percent and by requiring divestiture of at least 50 
percent of their generating capacity owned by incumbent utilitiesto set 
upto create a large number of independent rival generators. The 
legislation replaced the existing decentralized wholesale power market 
with a centralized energy market called the California Power Exchange 
(PX). Another institution called the Independent System Operator (ISO) 
became the traffic cop in the transmission grid that physically 
interconnected the electric consumers and producers. The ISO also ran a 
market for other services power plants provide (for example, voltage 
control) to manage power flows on the grid.
    The California restructuring plan faced a particular complication--
``stranded costs.'' The traditional utilities had billions of dollars 
of costs that could not be recovered at expected market prices. Thus, 
California included a transition plan to move to a market while 
recovering these above market costs. To do this, the state backed 
utility bonds to finance a rate reduction of 10 percent along with the 
establishment of a retail price cap with a competitive transition 
charge--otherwise known as the ``CTC.'' The CTC was the difference 
between the retail rate cap and sum of all power costs, including the 
wholesale power price. The retail price cap and its associated CTC 
expired once a utility recovered enough revenues to cover stranded 
costs. At this point, utilities remained obligated to serve customers 
by buying power from the power exchange and passing along this cost. 
The California crisis exploded when stranded cost recovery began to end 
and thousands of customers were released to the market just in time for 
the shortage to hit with far too little additional power supply in the 
works. As an emergency measure, the state returned to price caps to 
counter the shortage driven price shocks.
                too few new plants: obstacles to siting
    The state's approval process creates significant obstacles to 
building new plants. These include an open-ended environmental review 
process, tough siting and permitting procedures and well-organized 
community opposition. These hurdles make California one of the most 
difficult places on earth to build a power plant. As a result, year 
after year, the state failed to approve anything near its annual 
requirement for new supply to keep up with its growing demand.
    too few power plants: insufficient incentive to add '"capacity"
    Even without these obstacles to siting and building, no barriers to 
entry, California set up a power market guaranteed power prices that 
were too low to support enough timely investment in new supply. 
California set up an energy market that paid power generators to run 
their power plants but did not set up any market mechanism to pay 
generators for capacity--in other words, no capacity price signal to 
create an incentive to bring on new capacity. This meant that prices 
were lower in the short run, but it also meant that prices would 
eventually explode in a future shortage.
    Setting up a power market with the right price signals requires 
payments for two electric commodities--energy and capacity. For 
example, when someone turns on a 100-watt light bulb, the power system 
needs to have a power plant with the capacity to produce an additional 
100 watts of power. If capacity is available to meet this demand then 
utilization of the capacity through time can produce the watt-hours of 
energy. Unlike other commodities, electric energy is not stored in an 
inventory and thus requires capacity as well as utilization of that 
capacity to meet customer needs. Unlike other non-storable commodities 
like telecom, a busy signal (a blackout) is not an acceptable way to 
get around this capacity requirement--because, when you're talking 
about electric power, a ``busy signal'' takes the form of a blackout.
    California needs enough capacity at any point in time to meet the 
sum of customer demands for example, ten 100 watt bulbs add up to a 
kilowatt of demand and 1000 kilowatts add up to a megawatt. During the 
summer time when air conditioners are humming, California reaches a 
peak demand of about 53,000 megawatts. Since generating capacity can 
break down or hydroelectric capacity can vary depending on how much 
snow there was the previous winter,conditions can vary, California like 
any other power market needs a capacity reserve an additional 15 
percent or so of capacity to insure that supply meets demand at all 
times. This margin provides the cushion that can absorb shocks caused 
by shortfalls in supply or surges in demand. In California, that 
cushion was eliminated by the growth in demand, on the one side, and 
lack of new capacity on the other.
    Although compelling evidence of a developing shortage was apparent, 
most industry observers were complacent due to the belief that when new 
supply was needed the energy price would rise and bring forth new power 
plant in time. This faith in the energy market was ill founded. The 
California energy market alone was incapable of providing a timely 
investment signal because it was successful in doing the job of 
providing a price signal to efficiently utilize existing power plants.
    Most of the time the amount of generating capacity available to 
meet customer needs exceeds the sum of customer demands. Thus the 
typical problem for a power market is to figure out which plants ought 
to be running to minimize production costs at any hour. To do this, 
sunk costs are irrelevant and competition should drive energy prices to 
reflect the short run costs of rival producers even at time of peak. 
The evidence in California is compelling--as long as a surplus existed, 
the wholesale energy market cleared on the basis of short run 
production costs with a level and volatility that was half of what was 
needed to support new investment. Similarly, when demand and supply 
were in balance, energy prices continued to reflect production costs. 
Even in a slight shortage during 1999, competitive forces were so 
strong that the energy market did not break significantly from 
production costs.
    When the market tipped to a severe shortage in 2000, energy prices 
soared and volatility exploded to levels that were multiples of what 
was needed to support new investment. Besides being higher than needed 
to support investment, these price increases were also too late. The 
price signal for new investment needed to come several years before 
demand and supply reached balance to account for the lead time needed 
to site, permit and construct new power plants.
    Clearly, a properly structured power market can not rely on 
periodic shortages and reliability crises to provide timely investment 
incentives. Instead, a properly structured power market needs a 
capacity payment mechanism. This begins with the simple requirement 
that anyone selling electric energy to customers must also buy enough 
capacity to cover these customers capacity needs plus a reserve. A 
capacity requirement met by the right type of bilateral contract or 
through a formal capacity market can provide the timely price signal 
needed to avert shortages and keep power markets in balance in the long 
run.
                how other states have solved the problem
    California's lack of a capacity payment mechanism stands in stark 
contrast to other restructured power markets such as Texas, New England 
and the Middle Atlantic region. For example, Texas had a market rule 
that required anyone supplying electric energy to customers to also 
have enough capacity (either owned or under contract) to meet demand 
plus a reserve. As a result, power developers in Texas expected to sell 
both the capacity and energy from power plants. Besides looking more 
profitable due to two revenue streams instead of just one, building new 
electric supply in Texas was also possible. Texas approved the siting 
and permitting of more than enough new supply to keep the market in 
balance. Texas implemented its restructuring program after California 
and with less of an initial capacity surplus. The Texas power market is 
about the same size as the California market, yet last year Texas added 
over 5,000 Mw of new supply and expects to add 8,000 Mw more this year.
                           short term action
    California is currently about 5,000 Mw short of supply. 
Unfortunately, there is no quick fix. Nevertheless, there are many 
short run actions that can reduce demand and add supply. These measures 
include:

  <bullet> Find more conservation and interruptible load on the demand 
        side.
  <bullet> Add greater flexibility in legal and environmental limits on 
        the power supply side. For example, the back-up and emergency 
        generating systems at hospitals, hotels and office buildings in 
        addition to barge mounted and mobile emergency power sources 
        could provide a critical amount of additional supply in short 
        order.
  <bullet> Reactivate mothballed generating units.
  <bullet> Expedite permitting and construction of power development 
        already underway in California.

    Unfortunately, actions taken so far do not address the underlying 
problem and in some cases are making matters worse. The retail price-
freeze solved the price shock problem of this shortage but created a 
grave a serious liquidity problem. The state's utilities are trapped in 
a sort of no-man's land, between high wholesale prices and regulated, 
frozen retail prices. Forcing California's utilities to buy power at 
levels many times greater than the level they can charge customers 
caused major utilities to accumulate over twelve billion dollars of 
uncollected power expenses in just the past six months. Besides 
bringing these utilities to the brink of bankruptcy, the liquidity 
problem makes power sellers very nervous about selling their power 
creates a disincentive to power sellers and never being paid.
    The long run solution is clear--California needs a mechanism to pay 
for capacity and needs to approve development plans each year for 
enough capacity to close the current gap and keep up with demand. These 
reforms are not simple--instead of using the appropriate type of 
bilateral contract or making the proper rules for a capacity market, 
California could mistake long term energy contracts for the needed 
capacity payment mechanism and create massive take-or-pay obligations 
in the future. In addition, the politics of ``not in my backyard'' may 
subvert real attempts to site and permit needed supply.
                         flawed decision-making
    The problem in California is not deregulation itself. The system 
was only partially and not properly deregulated. The flaws in 
California's power markets resulted from a flawed process of 
deregulation based on an idea riddled with uncertainties--stakeholder 
democracy. Stakeholder democracy is the belief that if all of the 
stakeholders of a problem are brought together, the correct policy will 
emerge through negotiation and compromise. Instead of independent, 
expert oversight, California intentionally designed large committees of 
stakeholders for the governance boards of the California Power Exchange 
and the Independent System Operator. When California formulated its 
deregulation policy with plenty of power plants already in place, it 
was no surprise that the majority of stakeholders voted not to pay for 
capacity as long as the reliability was free. Citizens and businesses 
throughout the West, as well as the utilities, are now stuck with the 
bill for what has turned out to be a huge and costly failure in 
deregulation policy formulation.

    The Chairman. Thank you for staying within your time limit. 
We appreciate that very comprehensive statement.
    Mr. Peter Fox-Penner of the Brattle Group. Please proceed. 
We would encourage those of you on the following panel, if you 
are interested in learning new things, so do not repeat what 
somebody else said, which I do not have to remind you we have a 
little problem with that here on this side of the dais. We do 
not practice what we preach.
    Senator Domenici. Some of us have not even had a chance to 
preach.
    [Laughter.]

       STATEMENT OF DR. PETER S. FOX-PENNER, PRINCIPAL, 
                    THE BRATTLE GROUP, INC.

    Dr. Fox-Penner. Thank you, Mr. Chairman. Thank you, members 
of the committee. Thank you for the opportunity to share my 
views on the state of the electric utility industry and recent 
events in California. I am speaking to you today not for my 
company or its clients, but, rather, as an expert involved in 
the industry for many years.
    In fact, Mr. Chairman, believe it or not, 14 years ago I 
was a student doing a doctoral thesis on this very topic. I 
sought help from this committee and Mr. Useem gave me very 
generous assistance way back then. It is a pleasure to have 
this chance to thank him before the committee today and, 
Howard, after today, I sincerely hope you have no regrets.
    [Laughter.]
    Dr. Fox-Penner. Mr. Chairman, there is no question that 
what is happening in Western power markets is a tragedy of 
immense proportion. As a student of energy history, I believe 
that there is really no parallel for this episode in the 
history of the developed world.
    Now, there are two main schools of thought on this crisis. 
One group claims this episode shows that deregulation has been 
a total failure and reregulation is the way to go. A second 
group argues that the problem is that California failed because 
its deregulation was incomplete, and that a more complete 
deregulation, along with more supply, is the only answer.
    Mr. Chairman, neither of these views is correct. The 
solution to California's problems and to our electric supply 
nationally is a combination of Federal, and yes, there is a 
Federal role, State and regional policies that allow the power 
sector to evolve smoothly towards greater competition, 
recognizing the diversity of supply arrangements and public 
protections that are lasting features of our system.
    California's problems were caused by a host of factors, and 
I will try not to repeat Mr. Makovich. The State's robust 
economy spurred a substantial increase in demand, energy 
efficiency programs were cut, net capacity additions were 
inadequate, California did grow dependent on imports, we have 
had extraordinarily cold winter weather, depleted Western hydro 
reserves, the lowest gas storage levels since 1976, and the 
highest gas prices in a long, long time, and all of these 
factors exposed and amplified design flaws in an overly complex 
deregulatory scheme that Mr. Makovich did a good job 
discussing.
    I would note to the committee that some of these factors 
are present to varying degrees in other deregulated markets 
across the United States. The Midwest and Atlantic coasts have 
experienced several episodes of price spikes and reliability 
threats. Demand has outstripped supply nationally across the 
country by a substantial margin, but here, as in California, 
the marketplace is rapidly adding plant. The private sector I 
think is doing its job.
    I also note that every State that has implemented 
deregulation has required the utilities to continue to offer a 
price-regulated default service for customers who do not choose 
to shop, and that in every such State 90 percent or more of all 
customers have opted to stay with this regulated service, and 
this leaves other utilities vulnerable to the tragic 
undercollections that have nearly bankrupted two of the 
California utilities here today.
    What is the committee to learn from this experience? Mr. 
Chairman, I have five recommendations for Federal action, and I 
will not discuss State or other actions that I think are also 
important.
    First and foremost, one of the things that makes electric 
restructuring uniquely difficult in the United States is our 
overlapping State and Federal regulatory system. No other 
Nation in the world has such a diverse regulatory framework. 
Recognizing that we can change this only by degree, Congress 
must be prepared to engage on the issue of the jurisdictional 
structure of utility regulation if it intends competition to 
work in the power business.
    Gas and electric markets are regional, reliability is 
regional, and there is no avoiding this. Federal legislation is 
necessary, though not sufficient. In my opinion, legislation 
should include--and this is not a complete list--FERC authority 
over all transmission lines and reliability procedures. I think 
PUHCA and PURPA need to be addressed. FERC's authority to 
police market power needs to be clarified. I will have more to 
say about that in a moment.
    Of course, we need to continue to provide for public 
interest programs. Beyond this, we must face the explosive 
question of how to license and expand our energy 
infrastructure. I suggest that this Congress or the 
administration take the lead in creating a real dialogue 
between Governors, local authorities, the environmental 
community, and all segments of industry directed towards 
procedures that will enhance our energy infrastructure, and 
when I say energy infrastructure, Mr. Chairman, I am referring 
to the full vertical supply chain that brings us electricity, 
but it is not true that all segments of that supply chain have 
that same degree of scarcity or problems in them.
    I think that starting at the end of the chain, transmission 
lines are by far our biggest problem. After that, gas storage, 
which I mentioned, and perhaps gas production is next and is I 
think on the way to being fixed, and least scarce and of least 
concern--in other words, the market is doing the best job in 
this area--is the powerplants themselves and gas pipeline 
additions.
    Personally, I believe that any procedures adopted to 
address the infrastructure needs will have to demonstrate a 
maximum reliance on decentralized sources and minimum 
environmental impacts before the public will accept new large-
scale facilities, but until a forum exists for balancing our 
infrastructure needs the rest of the Nation will slowly reach 
the same throughput limits California has reached, to 
disastrous ends.
    Second, I implore we all recognize electric markets will 
never work properly, never, without demand-side responses that 
so far are largely missing. In this area, the Federal 
Government can take a leading policy and technology diffusion 
role.
    My third point concerns the environment. While 
environmental regulations certainly impose costs on power 
developers, there is no evidence that the Federal Clean Air Act 
is the cause of today's generation shortage in California. The 
plant construction boom in New England, where many States also 
impose very strict environmental controls, illustrates that 
robust development is possible under Federal environmental 
rules.
    California does impose stricter environmental quality 
standards than are mandated under the Clean Air Act and I 
believe this has limited powerplant development to a degree. 
However, since the State itself has begun to address these 
issues, I do not believe that weakening the Clean Air Act is 
necessary, or even necessarily an effective way to encourage 
new capacity in California.
    My fourth point concerns the difficulty of balancing energy 
price volatility supply adequacy and protections against market 
power. Deregulated gas and power markets are uniquely prone to 
extreme price variabilities, and will go through boom-bust 
cycles. We must carefully craft an alternative to the 
admittedly expensive supply buffer regulation gave us, or 
endure the consequences, and the acceptable outcome must not 
insulate consumers from all price signals, for this eviscerates 
not only deregulation but some regulated markets as well.
    A final point, Mr. Chairman. Let me briefly mention the 
important topic of market power. It is inordinately difficult 
for economists to separate illegal market power from natural 
industry variability in this highly volatile industry and 
inadvertent or even intentional market design flaws. I know I 
have discussed this with Senator Feinstein.
    The California markets illustrate this vividly. Whereas we 
have a near-unanimous verdict from economists that market power 
is present, we have a vast range of opinion on what to do about 
it. For this region, I urge Congress or the administration to 
convene an independent panel to examine this topic and 
recommend better Federal policies regarding these complex 
issues.
    To summarize, Mr. Chairman, California's crisis calls for 
immediate and concerted efforts in that State and region. 
However, we will only multiply the tragedy if we fail to use 
this opportunity to enact policies critical to the long-term 
success of our energy infrastructure and to our economy as a 
whole.
    Thank you.
    [The prepared statement of Dr. Fox-Penner follows:]
  Prepared Statement of Dr. Peter Fox-Penner, Principal, The Brattle 
                     Group, Inc., Washington, D.C.
    Mr. Chairman, and Members of the Committee, thank you for the 
opportunity to share my views on the state of the electric utility 
industry and particularly on recent events in California. I speak to 
you today not for my company or its clients, but rather as an expert 
involved in industry restructuring for many years.
    Mr. Chairman, there is no question that what is happening in 
California today is a tragedy of immense proportions. Families in San 
Diego and many other parts of the western U.S. face double-digit rate 
increases, businesses are laying off workers, two of the nation's 
largest utilities are on the edge of bankruptcy, and an entire state 
faces repeated rolling blackouts. These unprecedented problems threaten 
to spill over to weaken the U.S. economy. As a student of energy 
history, I believe that there is arguably no parallel for this episode 
in modern times in the developed world.
    If you follow the press on this crisis--and who can avoid it?--you 
know there are two main schools of thought. One group claims that this 
episode shows that electric deregulation has been a total failure, and 
re-regulation or public power is the answer. A second group argues that 
California failed because its deregulation was incomplete, and that a 
rapid, more complete deregulation (along with more supply) is needed.
    Mr. Chairman, the most important thing I have to say to you today 
is that neither of these views is correct, and neither represents a 
viable course of action for federal and state policymakers. The 
solution to California's problems and to our electric supply needs 
nationally is a combination of federal, state and regional policies 
that allow the power sector to evolve smoothly towards greater 
competition, recognizing the diversity of supply arrangements and 
public protections that are lasting features of our system.
                     the california market problem
    There is a fair degree of consensus concerning the proximate causes 
of California's problems. First, the State's robust economy spurred a 
substantial increase in electricity demand, rising between 2% and 3% 
per year between 1995 and 2000. Average peak loads rose substantially 
during the early summer months of 2000 compared to the levels 
experienced in 1999, driven by unusually hot weather. Some of the peak 
load and energy demand increases could have been averted through more 
aggressive energy efficiency programs, but California utilities reduced 
spending on demand-side measures by over 50% between 1994 and 1998. In 
addition, during the period between 1996 and 1999, when peak loads rose 
5,522 MW, net capacity additions only grew by 672 MW, and thus 
California grew increasingly dependent on power imports from the 
surrounding region. Cold winter weather, depleted western hydro 
reservoirs, and a natural gas price increase across the country all 
further contributed to the sustained level of high prices we see today.
    All these long-term or external factors served to expose and 
amplify design flaws in an overly complex deregulatory scheme. The 
design flaws, notably a massive over-reliance on spot markets and 
capped retail prices, are often cited as the main reasons for 
California's problems, but all of the ingredients listed above 
contributed to creating today's crisis.
                         national implications
    While these long-term and market design factors have produced a 
calamity in the western U.S., it is critical to understand that many of 
these factors are present to varying degrees in other deregulated 
markets in the U.S., and that these markets are not invulnerable to 
California-like problems, albeit at a smaller scale. The Midwest and 
Atlantic Coast have experienced several episodes of price spikes and 
reliability threats. Between 1995 and 1999, U.S. electric demand 
increased by 9.5%, while total electric generation additions rose only 
1.6% and investment in transmission lines actually declined. To make 
matters worse, deregulation reduced utilities' energy-efficiency 
spending by 50%. The result is a power sector in many regions 
critically short of new generation, needed transmission lines and/or 
effective conservation measures. Less than a year ago, an Electric 
Power Research Institute seminar concluded that, ``North America is 
closer to the edge, in terms of the frequency and duration of severe 
power outages, than at any time in the last 35 years.''
    The Committee should also note that every state that has 
implemented electricity deregulation has required utilities to continue 
to offer a frozen, reduced ``transition'' rate or a price-regulated 
``default'' electric service for customers who do not choose 
competitive suppliers. While some states have done better than others, 
no state has removed retail price protection from anywhere near all 
customers. In every deregulated state 90% of consumers or more have so 
far opted to stay with this regulated service, leaving many utilities 
vulnerable to the under collections that have nearly bankrupted Pacific 
Gas and Electric and Southern California Edison. Having said this, 
however, it is clear that deregulation is working better in most states 
than it is in California, and deregulation at the wholesale level has 
made great progress as well.
                      appropriate policy response
    What is the Committee to learn from this experience, and what 
policy response is appropriate at the federal level?
    Perhaps the first item to mention is that electric restructuring is 
uniquely difficult in the U.S. because of our overlapping state and 
federal regulatory authorities. No other nation in the world has such a 
diverse and complex regulatory system, and the reality is that we can 
change this only by degree. Electric markets will work only with 
cooperation between, and improvements in, state and federal regulation, 
including the creation of regional regulatory or quasi-regulatory 
entities. In short, Mr. Chairman, Congress must be prepared to engage 
the issue of the jurisdictional structure of utility regulation if it 
intends competition to work in the electricity business. Electricity 
markets are regional, and reliability rules are also most appropriately 
enforced at the regional level. There is just plain no avoiding this.
    Federal legislation will unquestionably be necessary, though not 
nearly sufficient. In my opinion, legislation should:

  <bullet> Give the FERC authority over all transmission lines and 
        reliability organizations and procedures;
  <bullet> Facilitate but not require state retail choice and enable 
        municipal and co-op utilities to participate without 
        penalization;
  <bullet> Clarify FERC's authority to police market power; and
  <bullet> Provide for continued public interest programs for low-
        income customers, environmental protections, and energy 
        efficiency and R&D programs.

    Beyond this you must face the explosive question of how to license 
and expand our energy infrastructure. I suggest that Congress or the 
new Administration take the lead in creating a real dialog between 
governors, state regulators, local authorities, the environmental 
community, and the industry, all directed towards procedures that will 
enhance our energy infrastructure. I believe that these procedures will 
have to demonstrate a maximum reliance on decentralized sources and 
minimum environmental impacts before the public will accept new large-
scale facilities. In any case, until a forum exists for improving our 
demand and supply infrastructure, the rest of the nation will slowly 
reach the same limits of energy service throughput that California has 
reached to disastrous ends.
    Second, I implore that we all recognize that electric markets will 
never work properly without demand-side responses that so far are 
largely missing. Allow me to explain. In every competitive market you 
can think of, consumers not only know the prices they pay, they are 
able to change their consumption almost immediately in response to 
price changes. So far, electricity is an unhappy exception to this 
rule. Electric markets do produce price signals, but most consumers do 
not see them; and even if they do, it is very hard with today's 
technology to reduce demand in relevant timeframes when prices go up. 
Imagine, Mr. Chairman, if Americans had to choose their gas station and 
fill up at the pump each week without knowing what they were paying 
until they received a bill at the end of the month. With recent 
advancements in information technology, it is not merely unfortunate 
that electric consumers can't adjust immediately to high prices, it is 
fatal for electric competition in the long run.
    In this area, Mr. Chairman, the federal government can take a 
leading policy and technology diffusion role. No state has the budget 
or the expertise to implement demand-responsive technology nationwide. 
This is a uniquely national mission and it is a vital one. And on a 
similar note, federal leadership on more general energy efficiency and 
demand management technology diffusion is equally valuable to the 
nation, and also has fallen back due to the forces of unleashed 
restructuring.
    Third, while environmental requirements certainly impose costs on 
powerplant developers, there is no evidence that the federal Clean Air 
Act is a cause of today's generation shortage in California. The 
substantial new plant construction boom in New England (where many 
states also impose strict environmental controls) illustrates that new 
development is entirely possible under federal environmental statutes. 
California does impose stricter air quality standards and emission 
offset requirements than mandated by the Clean Air Act, and this has 
limited powerplant development in certain areas. However, since the 
state has begun to address these issues, I do not believe that 
weakening the Clean Air Act would be an effective way to encourage new 
capacity in California.
    My final point concerns the difficulty of balancing energy price 
volatility, supply adequacy, and protections against market power. 
Deregulated electricity markets are uniquely prone to extreme price 
variability, particularly in times of shortage. Under such conditions, 
it is extremely difficult for even a well-functioning market to prevent 
a degree of volatility and supply uncertainty that elected officials 
must judge for its political acceptability. And regardless of this 
outcome, we cannot insulate consumers from all price signals, for this 
eviscerates not only deregulation but sound regulated markets as well.
    I believe that an under-appreciated and inevitable feature of 
deregulated energy markets is the sort of ``boom-bust'' cycles that we 
have often decried in oil and gas production in the past. Deregulation 
of electricity does imply that shortages may occur if only by accident 
and that the admittedly expensive supply buffer that regulation gave us 
for 50 years will no longer be there. In my opinion, either the economy 
will develop better ways to adjust to gas and electric price volatility 
or the public will lose patience with the concept, regardless of the 
many benefits of electric competition.
    Relatedly, it is a fact that deregulated utility markets are 
subject to the antitrust laws and to specific utility statutes as well. 
It is inordinately difficult for experts such as myself to separate out 
illegal sources of market power from natural industry variability and 
inadvertent or even intentional market design flaws. The California 
crisis illustrates this point vividly. Whereas we have a near-unanimous 
verdict from economic experts that market power is present in these 
markets, we have a vast diversity of opinion on what to do about it. 
Buyers are asking the federal government and the courts for action, 
sellers are asserting that they are doing nothing whatsoever illegal, 
and the agencies and courts are unable to respond with much certitude. 
Ambiguity over this issue also can erode suppliers' willingness to 
enter and expand, thereby compounding our problems. For these reasons, 
I urge Congress or the Administration to convene an independent panel 
or commission to carefully examine the topic and recommend federal 
policies to address these issues.
                                summary
    To summarize, Mr. Chairman, the California crisis gives us the 
perfect opportunity to address much-needed policy reforms in the 
electricity sector. Federal legislation should provide for regional 
reliability protections, public benefits, market power clarification, 
public power participation or opt-out, and other federal needs.
    Beyond this, this Committee and the nation face a challenge that is 
more fundamental than deregulation, and which ultimately will determine 
deregulation's fate: how to reconcile a deep-rooted, but obsolete 
state-federal division of regulatory authority with energy markets and 
infrastructure additions that are inherently regional. Regional energy 
issues need a concrete forum for resolution and action, while fully 
respecting the views of state and local leaders and other stakeholders. 
Similarly, we must develop a combination of policies and patience that 
allow us to achieve supply security without crippling competition 
itself.
    Solving these problems will be difficult, but we must remember that 
the hard problems take time. The policies that help create the world's 
most economical and reliable utility system were not built overnight. 
More than thirty years elapsed between the birth of the utility 
industry and state utility regulation, and it took another decade and 
the Great Depression to pass the Federal Power Act.
    California's crisis calls for immediate and concerted efforts in 
that state and region. However, we will only amplify the tragedy if we 
neglect this opportunity to enact policies critical to the long-term 
success of our energy infrastructure and our economy as a whole.

    The Chairman. Thank you.
    Our last witness on this panel would be Mr. Kit Konolige 
from Morgan Stanley.

 STATEMENT OF KIT KONOLIGE, MANAGING DIRECTOR, MORGAN STANLEY 
                   DEAN WITTER, NEW YORK, NY

    Mr. Konolige. Thank you, Mr. Chairman, members of the 
committee. Good morning. I am aware I am the designated Wall 
Street analyst here, and so let me avoid emphasizing some of 
the points made already and instead start by giving what I 
would say is the short answer from Wall Street for how the 
finance community views this situation and, more importantly, 
how, from a Wall Street perspective, the situation could most 
efficiently be solved.
    I would start by saying that a true supply and demand 
market would be most important for those who would invest in 
powerplants in California or other States. In particular, price 
caps are a negative for investors. Long-term contracts are a 
positive for investors.
    Certainly long delays in the approval of proposed 
powerplants are a negative for investors and, overall, I think 
clarity in the laws and the ability to have a firm belief that 
when you are going to build a powerplant that is going to last 
for 20 or 30 years, that the laws are going to remain the same 
over that time period and, for example, caps on prices and so 
on will not change in those period, is a very significant help 
to people making that investment decision.
    I will not go through the crises. Everybody knows what they 
are, blackouts, very high prices. Let me just add to what the 
chairman mentioned. He mentioned Tacoma and Idaho. My favorite 
neighboring site is Seattle, where the city utility already 
raised electricity prices 10 percent this year and now is 
talking about needing another 18 percent. All these rate 
increases, by the way, are higher than California has imposed 
on itself.
    I would also point out that the emergency help given to 
California this winter, in particular from the hydro resources, 
is that much less hydro electricity that is available for the 
even higher peaks that are coming this summer, and so I think 
many people are reasonably concerned that the crisis can get 
worse this summer before it gets better.
    What was the nature of this dysfunction in the market that 
we can all agree on? I would say again from the perspective of 
investors and Wall Street, I would say it is pretty simple, and 
it has been mentioned before. There was a very strong and a 
kind of mandated disconnection between supply and demand. 
California has not allowed, as has been mentioned, any new 
powerplants to be built for 10 years and at the same time it 
mandated lower prices to customers, so you had customers using 
electricity with no signals that it was in short supply, and 
powerplant builders who would have been happy to respond to the 
high wholesale power prices were not able to do so because of 
the extremely long period in which there was no ability to 
actually put the powerplant on the ground.
    Senator Boxer mentioned before that high prices, if passed 
through to the consumer if the market were freed, would result 
in runaway prices and, of course, there is a certain concern 
about that. If the prices to consumers were freed but the 
supply response is not freed, then you will continue to have a 
dysfunction.
    I think the central point of my testimony would be that we 
need to move towards a system in which both supply and demand 
of electricity are as open to the market as possible and in 
particular I think that means that we need to move towards a 
system where we let consumers pay the true market price of 
electricity. That will send signals to builders of powerplants 
that there is a need for new powerplants, and we need to allow 
powerplants to be built in a reasonable period of time in order 
to respond to that.
    As has been mentioned here, for more than 10 years 
California has built no new powerplants. That is unlikely to be 
just a coincidence. In that time, with the lower prices in 
California since the 1996 law, Californians are now using 6,000 
megawatts more than they did at the beginning of the period of 
the law. That is about 12 big powerplants' worth, so you need 
some more power to be generated in California.
    I think it has been mentioned already, the now sort of 
internally famous story of the Metcalf plant in San Jose, where 
the Calpine Corporation was willing and anxious to spend many 
millions, maybe millions of dollars to build one of the newest 
cleanest powerplants in the world, and yet the big company, 
Cisco, and the city of San Jose tooth and nail opposed this 
plant, and continue to oppose this plant, even though the 
Silicon Valley area there is most subject of all areas of 
California to blackouts and, in fact, has had the blackouts.
    Let me mention a couple of specific other points on the 
free market and then wrap up. California interfered with the 
free market in a couple of kind of unique ways that were 
troublesome. First of all, it prevented the market from signing 
long-term contracts in the market for electricity. In most 
countries and other States long-term contracts are considered 
the fundamental way in which both buyers and sellers levelize 
and hedge the price of electricity over a long period of time. 
This effective prohibition on long-term contracts drove up spot 
prices in California and throughout the West.
    As conditions got tighter in the year 2000, the State 
sought what I would consider a quick fix in the form of price 
caps. Four separate times last year price caps were lowered. 
California now has the lowest price cap in the country, at $150 
per megawatt hour, versus the next lowest price cap of $750.
    What has the result been? California is the only State that 
has produced the highest electricity prices and the only 
blackouts in the country. Maybe just a coincidence. Probably 
some negative impact in which the market gets around the price 
caps. I think clearly, from the point of view of Wall Street, 
you get a perverse incentive where, in a price cap situation, 
people will only sell into that market if they get what might 
otherwise be considered very high returns, because they 
consider that their long-term prospects are very suspect in a 
situation like that. If you leave the market alone, they are 
happy enough to build a plant and take their chances on the 
long term.
    I would say the good news is that this is a crisis that was 
created by political decisions, can be fixed by political 
decisions, and I think if it is fixed, I personally know dozens 
of energy companies that are willing to invest billions of 
dollars in new power in California. Of course power companies 
would want to build in California. There are not enough 
powerplants in California. In theory, it is an excellent place 
to build.
    But I would say two key things need to be done before that 
happens. One is, again on the supply side, the process for 
siting powerplants simply has to be made more transparent and 
much quicker. We could see not just gas, but clean coal, wind, 
solar projects would be lining up to build in California, but 
if it takes 5 years to get a decision you are eliminating a lot 
of the people who would be most interested.
    Finally, as I think others have mentioned, I think it is 
unrealistic, and it will not produce a functioning market, if 
you even for a period of years attempt to insulate customers 
from the high prices of electricity. If they do not see prices 
rise in times of shortage, customers will simply continue to 
run the air conditioning and that will just compound and add to 
the crisis.
    So I would end by saying simply, it may take some time and 
effort to put an effective market system into place, but it 
would be very much worth it to California and all its 
neighbors, because an effective marketplace with good supply 
and demand signals would bring down long-term prices, and it 
would certainly prevent the kind of devastating blackouts we 
have seen in California.
    [The prepared statement of Mr. Konolige follows:]
 Prepared Statement of Kit Konolige, Managing Director, Morgan Stanley 
                       Dean Witter, New York, NY
    Good morning, Mr. Chairman and members of the committee. Thank you 
for the opportunity to address this committee hearing on an issue of 
such national importance.
    My name is Kit Konolige. I am a managing director at Morgan Stanley 
Dean Witter. My job is equity research analyst in charge of our 
coverage of electric utilities and unregulated power companies. 
Basically, my team and I advise investors--such as pension funds, 
mutual funds, and small private individuals--on which power companies' 
stocks are likely to provide a good return on their capital, and what 
are the risks involved.
    In more than 11 years doing this job, I have never seen large 
electric companies in a more dangerous financial position than Edison 
International and PG&E Corporation over the past two months.
    Some people think that the possible bankruptcy of these companies 
is a matter of concern only to investors in the stocks and bonds of two 
utilities. I believe that is a very wrong and dangerous idea.
    The utilities' financial crunch is one symptom of a broken system--
other symptoms include blackouts and the likelihood of much higher 
electricity prices throughout the West. This is a crisis that has 
already caused severe problems for all electricity consumers in 
California, throughout the West, and even throughout the country.
    It has produced much higher than necessary electricity prices, 
which lead to higher costs throughout the economy, and thus overall 
lower economic performance. California caused the problem, and 
Californians are suffering blackouts and high prices as a result--but 
the rest of the West, and the country, are also paying the high price, 
probably for years to come.
    So fixing this crisis is a matter of some national urgency.
    The good news is that this is not a natural calamity. It is largely 
a politically created crisis and it can be fixed, though I think its 
effects will linger.
    This is not a crisis caused by deregulation. There was never real 
deregulation in California. This is a crisis caused by not enough 
deregulation. It was caused by California's unique, disruptive new form 
of re-regulation. These high electricity prices, which inevitably will 
be passed through to residential customers and businesses throughout 
California and the West, were mostly the predictable result of 
political meddling that disrupted the marketplace for electricity.
    And for those who now pine for the golden days of regulation, let 
me remind them that this 1996 law in California was meant precisely to 
bring down the high prices caused by regulation. Regulation was blamed, 
I think correctly, for encouraging utilities to overbuild expensive 
capital investments and for providing no incentive to keep down 
operating costs.
    The authors of the so-called deregulation plan, passed in 1996 in 
California, claimed to want a market system, yet they prevented both 
supply and demand from working. What they really wanted was permanently 
low electricity prices with no limits on consumption. No system can 
produce that, as the Soviet planners proved for decades--and this 
attempt at overriding basic economic rules had spectacularly perverse 
effects that we must now all deal with.
    California's system allowed neither supply nor demand to work 
properly to produce lower electricity prices. Preventing new power 
plant construction stifled supply, while fixing consumer prices 
artificially low encouraged excess demand.
    At the most basic level, this is a crisis of supply. There is not 
enough electricity--for a simple reason--there aren't enough power 
plants. In the last 10 years, demand in California has grown at 3 or 4 
percent in some years, while no new plants of any size have been built 
in the state.
    So eventually, the shortage of power in California was bound to 
produce high prices. In a well-constructed market system, the high 
prices would have called forth new supply of the commodity--and thus 
high prices would have solved their own problem. But since California 
requires generally five years of hearings before new plants can begin 
construction, there is no new supply in any reasonable time to compete 
down high prices.
    Even today, in the middle of this crisis, the hostility to power 
plants remains. The classic story involves the Metcalf plant proposed 
for San Jose's Coyote Valley. Among the major victims of last summer's 
blackouts were the citizens of San Jose and the stakeholders of Cisco--
one of the most important companies of California and of the entire New 
Economy. The blackouts produced inconvenience and, more important, many 
millions in economic losses.
    These blackouts were hardly a surprise, as the Silicon Valley area 
imports more than 80% of its electricity from outside the region--so it 
has few electrical resources when supplies get tight. And yet, offered 
a solution to their problems in the form of one of the newest, cleanest 
power plants in the world, both the city government and Cisco have both 
fought this power plant tooth and nail. Cisco apparently just didn't 
like a power plant next door to its proposed new headquarters.
    Everybody says they want cheap power, and plenty of it--just not a 
power plant to produce it. You don't need a Ph.D. in physics to figure 
out that, at least for now, you need big machines to produce 
electricity--and if you don't build them, you're going to run out. The 
Silicon Valley area imports 83 percent of its power from outside the 
area. We've seen this ``not in my backyard'' syndrome lots of other 
places--but seldom so obviously, and seldom with such disastrous 
consequences.
    California flunked another Economics 101 test as its desperation 
move to lower price caps--four separate times in one year--proved as 
predictably misguided as it had for all those decades in the Soviet 
Union. California now has the lowest price cap in the country at $150 
per megawatt-hour--the next lowest cap is $750. No special prize for 
guessing which state produced the highest electricity prices and the 
only blackouts. And yet there are still people arguing for yet lower 
price caps.
    The California ``market'' system also had a unique feature that 
seemed almost perversely designed to produce high prices. This was the 
requirement that the great bulk of power be bought and sold only in the 
spot market. Again, the open market was circumvented--an open market 
would have produced mostly long-term contracts to stabilize prices, as 
it has in other states and countries. This spot market reliance is now 
recognized as a big mistake and is on its way to being changed--but the 
effects linger.
    What about the demand side? Demand also wasn't allowed to work in 
the supposedly deregulated market of California electricity. Under the 
1996 law, high prices were deliberately not passed through to 
consumers. This shielding of consumers from high prices has put the 
utilities some $12 billion in debt--and eventually the customers will 
have to pay off much of that debt anyway.
    But artificially low fixed prices create an economic problem that 
is more important than the fate of the utilities. High prices are 
supposed to cause consumers to use less of a scarce commodity, and thus 
bring prices down. This is how gasoline and airline tickets and 
Disneyland passes work. But the politicians didn't allow it to work 
that way in California electricity. Encouraged by artificially low 
prices, California consumers naturally continued to increase their use 
of electricity, even as the wholesale price indicated the commodity was 
getting scarcer and scarcer.
    Higher prices are the simple, direct way to conservation.
                  how it hurts the west--and the rest
    Californians themselves are the main victims of this failed project 
to install a sort of market-manipulating system for permanently cheap 
electricity.
    But the West as a whole, and in fact the entire country, are also 
suffering from the after-effects.
    First of all, by damaging its own economy through blackouts and 
needlessly high energy prices, a California that is one-eighth of the 
entire U.S. economy inevitably has hurt every other business and 
consumer in the country.
    More specifically to the West, high electricity prices in 
California drive prices higher everywhere else that is interconnected, 
from Seattle to Las Vegas to Phoenix and beyond. In effect, by not 
building their own power plants, Californians are putting upward 
pressure on prices by soaking up electricity from regions that have 
built their own plants. Seattle City Light is now considering an 18% 
rate hike, on top of a 10% increase on January 1--more responsible 
pricing than California, a big part of the high-price problem, is 
willing to impose on itself.
    Citizens of neighboring states might also ask whether they want to 
dedicate their equally treasured land and water to siting plants to 
serve San Jose--the city that wants more electricity but no more power 
plants..
    The chaos of the California markets generally has spilled over into 
the entire West, producing higher prices throughout the region. The 
uncertainties of payment and of the emergency federal orders have 
raised the cost of energy for all California's neighbors--and those 
prices are indicated in the market to be substantially higher for the 
next five years.
    At best, all the residents of neighboring states are facing higher 
prices for electricity because of the policy failures in California. 
But in addition, the regional economy is disrupted when aluminum plants 
shut down to resell their electricity at much higher prices.
    Perhaps most pernicious, the political demand by California to be 
bailed out of a crisis of its own making has led to federal orders 
that, for example, have used scarce hydro resources in the Northwest, 
driving up prices now and setting up potentially dangerous shortages 
for this coming summer. Water used to generate electricity in the 
winter, when it normally isn't needed, is water that's unavailable next 
summer when the demand will be much higher.
    Thus, a continued federal policy of forcing out-of-state providers 
to subsidize California creates a moral hazard, allowing California to 
avoid building unwanted power plants and to keep its consumers 
subsidized at artificially low prices. The more responsible political 
systems nearby are paying the price.
    Finally, because some people tend to believe California's leaders 
when they blame ``deregulation'' for their political and market 
failures--even though deregulation never really existed in California--
this has set back the cause of true deregulation elsewhere in the 
country. Over time, this means higher prices than necessary in other 
states, as the inefficiencies of regulation are extended to avoid the 
mess that California called deregulation.
                        so what is the solution?
    But deregulation, real deregulation, is the solution, not the 
problem.
    Just as with telephone service, airlines, and other previously 
regulated industries, we can have every confidence that a true open 
market in electricity will produce lower prices over time than the 
regulated system could. The market is more efficient than the 
regulators and politicians, as the California electricity fiasco has 
proved once again.
    In fact, deregulation is working well almost everywhere in the 
United States but California.
    Other states including New York, Massachusetts, and Rhode Island 
have recently allowed rate increases of 10% or more to be passed 
through to their customers. Western states like Oregon and Washington 
are also recognizing the need for rate hikes when energy prices rise. 
Freeing prices to rise (and fall) helps control excess demand. It 
recognizes the reality of higher natural gas prices, and prevents the 
expensive financial disruption we've seen in California.
    In return for these modest price hikes--the first increases in 10 
years or more--the open market in New England is now producing a great 
infusion of new power plant construction. Though well known for their 
conservation principles, the New England states allow construction of 
power plants within a reasonable period of a few years after the first 
proposal. The resulting construction of billions of dollars worth of 
clean, efficient new power plants, now coming on line, should assure 
abundant electricity at reasonable prices for many years to come. 
Utilities and individual customers are signing long-term contracts to 
lock in those prices. Meanwhile, dirty old oil plants are being crowded 
out of the New England marketplace.
    In my view, California's way out is straightforward--since 
deregulation is already working so well in many other states. If 
California will move towards a reasonable approximation of the free 
market by letting customers' prices rise to reflect true wholesale 
prices, and by stopping its excessive opposition to entrepreneurial 
companies who want to spend billions of their own dollars to provide a 
commodity California needs--then Californians can regain the simple 
pleasure of on-demand electricity at a stable and reasonable price.

    The Chairman. Thank you very much. Now, you are aware of 
the progress being made and the manner in which the California 
legislature and the Governor and others are trying to address 
the problem. The question for us is, is this going to be 
adequate for Wall Street to come in and finance the expansion 
of energy-producing facilities in California?
    Mr. Konolige. I think two answers to that, Mr. Chairman, 
would be----
    The Chairman. Give me the straight answer first.
    Mr. Konolige. How about two straight answers, two aspects 
of it?
    The Chairman. If I get that lucky, that is fine.
    Mr. Konolige. I guess I would start by saying the first 
thing Wall Street wants is certainty. Wall Street can deal with 
a lot of intricate laws if those are the laws and they stay in 
place, so write the laws and say, these are going to be the 
laws for the next 5, 10, 15 years.
    The Chairman. You are talking to us or to California?
    Mr. Konolige. I am talking to the California folks who are 
working on this. If they put in position--if they were to say, 
for example, it will now take 4 years to site, to go through 
the process of siting a powerplant, well, that would be far 
from ideal, but there would be companies who would say, okay, 
I'll take my chances on 4 years. It is this possibility that it 
will not be 4 years, it will be 6 years, that really throws 
them for a loop.
    So having transparency and clarity on, first of all, how 
long it takes to build the powerplants, and secondly, on what 
market for the power is going to be when the powerplant is 
finished. Specifically there I'm talking about, are there going 
to be attempts at price caps or not? Is there going to be an 
open market where, when you build a powerplant, you can go out, 
solicit customers, make an arm's length agreement and sell the 
power, take your chances on what the market conditions are? 
After all, as the builder you are putting billions at risk and 
if somebody wants to buy the power from you, you should be 
allowed to sell the power under a contractual arrangement.
    The Chairman. I want to get at whether this is adequate. 
What California is doing now, is it going to be adequate? Is it 
going to meet the criteria of Wall Street?
    Mr. Konolige. Well, I do not think I have seen enough 
detail. I do not know that there are----
    The Chairman. Do you have a copy of this letter the 
Governor sent?
    Mr. Konolige. The letter?
    The Chairman. That was outlined by the Governor from 
California.
    Senator Feinstein. Mr. Chairman, I do not believe anyone 
has that letter. It was just brought in this morning.
    The Chairman. Well, we will keep the record open, and we 
would like to have your analysis, because to go through this 
exercise and then find that it is inadequate from the 
standpoint of Wall Street's point of view, you have got to go 
back to the drawing board again, is that not correct?
    Mr. Konolige. Well, if the Governor listened to me and Wall 
Street, then that might be correct.
    The Chairman. Well, you are either going to invest or you 
are not. You are looking for the highest return and the least 
risk.
    Mr. Konolige. No question about it.
    The Chairman. What is your second point?
    Mr. Konolige. Those were the two points.
    The Chairman. What we are doing here is, we are on a 5-
minute time, and I think my time is running down, but all 
members will have 5 minutes. I want to reflect on something 
that Senator Bingaman brought to our attention relative to the 
role of the administration and the implication of all they seem 
to be doing is promoting ANWR as some kind of, I guess, support 
for California's energy crisis.
    I think that is incorrect, and I would point out for the 
record what the administration has done and the liability that 
the administration has passed on potentially to taxpayers 
throughout this country. On natural gas there was an order on 
January 19 to mandate an energy sale of natural gas. That can 
only be initiated by the President of the United States, I 
might add, and it is implemented by the Secretary of Energy, 
and that original order was initiated January 19. There was one 
extension on it to February 7, on electricity.
    The original order, a sales order which is under the 
authority of the Secretary of Energy, was initiated on December 
14. There have been five extensions to February 7, so to 
suggest that the administration has not done much I think is a 
gross inaccuracy of reality.
    What the administration has done is, basically, in the 
event that California cannot repay the generators of this 
power, the Federal Government is going to have to meet that 
obligation, because this was an order of the Federal 
Government. I am sure it will be a full employment act for the 
lawyers on the theory of taking, if, indeed, California could 
not pay for it.
    Now, how can California pay for it? Why, there are a number 
of options. Floating the bonds, guaranteeing the debt, 
financing and so forth, but I just want to make the record 
clear that this administration has basically passed on to the 
taxpayers of the entire United States the contingent liability 
associated with billions of dollars of power that has been 
ordered by this administration to give California time to work 
out of this problem.
    Now, the only thing that is somewhat conclusive is the 
statement that they are not going to give them any more time 
beyond the 2-week period, which I believe ends February 7. I 
think what the administration may be trying to communicate to 
the American public and some of my colleagues is that when you 
become so dependent on outside sources, as California has, for 
electricity and energy, you risk your ability, if you will, to 
control your destiny, and there is a parallel here in oil, and 
I do not think anybody is unaware of it, and that is the 
reality that we are becoming more and more dependent on 
imported oil, 56 percent, so there is a parallel there and I 
think that is the point the administration is making.
    Oil and ANWR is not going to bail out California's energy 
problem, but this administration is, I think, going certainly a 
long way by basically underwriting payment when California 
cannot pay it. It will not be billed for 2 months.
    So with that, I would turn to Senator Bingaman.
    Senator Bingaman. Thank you very much. One issue that is 
foremost in discussions here in Washington is whether any 
effort should be made at the Federal level to restrict the 
price of wholesale electricity going into California. Mr. 
Makovich, I do not think you had a chance to comment on that, 
and also Peter Fox-Penner, I did not hear your comment on that.
    Dr. Makovich. Well, the question of price caps, 
particularly price caps that will be set for the entire Western 
power market, I think it is important to realize price caps are 
not something you want to be a permanent feature of any market, 
but as I mentioned, this is a market that was flawed and, of 
course, is in crisis, so I think we have to realize price caps 
are a very limited tool available to deal with this crisis.
    The first danger is if you set price caps you will cause a 
severe distortion. For example, if you set these on the basis 
of what historic prices have been in the past, you run the 
danger of setting them far too low. Gas prices have doubled or 
tripled since a year ago.
    The cost of NO<INF>X</INF> allowances, the emission credits 
out there have increased substantially, and so it is very easy 
to take a typical powerplant right now, a 10,000 Btu powerplant 
at the prices for gas that were available just last Monday, 
with $10 per pound on NO<INF>X</INF> you can get to $165 per 
megawatt hour on variable costs, so you have to be very careful 
you are not putting a cap at $150 and giving them the incentive 
not to run.
    If used, they should be temporary. They should not look 
indefinite, because that could discourage supply additions, and 
I would suggest if used you should tie it to reform and force 
California to fix the flaws of not approving enough powerplants 
and not paying for capacity.
    Senator Bingaman. You still have not answered the question, 
should they be used? You said, if used. If you were advising 
FERC, would you recommend that they step up to that issue and 
try to do something in the way of controlling prices?
    Dr. Makovich. Well, I think, given how short it looks like 
this market is going to be for next summer, we are going to be 
in a crisis next summer as well and, as I said, in a crisis 
situation the temporary use of price caps may be an appropriate 
thing to get us through this crisis, because otherwise the 
burden of this big mistake just gets passed right on to 
customers.
    Senator Bingaman. Peter, did you have a point of view you 
wanted to express?
    Dr. Fox-Penner. Yes, Senator. First of all, I would note 
that I think Kit mentioned that there are already caps on all 
of the deregulated markets, but they are at levels that are 
much higher than most of the markets are trading at, with the 
exception of California. California had a cap for most of last 
summer and the market traded right at that cap for almost the 
whole summer, particularly the second half of the summer
    I think I would echo what Mr. Makovich said, that it is I 
think extremely hard to set caps that are at a fair level and 
that do not sort of hamper or squelch investment, which is key 
to solving the problems in the long term, and you have to set 
them high enough to give people selling under the cap fair 
return on their investment, and that means you are essentially 
going back to the same determination you make in cost-based 
rates.
    I think it is very difficult to transition to that for 
short period of time, Senator, and to transition off of it, and 
yet you do not want to be on it for a very long period of time, 
so I think they are a last resort. Realistically they are 
probably going to be necessary for next summer and I think the 
FERC has all the authority it needs, and has used it time and 
again when it has felt the need to, but I want to say, Senator, 
most importantly, that in California and elsewhere a much 
better approach than caps is long-term contracts.
    Economically they do almost the same thing. You fix a price 
for a long period of time. It is a locked-in price, but as we 
just heard from Kit, Wall Street likes them. Powerplant 
developers are willing to sell under long-term contracts. The 
auction that California is holding now that Senator Feinstein 
mentioned is the best development to come along in California I 
have seen since the problem started. I think it is the path out 
of this. The utilities have to be able to cover the cost of 
those long-term contracts. They have to be at fair levels for 
sellers to sell and you will see, as Mr. Konolige mentioned, 
dozens of powerplant developers willing to sell under long-term 
contracts, willing to build plants, in my opinion.
    Senator Bingaman. My time is up. I want to introduce into 
the record an article * that Paul Joskow and Edward Kahn have 
written on this general issue, and I will ask a question about 
it during the next opportunity.
---------------------------------------------------------------------------
    * The article has been retained in committee files.
---------------------------------------------------------------------------
    Senator Campbell, you are next.

          STATEMENT OF HON. BEN NIGHTHORSE CAMPBELL, 
                   U.S. SENATOR FROM COLORADO

    Senator Campbell. Thank you, Mr. Chairman, and I thank the 
panel for the articulate, concise, and educational 
presentation.
    I think there is some misconception about what the 
administration is doing now. I know I have read in the paper 
some quote that was attributed to President Bush that there 
would be Federal help for California but, as you probably know, 
one of your suggestions, Mr. Fox-Penner, is probably already in 
the process, because the President did convene a panel that is 
going to try to study not only the problem but the Federal 
involvement and what it should be.
    Vice President Cheney is the chairman of that panel, and 
Andrew Lundquist, who was the staff director of this committee, 
just went over. In fact, I think yesterday was his last day 
with the committee, and so there is going to be some 
involvement, and hopefully we will find how to prevent future 
mistakes and help.
    But I have to tell you, I do not have any questions, but I 
have a very strong affection for California, as my colleagues 
from California, Senator Boxer and Senator Feinstein, know. 
They have always been able to count on me when it is an issue 
with the State in which I was born and went to high school in 
and went to college in, and was a policeman and a teacher and 
on the Olympic team, all from California, and I still go out 
regularly. I have lots of relatives.
    So I think that in some cases there may be some distasteful 
decisions we have to make, and some of us may hold our nose a 
little bit when you talk about what it is going to cost the 
American taxpayer to help, but I think we have to, and not only 
because of my affection for that State, but fully half of this 
committee, at least to my knowledge, comes from States and 
represents States that are in the same power grid.
    Certainly my colleagues from Idaho and Wyoming and Montana 
and Oregon and so on, we are all on the same power grid, and I 
think some of us are convinced that the economy of California 
that relies so much on energy, and now energy from our States, 
if that economy takes a nose-dive and gets into a downward 
spiral we are all going to be pulled into it, so we all have a 
vested interest in trying to do what we can to stem that 
downward spiral.
    I think most of us recognize that and we are going to be 
involved in it, but we also recognize that California cannot 
have it both ways. When I lived out there I lived in a little 
town called Wilton and one called Elk Grove, and I was right in 
the shadows of what was called Rancho Seco. It was a nuclear 
power-producing facility built by Sacramento--SMUD, I guess it 
was, Sacramento Municipal Utilities District, I think it was 
called, and I can still remember the regulatory problems they 
had getting that built in the late fifties, early sixties, when 
they were starting.
    I left there in the early seventies, and up until that time 
it had never been turned on except to test. There was so much 
opposition, regulatory opposition, and I can still remember on 
the main road--I could see the towers right from our ranch--
there was almost a daily stream of protestors going out there 
from the environmental community with placards, and all this 
stuff to prevent it from being fired up.
    So I kind of reject the attitude, the notion that the 
energy-producing companies did not do it because the profits 
were not right. There were a number of reasons why they could 
not expand, in my view, and certainly opposition from 
regulatory agencies that was driven by environmental concerns 
was part of the deal, too.
    I understand that that sat idle for a number of years, and 
another $600 million was put into Rancho Seco to upgrade it, 
retrofit it and all that, and it still has not been turned on. 
It still does not produce power. I might be wrong in that, 
because I left there a number of years ago, but that is what I 
have heard, but clearly you cannot have it both ways. You 
cannot have a growing economy, a growing number of people, a 
growing reliance, as the Silicon Valley is, on energy, as 
manufacturing is on energy, and then at the same time not be 
willing to build the very apparatus that produces the energy.
    I mean, I am not a nuclear scientist, but any damn fool 
ought to be able to figure that one out. You cannot have it 
both ways, and I think until the lawmakers of California come 
to that realization, that they are not going to have it both 
ways, then they are going to stay in this predicament ad 
infinitum, whether the Federal Government helps or not, because 
we cannot just support the State when the will to produce 
power-generating mechanisms is not there.
    In fact, some people in California are advocating tearing 
down the very dams that produce some of the hydro electric 
power. You cannot have it that way. So I would hope, when we 
get through all of this and we do find a solution, that it is 
going to also help all of our States that are some of the 
power-producing States that are in that same grid, that the 
legislature of California will take the lead in trying to 
prevent a recurrence of what is happening now.
    But just as one Senator, I wanted to just tell you and the 
other witnesses that I am absolutely committed to doing what 
ever I can, as one Senator, to try and resolve the problem, and 
I thank all of you for your testimony.
    Thank you, Mr. Chairman.
    Senator Bingaman. Senator Craig.

        STATEMENT OF HON. LARRY E. CRAIG, U.S. SENATOR 
                           FROM IDAHO

    Senator Craig. Thank you very much, Senator Bingaman. 
Gentlemen, I think we all agree that your testimony was 
insightful and certainly led to the kind of record that has to 
be established both for the Congress and for the American 
public to understand that what is going on out in California 
just did not happen by accident.
    It either happened by failure to make the right decisions, 
or wrong decisions made. I am not sure how you cast it, but I 
do know there is a problem that goes beyond California, and my 
full statement will become a part of the record, but I did want 
to reflect on some of that problem as a Senator from the State 
of Idaho and part of that Pacific Northwest hydro base out 
there that is being dramatically affected at this moment by 
California.
    I recognize that power flows both ways. There were times 
when California could produce surplus power, and that power 
flowed into the Pacific Northwest. There are times when we 
produce surplus power and it flowed to California, but that was 
a positive relationship when both sides of that flow were 
trying to keep relative balance with growth and recognize it 
and have those capacities and margins to offset. Obviously, in 
the last few years that's changed dramatically.
    Let me give you some facts for the record that are a very 
real concern to me. This last week I was informed by the 
Bonneville Power Administration that it is raising power rates 
60 percent over the next 5 years. Implementing this increase 
will require a 90-percent raise in rates for Northwest 
consumers over the next couple of years. I am suggesting to my 
consumers in Idaho that they send the bill to California. This 
will likely cause job losses. Our high-lift irrigation pump 
system may well have to shut down some of its operations. 
Hardships on the average consumer in the Pacific Northwest 
isn't because of the Pacific Northwest. It may well be because 
of California.
    California's energy needs have already exhausted Coolee 
Dam's water supply for power production. Now, that is one of 
the largest hydro systems in the world, and it has been drained 
down dramatically in the last month because of a Federal order 
that I am very cautious ought to ever be implemented again, and 
I have suggested to the President and the Vice President that 
one time was too much, twice is way too much, and a third time 
would be a major error on the part of the Federal Government to 
force the Pacific Northwest to solve California's needs.
    Yesterday, Mr. Chairman, I spoke with the new district 
commander of the Corps, the Army Corps of Engineers of the 
Walla Walla District and learned that orders were given to 
operators of the Federal Dvorjak project in Idaho to draft that 
reservoir 1 foot per day for the next 6 days in order to 
generate enough power for the current demand. Dvorjak happens 
to be in my State of Idaho.
    Now, that is a reservoir that is 4 or 5 miles in length. To 
draft it down a foot a day is a very dramatic thing to do. Most 
importantly, that reservoir's water has been used over the last 
several years intermittently to provide water cooling 
temperatures to the whole of the Snake-Columbia system for the 
purpose of moving fish downstream, fish that are endangered in 
the Snake and the Columbia system that many friends of the 
environmental community are extremely worried about, and yet at 
the same time the consequences of California is that we may 
lose capacity to augment an environment to make it more 
positive for the endangered fish of the Snake and Columbia 
system.
    Well, that story goes on and on, and if we have exhausted 
Grand Coolee and have exhausted Dvorjak, then we turn to Libby 
and to Hungry Horse. I am afraid that my colleague from Montana 
will get extremely exercised over that.
    Yes, the virus in California is affecting the Pacific 
Northwest dramatically, and for the reason you have all 
expressed. The grid system that is interlocked is not an 
isolated situation. If it were, my guess is we would be less 
sympathetic to California, because it truly would be a crisis 
of their own making. Today they are able to spread that crisis 
into the rest of the Pacific Northwest at a time when we are 
experiencing 62 percent of snow pack within the region. That is 
the water for next year's generating capacity, next summer's 
generating capacity, and that is a fairly average rate of 
moisture for the entire watershed region that provides moisture 
to the Snake and the Columbia River systems.
    I will conclude, Mr. Chairman. The brown-outs of California 
now could well be the brown-outs of Idaho and Oregon and 
Washington next summer, and I am afraid that my consumers and 
my voters are not very sympathetic to California. Now, we will 
work in the short term to solve their problems, but if their 
solutions for the short term do not address the things you have 
talked about for their long-term needs, we will grow less 
sympathetic and a good deal more angry.
    The Chairman. And you are happy this morning?
    [Laughter.]
    Senator Craig. Mr. Chairman, one last example. 2 cents per 
kilowatt hour versus $500, to the average consumer out there 
that is $2 a gallon going to $500 a gallon milk. Now, in Idaho 
my folks could quit drinking milk for the short term. They 
cannot quit using power.
    [The prepared statement of Senator Craig follows:]
   Prepared Statement of Hon. Larry E. Craig, U.S. Senator From Idaho
    Mr. Chairman, the California energy crisis is now the Western 
United States energy crisis, and perhaps soon, will be a national 
energy crisis.
    Late last week, I was informed by the Bonneville Power 
Administration that it is raising power rates 60% over the next 5 
years. Implementing this increase will require a 90% rise in rates for 
Northwest consumers over the next year. This will likely cause many job 
losses, farm foreclosures, and hardships for the most vulnerable 
citizens of the Pacific Northwest.
    California's energy needs are rapidly exhausting Grand Coulee's 
water supply for power production. Yesterday, Mr. Chairman, I spoke 
with the new District Commander in the Corps of Engineer's Walla Walla 
District and learned that orders were given to the operators of the 
federal Dworshak project in Idaho to draft the reservoir one foot per 
day for the next six days in order to generate enough power to satisfy 
current demand. That is an incredible volume of water being depleted 
when you consider that the Dworshak reservoir is currently over forty-
five miles in length.
    Ironically, Mr. Chairman, the water drained from Dworshak will be 
used by downstream federal dams on the lower Snake and Columbia Rivers 
to produce power to serve BPA customers. As you may recall, Mr. 
Chairman, those dams on the lower Snake River have been, and continue 
to be, the target of environmental groups who claim the power produced 
at those dams is not needed. Perhaps, now, more rational views will 
prevail in the dam breaching debate, and we can concentrate on recovery 
measures for fish that will work.
    It appears, Mr. Chairman, that the volume of water in Dworshak will 
be exhausted soon and that the Corps will be forced to turn to Libby 
Dam and Hungry Horse Dam to serve the power demand. There is little or 
no water reserve left for power after those options are used. Add to 
that the condition of the snow pack which is only 62% of normal, and 
you begin to appreciate the growing concerns of the citizens in the 
Pacific Northwest.
    Mr. Chairman, we need answers. Many of us on this Committee knew 
last Fall that there was something seriously wrong with the California 
deregulation experiment. Indeed, I went to the Floor of the Senate last 
October expressing concern about the problem in California and made a 
plea for a quick and honest assessment of the circumstances that were 
leading to failure there.
    Some assessments are emerging and perhaps today, Mr. Chairman, we 
will supplement those assessments with important facts.
    Clearly, editorial boards for major newspapers throughout the 
country are expressing their views on the California crisis.
    In the past decade, according to the Census 2000 figures released 
last month, California added more residents than any other state in the 
nation--4.1 million. Unfortunately, that same decade, the state 
sacrificed intelligent growth on the altar of environmental extremism.
    Those are not my words, Mr. Chairman. Those are the words of the 
editorial board of the Atlanta Constitution Newspaper written on 
Tuesday, January 16, 2001.
    The editorial entitled ``Balance Essential on Environment'' goes on 
to say:
    At the root of the problem is California's environmental regulation 
minefield, a primary reason that not one major power plant has come on 
line since the early '90s. In an over-the-top crusade for clean air and 
water, federal and state agencies have been manipulated by unelected 
vocal environmental groups determined to banish fossil fuels from 
California. As a result, the state mandates the toughest environmental 
regulations in the nation, cramping residents' choices and snowballing 
the cost of living and doing business in California. It's difficult to 
feel sympathy for people who gripe about high utility bills and outages 
when they meekly swallowed--indeed encouraged--the power grab by not-
in-my-backyard ``consumer'' groups and environmental zealots touting 
wind farms and solar power.
    Mr. Chairman, although environmental zealotry has contributed 
greatly to the energy crisis in the West, failure to ensure adequate 
fuel supply reserves are clearly complicating a quick and safe response 
to the pressing demand for reliable power.
    During the past decade, we have heard a chorus of energy marketers 
and environmentalists sing the praises of natural gas as a cost 
effective and environmentally sensitive energy source. The past 
Administration has hailed natural gas as the cleanest fuel for home 
heating and has aggressively pushed utility companies to convert oil 
and coal-fired electric plants to gas.
    The irony, Mr. Chairman, is that all this aggressive promotion has 
not been backed by commensurate efforts to ensure supply. Indeed, Mr. 
Chairman, what appears to be the case in the United States is that we 
lack a readily available and sufficient supply of natural gas to 
satisfy current demand, let alone the increasing demand that we expect 
in the immediate future. Consequently, natural gas prices are high and 
will continue to go up in the future.
    This will not change until we reverse government policies that have 
foreclosed opportunities for choice of fuels. The policies of the past 
Administration contributed greatly to fuel shortages in the Northeast 
by preventing additional pipelines from being built thereby depriving 
hard hit consumers in the Northeast the option of lower cost natural 
gas.
    Not only is this my opinion, Mr. Chairman, but also the opinion of 
many energy experts such as the well respected economist Daniel Yergin, 
and Federal Reserve Chairman, Alan Greenspan. Both have testified as to 
the lack of American investment in our energy infrastructure and have 
warned us of the economic consequences of failure to garner adequate 
supply.
    Moreover, Mr. Chairman, the past Administration has complicated our 
ability to retrieve adequate supply by locking-up federal land deposits 
of this valuable energy source and increasing federal red-tape and 
bureaucratic inefficiencies that on the one hand runs up costs to our 
citizens and on the other denies consumers the choice they have been 
promised. Both of these results are unacceptable, Mr. Chairman.
    I thank you for giving the Committee this opportunity to delve into 
the facts of California's energy crisis and I look forward to working 
with you and my colleagues on this Committee to successfully and 
quickly respond to this problem.

    The Chairman. Thank you, Senator Craig. We will not pursue 
the milkman any more.
    Senator Burns, from the great State of Montana.
    Senator Burns. I will not take a lot of time, Mr. Chairman. 
I want to thank you and I want to thank----
    The Chairman. You have only got 5 minutes.
    Senator Burns. I would like unanimous consent that I may 
put my statement in the record.
    The Chairman. Without objection.
    [The prepared statement of Senator Burns follows:]
   Prepared Statement of Hon. Conrad Burns, U.S. Senator From Montana
    Mr. Chairman, thank you for calling this very important, and well-
timed hearing on ``California's Electricity Crisis and Implications for 
the West.'' My constituents in Montana are watching us very closely 
today because they need to see leadership. They need to see that 
California is taking a responsible role in leading us out of this 
crisis. They need to see leadership from the Bush Administration. They 
need to see leadership by this Committee. And they need to see 
leadership within the energy industry.
    First, we need leadership out of our new administration. The Bush 
Administration, to their credit, is following up on their campaign 
promise to structure a national energy policy that takes into account 
everyone in America. They are sensitive to environmental concerns, 
while making sure that production and generation increases so that we 
do not handcuff the United States' economy to such a degree as to 
minimize our role in the world's economy. The United States should take 
an active role in our world's energy policy, and our role should 
encompass the needs and desires of all facets of the U.S. economy. In 
short, I am confident that the Bush Administration will lead us towards 
a regulatory regime in the energy industry that allows all of America 
to take part in economic revitalization.
    Second, America needs to see this Committee take an active role in 
our nation's energy problems. Many critiques of deregulation want to 
say that deregulation is solely to blame for our current energy 
problems. I want to make it clear that in determining what to do about 
our energy problems we must know the difference between correlation and 
causation. Because two related events happened at nearly the same time, 
it does not necessarily mean that one caused the other. Critics say 
deregulation caused our current energy problems. I find that hard to 
believe after analyzing some basic statistics. In the Northwest, demand 
for electricity is up at least 24 percent over the last 10 years. At 
the same time, generating capacity is only up around 3-4 percent. I am 
not an economist, but I can tell you that balance within our 
electricity industry is skewed towards higher price. Therefore, when we 
look at our role in solving the energy shortage, I want this committee 
to take an active role in seeing that we lessen some of the impediments 
to electricity generation and transmission. Let's make sure that the 
federal agencies that oversee the energy industry are streamlining 
their processes to help ensure that supply meets demand.
    In Montana, we have the resources and we have the ability to bring 
more power plants on line. However, even if we were producing more 
power, we do not have the ability to bring this power to market because 
I am told that all of the transmission lines are at maximum load. The 
American people are looking for leadership from this Committee. Let's 
take an active role in ensuring we streamline government so that it 
enhances industry's ability to generate and transmit electricity.
    Last, the energy industry itself must provide leadership. Many 
people say that industry is making today's energy shortages even worse. 
I think that there are some legitimate concerns revolving around 
today's energy producers. If it is true that energy producers are 
taking enormous profits at the expense of the American economy, then 
they need to analyze their practices and show restraint. I understand 
that publicly-held companies have a fiduciary duty to maximize profits. 
However, consumers also have a right to fair market prices that are not 
the result of market manipulation and industry collusion. While I 
continue to maintain that our largest problem is lack of supply, I will 
keep my eye on our energy producers to make sure they are not 
exacerbating our problems. I remain confident that our producers will 
realize they have a duty to consumers as well as to shareholders. I 
believe they will help lead America back to stable energy prices.
    Mr. Chairman, again I thank you for calling this hearing today, and 
I look forward to the testimony of our panelists.

    Senator Burns. I happen to look at the California situation 
maybe a little bit different, because I still think they are 
part of this union, and we have to do something to help our 
folks in California, although I will tell you this is a good 
time to run a good commercial for Montana. Those folks that 
want to do business and need a lot of power, we produce about 
3,900 megawatts a year, and we use less than that. We would 
like to move more into the California market, but I am told 
that the transmission lines and our ability to transmit that 
power is limited and almost at capacity now, so those of you 
who want to look to Montana, why, you may do so. You can call 
my commercial office downtown. They will set you up.
    I do believe that that is one way that we can solve some of 
our problem on the Western grid. I think the whole thing needs 
to be looked at in totality. We look to the BPA for part of our 
power. We look also to WAPPA, to the East, and of course our 
own ability to produce in Montana. I think mine-mouth using 
coal, clean coal technology, and mine-mouth generation, and 
moving it in transmission lines, is probably the best way we 
have to addressing the problems we have in California. That may 
not be the cheapest way, but it is a reliable way in order to 
address that.
    Curves should have told us something, Mr. Makovich, as near 
as 5 years ago if we look at everything, we looked at Economics 
101 as we watched curves, and we could see where the demand for 
electricity was going up, yet our curve for production was just 
barely going up. Like, 24 percent increase in the last 10 years 
and only a 3 percent increase in our generating capacity tells 
us that that curve had to start at least 5, 6 years ago, and 
someone did not pick up on that.
    You made the comment that the overlapping of 
jurisdictions--I think, Peter, maybe you made that, of 
jurisdictions of FERC and State, lends a lot of confusion on 
where are we to go. We have had applications in for small dams, 
the recertifications of FERC, and that takes forever for some 
reason or another, 4 or 5 years on recertification. That should 
not take that long. Do we pass legislation that gives our 
regulatory people a time line in which to complete 
recertification, or to do something that is required, and would 
any of you want to comment on that?
    Dr. Makovich. I think that each State has its own unique 
set of requirements. In order to site and permit powerplants I 
think a time line requirement is a good idea, but I think more 
importantly, I think States have to have a minimum target of 
approvals regardless of how long this process is going to take, 
or what time line they have got.
    For example, in California's case, if they are not 
approving 1,200 megawatts a year then they are not keeping up 
with demand, and so I think you have to force them to meet some 
targets.
    Senator Burns. Peter, what is the increase in demand in 
California? What is the growth? I am told it is around 3,000 
megawatts a year. Is it increasing that much?
    Senator Feinstein. Demand went up 14 percent last year. I 
cannot translate that into megawatts.
    Dr. Fox-Penner. I think demand went up, I believe, 4 
percent last year, which was extraordinary, off of 50,000 
megawatts. I am not good at doing that in my head, but 3,000 
sounds a little too high.
    Dr. Makovich. Actually, the peak demand this last summer 
was a little bit below where it was the summer before. If you 
look at peak demand, the maximum demand in California, it is 
growing, if you correct for weather and the business cycle, 
about 2 percent a year.
    Dr. Fox-Penner. I got about 2,000 megawatts
    Senator Burns. In other words, we were at least close, but 
it is hard, it seems like in the investment world--as our man 
from Morgan Stanley will tell you, it is hard in this business 
to build a church for the Easter crowd, it seems like, but 
nevertheless it looks like we are going to have to do some of 
those activities, is that correct?
    Dr. Makovich. Yes.
    The Chairman. Your time has expired.
    Senator Burns. And I will yield, and I have got something 
else to do, but I will be back in time to talk to the industry. 
Thank you for your testimony today. I appreciate that very 
much.
    The Chairman. Thank you, Senator Burns.
    Senator Akaka.
    Senator Akaka. Thank you very much, Mr. Chairman, and thank 
you for having this hearing.
    Mr. Makovich, you stated that what has happened is that 
there is a severe shortage of power in California, and Mr. Fox-
Penner said it is a tragedy of immense proportion, and the 
Senators from California have indicated that it is so severe 
that Congress has to act immediately on this.
    Mr. Makovich pointed out that part of the problem is that 
consumption has grown 24 percent and there are structural flaws 
creating the problem. You also mentioned, Mr. Makovich, that we 
need to create lower demand as well as increase power 
production, and my question to you on those two, on creating 
lower demand and increasing power production, is whether you 
have any suggestions or any ideas as to how this can be done.
    Dr. Makovich. Well, when we look at the magnitude of this 
shortage, as I mentioned, 5,000 megawatts, we are at least 
5,000 megawatts short, I think it is important to recognize 
conservation and efficiency gains which have been occurring in 
California over the past 5 to 10 years. They can help on this 
problem but they cannot even be a major solution here. What you 
can get in the short run on conservation and additional 
interruptible load will help, but you have to do--this is not a 
question of just shutting off all of the swimming pool pumps in 
California. This is a major shortage that conservation and 
efficiency cannot meet alone, and so what it means on the 
supply side is do everything you can on the demand side, but on 
the supply side you need emergency generation. You need to 
bring barges in where possible to California with generating 
capability.
    I think if you could put some flexibility in environmental 
regulations to allow backup systems at hospitals and 
universities and hotels, the diesel gen sets they have for 
emergency purposes to be able to run this coming summer, that 
is another thing that would help. I think you have to scramble 
right now on both the demand side and the supply side, because 
we have a looming crisis again this summer.
    Senator Akaka. Mr. Fox-Penner.
    Dr. Fox-Penner. Senator, there are many conservation and 
pricing measures that I think should be looked at. I do agree 
that many of them take a while to implement and will not be 
ready for this summer, just as it is going to be hard to build 
any permanent powerplants for the summer, I would say 
impossible, but I hope that this episode teaches us that we 
must continue those efforts. There is a whole variety of 
efficiency options and we are going to need lots of power for 
the long run here, and we cannot take our eye off that ball.
    There are a few, though, short-term demand-related measures 
that I feel are extremely important, and one of them is to 
accelerate the implementation of technologies that make 
buildings demand-responsive price-responsive themselves. 
Buildings can actually reduce their energy use dramatically 
with no humans involved in response to price signals, and 
research has shown, as I mentioned in my testimony, that until 
we get technologies like this and more demand response, we will 
never have fully working electric markets, so we have to do 
this. We should do it as quickly as we possibly can, and this 
sort of thing does not take a terribly long time to implement.
    Mr. Konolige. If I might mention one suggestion, the 
standard, most straightforward conservation measure is to raise 
prices to customers, and since California has already raised 
prices 10 percent, I think that will have some impact on 
lowering demand.
    If it were to go ahead with some of these suggestions that 
have been raised in the political process so far and increase 
prices further, they would have to be increased for the summer, 
perhaps an emergency surcharge of some kind would be a 
reasonable way to really dampen demand. In fact, last summer, 
when San Diego radically raised prices, there was an immediate 
sharp decrease in the usage in San Diego, as you would expect.
    So while that may sound like shock therapy, if the problem 
is bad enough, namely blackouts, it might be something that the 
State may want to consider.
    The Chairman. Senator Akaka, your time is up.
    Senator Akaka. Thank you very much, Mr. Chairman.
    The Chairman. Thank you, Senator Akaka.
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman. What is especially 
troubling to me is that the same California utilities that 
engaged in the questionable transfer of billions of dollars to 
their shareholders and others cannot provide iron-clad 
guarantees that we are going to be paid back for the power we 
have already given, so I am not going to support another 
megawatt of power to California unless we have real reforms 
that truly protect everybody in the West.
    My sense is, and this is my question for our witnesses, 
that a critical first step in terms of real reform is to lift 
this veil of secrecy that surrounds the energy markets. It 
seems to me it is time to make information available about 
market power and transmission capability and outages, and I 
would like to ask, perhaps Mr. Makovich and Dr. Penner, do you 
agree that California, the California ISO and the regional 
transmission organizations, ought to provide more information 
so that the public is in a position, and investors and others, 
to make intelligent choices?
    Dr. Penner.
    Dr. Fox-Penner. Senator, I would only agree a little bit. I 
think the information available about the electric industry, 
although it has declined significantly as deregulation came in, 
is still pretty good and probably more, I would say from the 
industry's standpoint, burdensome than in almost any other 
industry, and it is not the greatest barrier that we analysts 
see to figuring out what is going on.
    Now, having said that, I think there are some minor 
improvements between EIA and the FERC in their information 
collection. I would be glad to discus them off-line, and though 
they are small, I think quite small, they would be quite useful 
in making studies, but it is generally not a major issue.
    Senator Wyden. I am going to give you a copy of the letter 
from the Oregon Public Utility Commission, because they say 
they are basically in the dark about these issues. I mean, just 
the debate that is going on right now with respect to 
deregulation, it is very hard to get accurate objective facts 
about how these markets work.
    Mr. Makovich, did you want to take a crack at it?
    Dr. Makovich. Sure. Good information flows are the life 
blood of markets that work well. I think the evidence in the 
California energy market was that having set up a formal power 
exchange to replace the informal wholesale market that had 
existed in the California area did a lot to improve information 
flows about supply, demand, and price at any point in time.
    In fact, what the information said was, unless this 
California market is in a shortage, prices are too low to 
support investment, so the information flow to investors was 
pretty good. Do not build a powerplant in California because it 
is not profitable.
    Now, there are some information flaws, and one in 
particular is, I think it would help if planned outages of 
powerplants----
    Senator Wyden. That is one of the first things I want to 
see in a California bill, is outages. What about transmission 
capability?
    Dr. Makovich. Well, if outages were reported I think we 
would have much better coordination, and we would avoid the 
problem of everybody being down at the same time because they 
didn't know everyone else was going to be down, but on the 
transmission end, transmission network is very, very 
complicated.
    If you think this wholesale market restructuring is a mess, 
well, if you dig into the transmission restructuring right now, 
we think the transmission system in the United States right now 
can be described as being in a state of gridlock. People do not 
know how to price transmission. They do not know how to manage 
the congestion. We have got all sorts of schemes at work right 
now to try to figure this out, other grand experiments here, 
and yes, there are many economic investments that could create 
better power flows, higher integration in the West that are 
currently not being done because of this tremendous state of 
flux.
    Senator Wyden. I guess my concern is that if we are 
entering this era of electric power competition, electricity is 
traded as a commodity, but there is not open access to the 
information that is necessary for a commodities market to 
function properly, it is going to be hard to make real 
progress.
    So I would just say to our friends from California that we 
have been more than a good neighbor here. We are going to need 
to see some reforms that benefit everybody in the region, and 
it seems to me right at the heart of that discussion is getting 
good information rather than keeping the public in the dark, 
and that is what my constituents are troubled by at a time when 
we have got a lot of economic hurt in our region and we are 
forced to send more power to California without any guarantees.
    Thank you, Mr. Chairman.
    The Chairman. Thank you, Senator Wyden.
    Senator Thomas.
    Senator Thomas. Thank you, Mr. Chairman. I also have a 
statement that I would like to have entered into the record.
    The Chairman. It will be entered into the record without 
objection.
    [The prepared statement of Senator Thomas follows:]
   Prepared Statement of Hon. Craig Thomas, U.S. Senator From Wyoming
    Thank you, Mr. Chairman, for holding this hearing today. We are all 
very concerned about the electricity crisis that is occurring in and 
around California, especially those of us from the West. California's 
version of deregulation has not worked well to date. In fact, it is 
putting distorted market pressures on electric power rates in 
neighboring states and we, in Wyoming, are beginning to see signs of 
the increasing price pressures. This is not good news for my 
constituents--on top of high prices for natural gas this winter, 
electricity power rates will rise as well.
    For the last eight years we have seen a flurry of stringent 
environmental regulations combined with a campaign against off-shore 
drilling, coal fired power plants, nuclear power plants, developing 
minerals on public lands, and hydro relicensing--all contributing to an 
overall supply problem. California led this march. And now, they, along 
with the rest of the country, are feeling the affects of having no 
energy policy in place.
    Even so, to a large extent, the problems facing California are 
unique to that state:

  <bullet> No major new generation facilities have been built in 
        California in more than a decade, and in the meantime, demand 
        has soared;
  <bullet> Inadequate natural gas transportation capacity into the 
        state, coupled with increasing reliance on natural gas for 
        power generation, has helped drive up natural gas prices to the 
        highest levels in the country, thus further increasing the 
        price of electricity;
  <bullet> Environmental and facility siting restrictions that are the 
        toughest in the nation make it difficult to build new 
        generation or even operate existing facilities for the entire 
        year;
  <bullet> Abnormally dry weather has reduced the amount of available 
        hydropower generation by nearly 40% this winter;
  <bullet> A critical shortage of transmission capacity in some regions 
        of the state makes it difficult to efficiently transmit power 
        to where it is needed;
  <bullet> An almost total reliance on volatile day-ahead and hour-
        ahead electricity markets by prohibiting effective hedging and 
        long-term contracting by incumbent utilities has driven up 
        prices.

    The shortage of generation in the State of California has had a 
ripple effect throughout the entire interconnected West, where 
wholesale prices have been driven upward. In general, the electric 
power market is fraught with uncertainty with about half of the states 
moving toward electric industry restructuring and deregulation and 
about half the states still served under regulated monopoly 
provisioning of electricity to customers. This uncertain environment 
has resulted in a lack of capital investment in electric power 
generating facilities and in electric power transmission facilities. We 
now have a market situation where growth in demand for electric power 
has been much faster than growth in supply.
    I have always been a supporter of electric industry restructuring. 
Having been involved in the electric power industry, I understand the 
unique characteristics of each state. I have supported legislation that 
empowers the states to restructure their electric industries at the 
rate and in the way they decide. Legislation should not impose a 
``retail choice mandate'' or deadline on the states so as to fully 
allow the best market ideas and approaches to occur. A federal mandate 
on the states requiring retail competition by a date certain is not in 
the best interest of all classes of consumers.
    Despite the problems in California, states are in the best position 
to deal with this complex issue. Although the cost of electricity 
varies across the country, electric industry restructuring can result 
in lower consumer prices for everyday goods and services, the 
development of innovative new products and services, and a growing, 
more productive economy. Throughout the country, wholesale markets are 
not functioning as efficiently as they should. In addition, the 
situation in California has made it clear that we should be seeking to 
encourage, not discourage, the building of new generation and 
transmission facilities that are needed to meet the demands of growing 
economy.
    That is why I believe Congress can help make wholesale markets work 
more efficiently, while deferring to the states on the question of 
retail markets, including whether to restructure the electric industry 
in their respective states. I plan to introduce legislation that would 
help wholesale markets function better, would encourage the building of 
new generation and transmission facilities, would enhance system 
reliability and that would provide the regulatory certainly necessary 
for investment in this critical industry.
    Thank you to all the witnesses and I look forward to hearing your 
testimony.

    Senator Thomas. We talk about transmission. We ought to 
take some information from Senator Akaka from Hawaii. They have 
dealt with the interstate transmission very well.
    [Laughter.]
    Senator Thomas. I think certainly we have a crisis in 
California, and one we need to deal with, but I have been 
around this business quite a while, and it seems to me we ought 
to be looking at where we want to be over time with this whole 
reregulation thing, and we ought not to ignore that as we deal 
with this particular problem.
    I think some of you agreed with the idea that FERC ought to 
control, set some limits on the wholesale prices. What about if 
California does not change the retail price? Is that going to 
be workable?
    Dr. Makovich. Well, obviously, in a well-functioning market 
you do not want to have customer prices capped. You want them 
to be linked to what is going on in the wholesale markets, so 
this tremendous misalignment we have now, where utilities are 
forced to buy wholesale power in multiples of what they can 
pass along to customers, is completely unsustainable and, of 
course, it has brought the major utilities to the brink of 
bankruptcy, and it has contributed to the shortage problem.
    Senator Thomas. My question is, should FERC set a price 
limit on wholesale power if California is going to continue to 
have a limit on retail?
    Dr. Makovich. As I said, if they are not aligned properly, 
as I mentioned----
    Senator Thomas. Are they aligned properly?
    Dr. Makovich. Now, no, they are not.
    Mr. Konolige. I guess my feeling would be a little 
different from the other panelists, which is, I think that 
price caps at the wholesale level have no good use. They 
inevitable distort the market, and I think we can see very 
clearly in California that the lower they made the price cap, 
the higher the actual prices occurred.
    Now, how could that happen? Well, what happened was that 
the out-of-State suppliers would not sell below their cost into 
California so the ISO and the PX would have to go around and 
around their own price caps, and so the actual prices were 
significantly higher.
    Senator Thomas. So what is your suggestion for the short-
term remedy?
    Mr. Konolige. I think for the short-term remedy, say for 
this summer----
    Senator Thomas. Well, it is going to be several years, a 
couple of years before you get more generation.
    Mr. Konolige. I think the solution is that the State of 
California should pay the market price. The market price can be 
significantly lower by this summer if the authorities move 
ahead with their initiative to sign long-term contracts with 
the suppliers of power. The long-term contracts are a much, 
much better solution than price caps. Long-term contracts are 
the market solution to the problem that the price caps attempt 
to address, and we know they are the right price because those 
are the prices that both sides can agree to.
    Senator Thomas. They would have to be pretty low if you are 
going to continue to have retail limits.
    Mr. Konolige. Well, I think it is clear that long-term or 
short-term price caps in California, because of higher gas 
prices, because of low hydro conditions, because of the 
NO<INF>X</INF> credits problem, the actual cost of energy in 
California of electricity is significantly higher than was 
embedded in the rates of the utilities.
    I mean, there is a significant discount that the people in 
California are getting on the actual price of electricity 
today. I would say that sooner rather than later the end 
customers have to start paying the freight, but I think the way 
that you make that an acceptable transition is, you go to the 
generating companies and you sign long-term contracts with 
them. You say, what is your best price for 10 years, if we 
levelize it, so that they will give up the high near-term spot 
prices in return for some assurance that they will get paid 
good prices out 3, 4, 5, 8 years from now.
    Senator Thomas. That is fine for the generators, but the 
distributors are then caught in the middle.
    Mr. Fox-Penner.
    Dr. Fox-Penner. Well, I largely agree with Mr. Konolige. I 
think long-term contracts are far preferable to price caps, and 
the States are moving in that direction. They can set a true 
competitive market price for power starting this summer and 
moving forward, and I do think that over time that retail 
prices, or the prices that distributors collect to pay for that 
wholesale power, have to come into alignment with fair 
competitive wholesale prices. That is sound economics, and I 
just think it is the only possible solution in the long run.
    Now, you have to take care of special cases and we have to 
take care of low income customers, and I am sure that is true 
in your State, too, Senator, and we have to align the time path 
of these things, and maybe do a phase-in and so on, but they 
have to reach alignment.
    The Chairman. Senator Thomas, your time is up. Thank you.
    Senator Feinstein.
    Senator Feinstein. Thank you, Mr. Chairman. I just want to 
put something out for these three gentlemen.
    Senator Landrieu. I am sorry, Mr. Chairman, are we speaking 
in order of attendance?
    The Chairman. Yes. Senator Feinstein.
    Senator Feinstein. I would just like to correct the record. 
California ISO has said that the State will be short 2,000 to 
5,000 megawatts every day this summer, and so the bilateral 
contracts alone, gentlemen, are not going to take care of it, 
and that has to be realized. That is the reason why something 
needs to be done in the short term to stabilize the generation 
market.
    Let me read to you, if I might--Senator Bingaman has put 
together, put in the record a study out of MIT titled, ``A 
Quantitative Analysis of Pricing Behavior in California's 
Wholesale Electricity Market During Summer 2000.'' Let me quote 
from that report. Paul Joskow and Edward Kahn are the authors.
    ``There is considerable empirical evidence to support a 
presumption that the high prices experienced in the summer of 
2000 reflect the withholding of supplies from the market by 
suppliers, generators, or marketers. We base these conclusions 
on results of the two analyses described herein. One analysis 
is a competitive benchmark price analysis and the other is a 
capacity withholding analysis. There was price-gouging in this 
market.''
    Now, that raises the problem, because the FERC found that 
prices in this market were unjust and unreasonable, but the 
FERC decided not to do anything about it, so my point is, while 
everybody blames California, remember this. California is 
bigger than 21 other States put together. California is the 
fourth most energy efficient State in the Union, and I will put 
documentation in the record to support that. There is a huge 
problem out there. California is moving--it will build new 
generation facilities. It needs time to do that.
    California today is not receiving anybody's power 
allotment. This is surplus power that is coming in. California 
generates 2,000 to 5,000 megawatts of power a year that go 
outside of the State by bilateral contracts. We have honored 
those contracts, and will continue to honor those contracts.
    There is a real problem in just blaming the State. You 
know, there are huge water shortages affecting hydroelectric 
power up in the Bonneville area. That is subsidized power, I 
agree, the rates have to go up. There is legislation being 
considered by the legislature to raise rates, as a matter of 
fact, if consumers exceed a baseline consumption level. What 
they are talking about is setting rates higher for those that 
exceed the baseline, which is about 75 percent of the people in 
the State, so I think there will be at least some attempt to 
fix the brokenness in the market on that end.
    But the point I want to make is, there is not enough power. 
Now, this means the common carrier lines for jet fuel will be 
clogged. We will not get jet fuel from, say, Chevron to 
airports on time. You are going to continue to have business 
closures. It is going to impact communication between the 
States. It is a very serious issue.
    Now, what I am asking you gentlemen, assume for a moment 
what I have said is right, and I believe it is, but assume it 
is right. What controls the market from charging $3,000 per 
megawatt in this summer? Unless you have some mechanism--the 
FERC has tried under an administrative law judge for over a 
month to bring some long-term contracts and was unable to 
succeed. They could not come to terms, so you have a ribald 
market out there.
    What do you suggest would get us through the summer, short 
of somebody being able to make a decision as to how much profit 
and how much cost should be passed through, and some control? 
If utilities can only pass through $64 a megawatt hour and they 
are buying at $3,000 a megawatt hour, what is going to solve 
the problem?
    Mr. Konolige. Well, I would first suggest, Senator, that if 
your problem is a shortage of supply, standard economic theory 
would be that if you put a price cap on the supply you will get 
less of the supply and not more.
    Senator Feinstein. But what is your solution?
    Mr. Konolige. The solution is twofold. One is, sign all the 
long-term contracts you can.
    Senator Feinstein. It will not be enough. It will be 2,000 
to 5,000 megawatts short. If I am wrong, I will buy you lunch.
    Mr. Konolige. That is fine. Unfortunately, that is such a 
hard thing to prove. It is in the future as well.
    Senator Feinstein. This is the ISO. This is not my 
statement. No matter what they do, they are going to be short 
this summer.
    Mr. Konolige. I would say if you put a price cap you will 
never fill that gap. In other words, if you do not allow 
yourself to pay a lot of money for that 2,000 to 5,000 
megawatts, you will never get it.
    If you put the price up enough, then there would be 2,000 
to 5,000 megawatts that, for example that people in Idaho or 
the State of Washington might decide at the right price they 
will be happy to send to California, but putting a price cap I 
think has the exact opposite effect of what you are trying to 
achieve. A price cap will not increase supply.
    Senator Feinstein. Well, there was a cap, one of $250. All 
of this happened when the price cap was taken off. Now, what we 
are talking about is just something to get us through the time 
when supply and demand can meet, and once you have got the 
supply, then you do not have to worry about taking the cap off 
then.
    Mr. Konolige. Well, I think what might work, and not that I 
would necessarily agree that it is a good idea, is if you had 
some sort of FERC order that required people from outside the 
State to sell into California at some kind of fixed price, but 
as I think you have heard on the panel today, there are 
probably a number of Senators who would not feel that that was 
an appropriate way to deal with the problem.
    Another approach, obviously, is if you are 2,000 or 5,000 
megawatts short, do not use the 2,000 to 5,000 megawatts. I 
mean, California is well-known for its conservation programs. 
Perhaps there can be a crash program to improve them so that 
there is even less use.
    Senator Feinstein. Do you know what this would do to the 
economy?
    Senator Bingaman. I am sorry, we are going to have to go to 
the next questioner.
    Senator Dorgan.
    Senator Dorgan. Thank you very much. Let me thank the 
panelists, and I want to pledge to be helpful, Senator 
Feinstein and others who are interested in this issue. This is 
a terribly difficult issue, but let me also say, just as a 
matter of course, that the energy issues are complicated, not 
just this issue. In many ways this is not just about 
California, and it is not just about electricity.
    I had a hearing in North Dakota 2 days ago talking about 
natural gas prices propane prices, heating fuel prices, and so 
we have a lot of energy issues. Our country has studiously 
managed to avoid a comprehensive energy policy for some decades 
now, and we continue to let much of our energy future depend up 
on decisions made by OPEC ministers, which in my judgment is a 
thoughtless policy, and we have to change it.
    The method of deregulating electricity in California, 
however, is a giant billboard for failure, in my judgment. They 
constructed something that could not possibly work. I am a 
skeptic of deregulation in any event, but clearly the construct 
of the California experience was unworkable. Deregulation, we 
have got a lot of experience with it I would say to Senator 
Feinstein.
    In the next panel we will have Californians testify, and to 
the extent that they flew here commercially, they paid half as 
much to fly from Los Angeles to Washington as they would have 
paid to fly half as far from Bismarck to Washington. That is 
gratis of deregulation, a so-called ``market system,'' when you 
have several large participants deciding how they are going to 
price a product that is essential to us, and if I might just 
for therapy purposes say, another part of the market system is 
a short stop that gets $256 million a year and a short teacher 
in Fargo that gets $35,000 a year. $256 million over 10 years 
is the short stop's contract. That is a market system.
    Or the short-tempered Judge Judy paid $7 million a year and 
Justice Rehnquist $180,000 a year, so the market system is a 
very interesting place, but the market system itself, I would 
say to Mr. Makovich, you talked about this. You said that the 
general assumption that the electricity markets are just like 
other commodity markets is wrong, and I welcomed that, because 
it is a very different set of circumstances, to talk about 
electricity versus chewing gum, and you point to the unique 
characteristics, including capacity versus generation.
    You said California has set up an energy market that paid 
power generators to run their powerplants but did not set up 
any market mechanism to pay generators for capacity. In other 
words, no capacity price signal to create an incentive to bring 
on new capacity.
    Given that flaw in the construct which I heard in your 
testimony, these high wholesale prices then are not an 
incentive to construct new capacity, are they? In fact, they 
would be an incentive to generate a windfall for the current 
owners of capacity. Do you agree or disagree with that?
    Dr. Makovich. Well, as I said, there is a right way and a 
wrong way to set up a power market. I think that power markets 
can be set up properly, but relying on this energy market alone 
to provide an investment signal is a mistake.
    The price signal we have got right now is far higher than 
it needs to be, but the most important thing, it is far too 
late. This was a signal that needed to be there a few years ago 
when we started deregulation. Put any market of any kind of 
commodity in the shortage we are in right now, prices will go 
up, and it is also due to the fact that electric use, as 
someone mentioned, is very critical to our every-day lives.
    What uses a lot of electricity are refrigerators and air 
conditioners and so when we see a shortage like this and prices 
run up, this is a shortage, and all markets will do that.
    Now, the question of price-gauging, if that is meant to 
imply, then, that people are manipulating this market, the 
generators that bought generating assets out there were not the 
ones that prevented anybody from building powerplants. They 
were not the ones that set the rules up for how this market 
will be flawed in its operations, and so if we look at these 
high prices that we have got now and coming up for the summer, 
we have to remember, the flawed markets, it was not too long 
ago that the Western power markets cleared at zero, and so you 
know, the flaw in these markets created prices that were too 
low in the past and not prices that are too high, and if you 
fix the market you can get it right.
    Senator Dorgan. Mr. Makovich, thank you for that. Lest 
anyone misunderstand my statements, I have studied economics 
and taught economics in college. I am a fan of the free market 
system, but the free market system exists and works when you 
have robust competition with easy entry and easy exit, and 
sellers willing to compete with each other.
    I must say, in my judgment, as I have watched some 
essential services be deregulated, airlines being one, 
railroads another, and some others, that there are many in this 
country that have suffered dramatically, dramatic injury as a 
result of that, and that is why I assume that California 
created a construct that would try to protect the consumer, but 
that construct was, in my judgment, at its outset unworkable, 
and this may be a billboard for the failure of the California 
system. It may be a billboard for a much broader failure in my 
judgment, as well, with respect to deregulation.
    Mr. Chairman, thank you very much.
    Senator Bingaman. Senator Cantwell.
    Senator Cantwell. Thank you, Mr. Chairman.
    Senator Bingaman. Let me just give people the order that I 
was given here, Senator Hagel, who is not here, Senator 
Cantwell, Senator Kyl, who is not here right now, Senator 
Smith, Senator Landrieu, and Senator Nickles. So, Senator 
Cantwell.
    Senator Cantwell. Thank you, Mr. Chairman. As the newest 
member, I always appreciate that opportunity, and I will submit 
testimony for the record, but I did want to make a few points.
    [The prepared statement of Senator Cantwell follows:]
Prepared Statement of Hon. Maria Cantwell, U.S. Senator From Washington
    Thank you, Mr. Chairman. I want to thank you for agreeing to have 
this hearing to address the larger implications of the California 
crisis, especially for Washington state. One significant consequence 
for my constituents is the loss of a paycheck as their employers are 
closing their doors. We hope temporarily.
    These closures are not limited to our aluminum industry but include 
timber products, refineries, steel foundries and many other 
manufacturers, soon to be followed by companies that make a living 
supporting or using the by-products of these same companies. At the 
Georgia-Pacific mill in Bellingham, management made the tough decision 
that Christmas would feature the layoff of 850 employees. Public 
agencies are faced with the prospect of curtailing services to meet 
unexpected costs, such as the waste water treatment facility in King 
County which already needs an additional $8 million to cover energy 
costs.
    Let me be clear that the people of the Northwest respect the long-
standing power-sharing relationship with California and we support its 
continuation over the long term. We appreciate Senator Feinstein's and 
Governor Davis's letters of thanks to BPA for its role in helping to 
avert rolling blackouts in California and we stand ready to be partners 
in resolving this western crisis. However, let me be equally clear that 
I cannot support ``solutions'' which require more pain for Northwest 
consumers in order to maintain current rates or increase supply in 
California.
    The continuation of the Secretary's order that forces the sale of 
excess power further erodes the financial stability of Northwest 
utilities. This, combined with the continued volatility of the entire 
western marketplace, only guarantees more drastic rate increases in 
order to cover costs, including the Treasury payment by BPA. While you 
will hear later more details of Northwest utilities' actions, BPA most 
recently announced a 60% rate increase over 5 years, with a 95% 
increase in the first year. These increases, which have been put in 
motion but not yet fully felt by many industrial and residential 
customers, will have further negative effects on our economy, and on 
the family paycheck.
    Again, I appreciate having the Northwest's voice heard today and I 
look forward to working with my colleagues and our witnesses to help 
resolve this crisis in the West. Washington State's concerns cannot 
remain an afterthought. Our people, our cities, our rural communities 
and our industries are reeling from the impact already.
    As some of you may remember from an earlier economic crisis in 
Washington state, the Boeing downturn of the 1970's, there was a 
billboard that asked, ``Will the last person out of Seattle please turn 
off the lights?'' Through dramatic rate hikes and shuttered businesses, 
the billboard this time may well read, ``Will the last person out of 
Seattle please blow out the candle?''
    My question for the panel focuses on the terms ``dysfunctional and 
irrational'' which have increasingly been used to describe our shared 
marketplace. As a result, a number of important figures in the energy 
industry have been calling for temporary price caps in the western 
market--many of whom are incredulous that they would ever have found 
themselves advocating for market controls. As a further example, the 
Attorney General of Washington state, Christine Gregoire, yesterday 
announced an investigation of price manipulation and unfair business 
practices.
    Have we reached a point in the market where some form of temporary 
price caps would help restore us to a rational marketplace? How is this 
answer affected by the requirements of the Federal Power Act that 
wholesale rates be just and reasonable?

    Senator Cantwell. This is a very important hearing this 
morning not only for the State of Washington but for California 
and the Northwest, so I appreciate your comments in referring 
to the larger region and the challenges we face.
    Obviously, the impact on the Northwest is that employers 
are closing the doors, and I hope that is only temporarily, and 
this is not just limited to the aluminum industry but the 
timber products refineries, steel foundries, and many other 
manufacturers I think are all impacted by this.
    At Georgia Pacific a mill in Bellingham made a decision 
this Christmas to lay off about 850 employees, so let me be 
clear that the people of the Northwest understand the 
longstanding power-sharing relationship we have with 
California, and we support that continuation over the long 
term, and I certainly appreciate Senator Feinstein's leadership 
on this and Governor Davis in working with the region's 
Governors, but obviously I just want to make a point, too, 
about the Northwest Power.
    BPA is a cost-based power and operates with ratepayers' 
revenues. The ratepayers repay the debt to the Federal 
Treasury. They pay the interest on it, and they also repay non-
Federal debt, so I very much want to work on a regional 
solution, but obviously very concerned that the Northwest in 
the Secretary's continued force of the sale of excess power, it 
also erodes the financial stability of those utilities within 
the Northwest.
    I will not go on with my further comments about the rate 
increases that we are seeing in the Northwest, not solely 
because of California, but the complexity of the issue, but 
that gives some impact. What is your sense of the economic 
impact to the Northwest and the urgency in resolving this as 
the executive order continues?
    Mr. Konolige. Well, I guess you are referring to the 
Department of Energy order, which I guess is scheduled to not 
continue for very much longer from what I understand that the 
administration has said. I think they have said February 7 was 
going to be the end of that, so that may be a self-solving 
situation, but we will see.
    To the extent that that continues, but regardless of 
whether there is an order like that, I think the high prices in 
California, I mean, California has a market that imports 
electricity. Its wholesale prices, whatever the situation with 
the price caps, the price caps can only affect inside 
California, so there has been anomaly all along, where 
California is willing to pay higher prices for Northwestern 
Power and much lower prices for electricity inside California, 
so the fact that California is in a very massive short supply 
situation sucks in power from the rest of the region and forces 
prices higher.
    In other words, any seller in the Northwest such as an 
aluminum plant who did not even used to be a seller will feel 
the very strong economic pressure of very high market prices, 
so directly and indirectly high prices in California cannot 
help but have a significant effect in raising the price level 
of electricity throughout the Northwest.
    Senator Cantwell. Yet you still have resistance to the 
temporary price cap as a concept?
    Mr. Konolige. Simply because I think it does not work. I 
mean, that temporary price cap, I think it is a practical 
impossibility to extend it to the West. Outside of California 
there is no organized marketplace. The issues of exactly who 
you would impose it upon, under what circumstances--could you 
take, for example, private contracts between a buyer and a 
seller and say, this buyer and seller cannot contract for a 
different price? I mean, that seems like an elaborate system 
you would have to put into place to try to enforce that.
    So our feeling all along has been as a practical matter 
price caps do not work. I mean, that is the opposition, is that 
they do not really hold down prices.
    Senator Cantwell. So do you think, then, that in thinking 
out this from a regulatory perspective, that UTC's or others, 
or even the concept of, in the banking industry at least you 
have, if there is a run on a bank you have FDIC insurance. They 
are mandated to have some coverage, some plan as a backup, so 
what is the backup plan?
    Mr. Konolige. The backup plan here is, for example, 
Bonneville Power hopefully will not run out of water this 
summer. There will be enough electricity for everyone as long 
as, look, if we literally do not have enough water and do not 
have enough gas, then there would be blackouts for everybody.
    Short of that, there will be a price at which the market 
clears, so the issue ultimately comes down to who pays that 
price, and if you set the price too low I think what is going 
to happen is you have a lot of generators who will simply go 
out of business, or at least temporarily go out of business, 
and they will say--so the perverse effect of price caps is, if 
you are short power, setting a low price cap represses the 
amount of power available. I think that is the practical issue 
with setting price caps.
    Senator Bingaman. Senator Smith.
    Senator Smith. Gentlemen, I appreciate very much your 
testimony. I wonder if you can give me a one-word answer to the 
following question. From all that you have heard proposed and 
likely to be passed in Sacramento, is it apt to fix 
California's short-term problem? If each of you could take a 
shot at that.
    Dr. Makovich. No.
    Dr. Fox-Penner. I would say mostly.
    Senator Smith. And the financial man?
    Mr. Konolige. I take the Fifth.
    [Laughter.]
    Senator Smith. From all you have heard proposed and likely 
to be passed in Sacramento, will what California is doing, will 
it solve their long-term problem? A one-word answer, if you 
can.
    Dr. Makovich. No.
    Dr. Fox-Penner. Senator, did you mean proposed and likely 
to be passed?
    Senator Smith. What Governor Davis is proposing, is it 
going to be sufficient to fix this problem?
    Dr. Fox-Penner. Well, I am not quite sure who exactly has 
proposed what at this point, Senator, but of the total----
    Senator Smith. You are not alone in that, by the way.
    Dr. Fox-Penner. Of the total legislative package, the most 
recent understanding I have of the total legislative package, I 
believe it is most of what is needed but not all.
    Mr. Konolige. I would agree with that. I think there is 
enough good ideas in there, and if they all got implemented and 
in the right combination I think we would be well on our way to 
fixing the long-term problem. Short term is harder.
    Senator Smith. But you have disputed with Senator Cantwell 
the idea of price caps, and that is one of the proposals that I 
understand is out there, at least short term.
    Mr. Konolige. That is what I said, if the right things go 
in and the wrong things stay out.
    Dr. Fox-Penner. May I comment on that, Senator?
    Senator Smith. Yes.
    Dr. Fox-Penner. I agree with Mr. Konolige's point that the 
danger with price caps, the overwhelming danger is that they 
will not work and will be counterproductive.
    If we are in a true shortage situation this summer, where 
prices are rising to a level where it is clear that--and we 
kind of say pure rent, that the prices regardless of how high 
they rise are not bringing forth any more supply, price rises 
above that point we economists say do not have social or 
efficiency-enhancing values and at that point they become just 
a fairness and a hardship issue, and for this summer, if we 
could find that spot, that point where it no longer brought 
forth any supply and was just a pure transfer of wealth, it 
would be fair and even efficient to cap prices at that level. I 
wish I had that answer for you.
    Senator Smith. Well, let me tell you what steams me. right 
now, Oregonians are being notified, and many Washingtonians 
with even higher rates, that their rates will be going up 20, 
30, 40, and in one Washington utility 50 percent. Now, I do not 
think that is fair while California is capped at 10 percent. I 
have to tell you that. I think that stinks.
    What really has me steamed this morning is a cartoon in an 
Oregon paper that says, our view from California. It is a 
diagram of my State with a couple of energy sockets in it, and 
I got a laugh at first, until I realized in real human terms 
there is a lot of people about to go out of work, and I do not 
like it.
    In addition to that, for the last 8 years we have had an 
administration at war with energy, when it could not pass its 
Btu tax, to the point that serious people are trying to destroy 
hydroelectric power in the Pacific Northwest. Now, even with 
conservative estimates, our region is 3,000 megawatts short of 
power needed, and these supposedly four small dams they want to 
pull out on the Snake River produce enough power to run Seattle 
every day. I wonder if you could comment on the wisdom of 
destroying those four dams right now.
    Dr. Makovich. Well, as I mentioned, I think we have to do 
everything we can to close this gap that we have talked about 
and, as far as the existing solutions, I would just add the 
caution that long-term contracts have been mentioned as a 
solution here. The right type of long-term contract may solve 
this problem. I think the danger is, we enter into the wrong 
type of long-term contract.
    Do not forget, half of the stranded cost in California came 
from long-term contracts that obligated utilities to buy 
volumes of energy at expected competitive power prices, the 
PURPA contracts.
    Senator Smith. You cannot do that when you are tearing out 
the power sources, can you?
    Dr. Makovich. Right.
    Senator Smith. My time is up, but I just wanted to say, 
Senator Boxer mentioned we should not lower environmental 
standards to produce power. I do not think we should lower 
environmental standards to produce more power. I think we ought 
to live with our environmental standards, but I did want to 
point out to her and the whole world that right now we have an 
environmental disaster, because we are paying hundreds of 
thousands of dollars every year to save salmon and right now 
they are getting flushed at a time when we are not going to 
have the ability to save them in the spring nor produce the 
power to keep the air conditioners on in California this 
summer.
    I just think everyone needs to connect with reality here, 
that we do not produce power by hitting a light switch, and 
that has been the fiction that has been foisted upon the 
American people for the last 8 years, and it needs to change.
    The Chairman. I thank the Senator from Oregon. We will move 
from Oregon to Louisiana.

       STATEMENT OF HON. MARY L. LANDRIEU, U.S. SENATOR 
                         FROM LOUISIANA

    Senator Landrieu. Thank you, Mr. Chairman, and thank you 
for calling this hearing. I have a full statement to submit for 
the record, but I do want to follow up with my good colleague 
from Oregon to say he is absolutely correct. I would just 
disagree that maybe it has only been the focus of the last 8 
years.
    I think perhaps for a long time in this Nation we have not 
been realistic when it comes to what it takes to produce and 
consume energy. Our present capacity is not sufficient to meet 
the demands of this Nation, growing at its present rate. While 
we are grateful for the growth, this is a good time for a 
reality check.
    No. 2, I would like to say to my colleagues from California 
that I do want to be helpful, and I appreciate and can 
understand the tremendous pressures that have been brought to 
bear on them representing this great State of 30-million-plus 
people. However, I am also very sensitive to my colleagues 
representing Western States that are directly negatively 
impacted, based on the testimony we have heard today, not only 
from the panelists but also from other Senators about high 
prices as well as the effect on jobs, businesses and consumers.
    So, let me make just three brief points, and then I have 
two questions for the panel. One, ANWR may or may not be part 
of the solution, but this Senator is convinced that increased 
domestic production of natural gas, laying of pipelines and 
flow of transmission from the sources of power to the consumers 
of power are absolutely essential.
    As a State that is a producer, we are happy to continue 
producing while maintaining high environmental standards. 
However, all of the production in the world that we can and are 
willing to do in Louisiana on and off of our shore is not going 
to mean a hill of beans unless we can get that power to places 
like California that need it.
    Let me say that I think every State should assume some 
responsibilities for producing the sources of power that they 
can. We are blessed with available natural gas. We all have an 
obligation, every State, to produce our respective sources of 
energy in an environmentally sensitive manner. It is a mistake 
for this Nation to believe that you can, as the Senator said, 
just flip a light switch and create energy. We need to produce 
the nuclear energy, or hydro, or clean coal, or oil, or gas or 
renewable energy or some alternative. While some States resist 
the production of those power sources we now see it can be to 
the disadvantage of not only the producing State but to other 
States as well.
    My second point is that while we do not want to lower 
environmental standards, we also do not want to add on top of 
Federal standards State standards that are perhaps overly 
bureaucratic or overly regulatory and then find ourselves in a 
situation where we cannot construct a powerplant in less than 
10 years, and then the rest of us have to pick up the cost for 
the delay.
    I am not talking about lowering environmental standards, 
but I think this raises the question of what rights do States 
have to implement even higher standards when the result is 
other States are either effected in some way by a decision or 
have to pick up that tab themselves.
    Third, whatever the solution is--and I had a question that 
the Senator from Oregon answered. I was going to ask you what 
are the three things that we can do immediately to address the 
situation in California. In all of your testimony, you 
indicated many things, but is there something we could do to 
help California and the Western region immediately? I hope the 
administration and the members of Congress realize that there 
is a huge price to pay for what has happened, which falls on 
the shoulders of the low income and the small businesses. This 
is the worst result we could find ourselves with and we need to 
all start focusing on this possibility.
    Thank you, Mr. Chairman. I will wrap up by recognizing that 
there is going to be a monetary cost to any comprehensive 
resolution, but not allow those that have the least seats at 
the table in all of these discussions to pick up the price for 
mistakes we have made is not fair.
    Finally, I will ask my question, and if you cannot answer 
it right now, if you could get it to me in writing I would 
appreciate it. In our State, where we are doing our job in 
terms of producing for ourselves and other States, we are faced 
with a question raging about the need for a water source to 
feed merchant powerplants.
    Now, we have a lot of water in Louisiana. We have it coming 
every which way but loose. However, there is a tremendous 
amount of concern among farmers, business people and consumers 
about the need for groundwater to run these plants.
    Could you just give a brief comment, in writing, about 
whether this should be a concern for this committee as we 
encourage the development of plants to generate sources of 
energy? Are there some water policies that need to be reviewed 
to make sure that we have adequate sources of water necessary 
to run these plants?
    I thank you, Mr. Chairman, and look forward to continue 
working with you and the committee on this issue.
    The Chairman. Thank you, Senator Landrieu, and you will 
respond in writing?
    Dr. Fox-Penner. Yes, sir.
    The Chairman. Senator Nickles.

          STATEMENT OF HON. DON NICKLES, U.S. SENATOR 
                         FROM OKLAHOMA

    Senator Nickles. Mr. Chairman, thank you very much, and I 
want to thank our panelists and apologize maybe to the next 
group of panelists. You have assembled a great group of 
experts, I think, that can contribute a lot to our education on 
this issue, and so thank you all for your participation.
    Mr. Chairman, I will just make a couple of comments. When 
we debated electric regulation over the last Congress I 
complimented you then because you had a lot of hearings and I, 
for one, wanted to do a national bill. I still want to do a 
national bill, and some people have indicated, well, wait a 
minute, the California result of deregulation proves that we 
cannot do one. I think they have proved that you can do one 
wrong and make a serious mistake.
    Some people said, we do not need to do a bill because a lot 
of States are doing it on their own, and we have this chance to 
see this progress work, and I think you have seen that. I think 
you are seeing a lot of States doing it and do it well and do 
it right, and you have ample supplies. You do not have the 
shortages.
    In California, I think you do not have so much a power 
failure as you have a political failure. The politicians 
goofed, Democrats and Republicans. A lot of people wanted to 
superimpose their wisdom and replace the laws of supply and 
demand, and they have really messed up, and they are asking 
other States to bail them out, and maybe they want the Federal 
Government to bail them out. I hope and think that that will 
not be the case. I think it will be a serious mistake.
    Most of the solutions of the panelists I have heard, I have 
heard people say, wait a minute, price caps are a failure. It 
is the politicians that put price caps on, and it is a serious 
failure. It has not allowed the marketplace to work.
    I have heard the panelists say, we need more long-term 
contracts. California is the only State that has--and correct 
me if I am wrong--a significant percentage of the contracts or 
their buying power on the spot market. Most States have a very 
large percentage of their power purchased contracted on a long-
term basis. California has a very significant percentage on a 
short-term basis, on spot market, much more fluctuating, much 
more volatile, and much more expensive at this particular time.
    California has now embarked on a situation where their 
regulatory requirements, the NO<INF>X</INF> standards, the 
emission standards have gone up substantially in this year, not 
a freeze to 2000, but an increase in 2001.
    It will be interesting to hear from panelists, maybe not 
this panel but the next panel, how much power is idle because 
of the increasing emissions standards. Could, or should there 
be a moratoria, or should there be a waiver from those emission 
standards? Could we help alleviate the shortage?
    You have a situation caused by politicians that because of 
the price caps that now you have bankrupt utilities, really as 
a direct result of the political action that was taken by 
politicians. People do not want to sell to the utilities 
because they are bankrupt, or they are heading to bankruptcy, 
or they are not too far from bankruptcy, or they are behind on 
their payments. Therefore, people do not want to enter into 
long-term contracts.
    Again, that is a political failure caused by legislation, 
caused by politicians, and now I am afraid that part of the 
Governor's solution--and you all may have been more 
complimentary. From what I understand you are now talking about 
Governor Davis and the politicians and saying, well, we want 
the Government to make contracts, long-term contracts, and in 
exchange for that we will buy equity, we will get equity in the 
utilities.
    In other words, drive them down to bankruptcy, but oh yes, 
we want to be stockholders, and then they will come out when it 
comes up. I think that is a serious mistake, and we have to be 
careful, when you have problems or crises you have to be 
careful you do not compound the mistakes, and I look at that 
as--again, I am all for States having a lot of flexibility, but 
I think that avenue, if that is what they still pursuing, and I 
have not seen what they have done in the last day or so, is a 
serious problem.
    Also, you have politicians that have intervened and made it 
very difficult to license and build new plants. California has 
not built any new plants. The majority of California's plants 
are 30 years old, and so we have significant problems. The sale 
of credits for a lot of those old plants, it makes it difficult 
for them to operate. It makes it expensive to even bring in a 
new plant because they have to purchase credits to do so.
    To compare State-by-State, other States have been building 
a lot of plants for the last 10 years or 12 years, so 
politicians again, I think maybe in some cases county level, 
State level have made it difficult to have additional power 
supplies, again somewhat intervening and intervening in the 
laws of supply and demand and in the process really creating a 
major problem.
    So my point is, and this is really more comments than 
questions, I think you have not so much a power failure but a 
political failure, and it is important that we have steps taken 
in the right direction, and from what I am reading in the 
papers, I am afraid that a lot of what California is talking 
about, more long-term contracts and so on, will be helpful, 
some of what they are talking about doing, having the State be 
primary purchasers, or purchasing a significant amount, having 
the State government picking up the pieces for these utilities, 
I think is absurd, and I wanted to make that editorial comment.
    Mr. Fox-Penner, did you want to comment?
    Dr. Fox-Penner. If I may just answer one point, Senator, 
and thank you for the time, my information is that there are no 
powerplants now in California failing to generate for 
environmental reasons. They are all on, with the possible 
exception of a 100-megawatt plant in Glendale, which ironically 
may not be generating because it did not participate in the 
pollution-trading scheme they have there.
    Senator Nickles. We will ask the next panel, because I do 
not think that is accurate, but we will find out, and I am not 
sure, I may be incorrect, but I think there are plants that are 
idle because of the increased NO<INF>X</INF> standards, and we 
will find out. We will ask the panel.
    Mr. Chairman, I apologize. This panel is--timewise, I am 
going to have to leave, but I am very interested in what the 
next panel has to say, and I will be reviewing those comments 
extensively, so thank you.
    The Chairman. Thank you very much. It is appropriate now 
that I think we go to the next panel and combine panel 2 and 
panel 3, and I apologize, I would hope we could conclude after 
Senator Schumer has asked his questions that have not already 
been answered by you or proposed by a previous member, is that 
fair enough?
    At the conclusion we will bring the entire two panels 
together, it would be my intention, and I have talked to 
Senator Bingaman that we allow them to make their statements, 
all of them, before we begin any questioning, and Senator 
Feinstein has a question.
    Senator Feinstein. Do you intend to take a break?
    The Chairman. No, I do not intend to take a break. I am 
fearful we will drag this thing out beyond reasonableness, but 
I concur, somebody has got to call the shots.
    Senator Schumer.

      STATEMENT OF HON. CHARLES E. SCHUMER, U.S. SENATOR 
                         FROM NEW YORK

    Senator Schumer. Thank you, Mr. Chairman. I want to thank 
you for holding this hearing, and our witnesses, all of our 
witnesses, particularly those from New York, being here, and my 
questions actually relate not so much directly to the 
California crisis, but to the lessons it has for New York and 
the rest of the country. Fundamentally, anyone in America who 
thinks, well, you can isolate California and say they made a 
bunch of mistakes and it will not happen anywhere else I think 
is sadly mistaken. There is a fundamental problem.
    California may be ahead of other parts of the country, but 
the fundamental problem is the same, and that is demand 
increases, supply stays flat, and there is not much you can do. 
When that happens you will have probably, higher prices, much 
higher prices, and shortages, and we ought to be thinking in 
terms of national policy.
    I am a new member of the committee and probably know less 
about this issue than anybody else here, but from my 10,000-
feet-up-view, as opposed to knowing all the trees, the bottom 
line is very simple, that here in Washington one side of the 
aisle says supply, increase supply, increase supply. The other 
side of the aisle says, decrease demand, decrease demand, 
decrease demand, and the twain never meet, and hence not much 
has happened.
    I hope one of the things that the California crisis can do 
is importune all of us to sort of come together in the middle. 
There are merits on both sides. There are merits about 
increasing supply, there are merits about decreasing demand, 
and frankly we are not going to get anywhere unless somehow, 
led hopefully by this committee, we meet on both of those 
issues.
    But for me the implications in California, which I think 
have relevance to my State of New York and to the whole 
country, are that demand increased rather dramatically and 
supply stayed rather flat.
    I think the second problem which also has relevance, 
particularly to New York but other places as well, is that 
California sort of assumed it could regulate the wholesale 
market independent of other regional supply systems. They sort 
of felt--and they are pretty big, bigger than us, but they sort 
of felt they could just sort of wall off California and deal 
with the problem that way, and that is not true.
    FERC really recognized for the States tried to work 
together to build regional transmission organizations which 
lead to seamless energy across borders and create incentives of 
building new transmission lines to adapt to that situation, and 
it did not happen.
    Again, I think New York is similar. We have large parts of 
our State, particularly New York City and Long Island, which 
even if they build a powerplant up-State cannot very easily get 
that power down-State, so the fundamental questions I have for 
you are based on the two biggest lessons that we learned from 
California, and my question is, are those correct lessons to 
extrapolate not only to New York but the whole country, and 
what other lessons can we learn from California as we apply it 
to the whole country?
    I would open that up to any of the three panelists who wish 
to take a stab at it.
    Dr. Makovich. As you look at supply and demand fundamentals 
in regional power markets, New York, if we have normal summer 
weather and the economy holds up, New York is very likely to 
have an electricity crisis this summer, and it is down-State 
New York, it is New York City, Long Island.
    As you mentioned, demand has grown, supply has not. There 
are bottlenecks in the transmission system that will not allow 
enough surplus capacity from New England and up-State New York 
to solve this problem, and yes, this summer in New York it 
looks very tight.
    Dr. Fox-Penner. Thank you, Senator. I would agree with 
that, but let us be careful to draw the correct lesson from 
this. The correct lesson is not that we do not know how to 
build powerplants in the eastern part of the United States, 
because we have as much capacity as New England demands today, 
and not all of it could even be absorbed, so the primary 
problem in New York, the poster child for this is transmission 
capacity, and that is a lesson that this Congress and this 
country must learn, and it is very, very challenging, Senator. 
It is challenging in urban areas most of all, but every urban 
area almost in the country is facing transmission constraints, 
so in that sense it is very definitely national.
    Senator Schumer. Would you name some other ares that are in 
as tight----
    Dr. Fox-Penner. The city of San Francisco is in what is 
called a load pocket with not enough transmission. Boston is a 
load pocket. Chicago had transmission constraints a few summers 
ago. They had to bring in power on flatbed trucks because they 
could not get enough transmission, and there are other load 
pockets. I think Louisiana has one, Senator Landrieu has one, 
and I cannot even name all of them.
    Senator Schumer. But there are lots of them around the 
country?
    The Chairman. Senator Schumer, your time is up.
    Senator Schumer. Thank you, Mr. Chairman. Could I just ask 
one quick other question? It will require a yes or no answer.
    The Chairman. We will see.
    Senator Schumer. I just heard the following statistic, 
which I found astounding, and can you just tell me if it is 
right or wrong? Someone told me that 3 or 4 years ago computers 
and other sort of new economy devices consumed about 7 percent 
of the energy in California and today they consume 18 percent 
of the energy in California, and in 10 or 15 years from now 
they will come close to consuming half of the electricity needs 
of California. Is that crazy, or is that fairly accurate, and 
you have to answer yes or no.
    Dr. Makovich. False.
    Dr. Fox-Penner. False.
    Mr. Konolige. False.
    Senator Schumer. Thank you, Mr. Chairman.
    The Chairman. Thank you, Senator Schumer. We still do not 
know what the percentage is.
    Senator Schumer. I could ask that next question if you 
like.
    [Laughter.]
    The Chairman. We are not going to let you off that easy. I 
want to thank you, gentlemen, very much. You have contributed 
to the record and identified some of the inconsistencies and 
called them as you saw them, and we may have some questions for 
the record. It will remain open, and I wish you a good day and 
invite you, since others sat through your presentations, that 
you sit through theirs.
    We are going to call panels 2 and 3, who are going to get a 
little chummy up here because we will probably have to bring in 
some hard seats. The first is Mr. Steve Frank, president and 
CEO of Southern California Edison, Rosemead, California, Mr. 
Steven Kline, vice president, Federal Governmental & Regulatory 
Relations, PG&E Corporation, Washington, D.C., Mr. Fred John, 
senior vice president, External Affairs, of Sempra Energy--that 
is San Diego Gas & Electric, San Diego, California--Mr. Keith 
Bailey, president and CEO, the Williams Companies, Oklahoma, 
Mr. Steve Kean, executive vice president and chief of staff, 
Enron, Houston, Texas, Mr. Joe Bob Perkins, president and chief 
operating officer, Reliant Wholesale Group, Houston, Texas, Mr. 
Curt Hildebrand, vice president, Business Development, Calpine 
Corporation, Pleasanton, California, Mr. Richard Ferreira, 
executive advisor, Sacramento Municipal Utility District, 
Sacramento, California, Mr. Tom Karier, council member, 
Northwest Power Planning Council, Spokane, Washington, Mr. John 
Gale, general manager, Pricing and Regulatory Services, Idaho 
Power Company, Boise, Idaho, Mr. Brett Wilcox, chief executive 
officer, Golden Northwest Aluminum Incorporated, The Dalles, 
Oregon, Mr. Mark Crisson, director of utilities, Tacoma Public 
Utilities, Tacoma, Washington, and Judi Johansen, executive 
vice president, Regulation and External Affairs, PacifiCorp, 
Portland, Oregon.
    Have we been able to accommodate everybody somehow? All 
right. Lady and gentlemen, I would encourage you to submit your 
statements as written, summarize your statements, and 
highlight, if you will, the points you want to make, and 
please, you have sat through the other presentations with a 
great deal of patience, and hopefully you have either learned 
something or have something to point out relative to the points 
that were overlooked, or points that you take exception to, so 
I would encourage you not to be repetitive.
    We all know the problem, so we do not have to address it 
any more. The question is, of course, how do we get out of the 
problem and what the workability is, and the impact in the 
future of what we are concerned with, and if anybody is really 
hungry or has something immediate, we would allow them to go 
first. Otherwise, we will go on the basis of the panel as I 
announce them.
    I see nobody seeking relief, so--although Steve Frank of 
Southern California Edison and Steve Kline of PG&E might be 
seeking relief, we will start with them.

   STATEMENT OF STEPHEN E. FRANK, CHAIRMAN, PRESIDENT & CEO, 
            SOUTHERN CALIFORNIA EDISON, ROSEMEAD, CA

    Mr. Frank. Thank you, Mr. Chairman. I will stay brief. In 
fact, a good deal of my best material has already been used 
this morning, and everybody has had a chance to read about us 
in the newspapers probably ad infinitum, but it is clear that 
our market is broken. It has been broken for sometime.
    Last year, we paid $28 billion for electricity, four times 
as much as was paid the year before. In December and January of 
last year, average prices were about $30 a megawatt hour. This 
December and January, average prices were $270 a megawatt hour.
    Now, from my company's standpoint, what that has meant is 
that we have now paid about $5 billion more for electricity 
than we have recovered from our customers. Our credit ratings 
have been reduced to junk. Our access to the credit markets are 
closed. We have suspended about $800 million in payments in 
debt and power purchases. We have eliminated our dividend, the 
first time in 100 years that that has happened.
    We have reduced costs sharply, reducing and impacting over 
2,000 jobs, and put our ability to run our system out into the 
future into jeopardy, and I think the worst thing here for all 
Californians is that with all of the money that has been 
flowing out of the State over this period of time the people in 
our State do not have a clue as to whether they are going to 
have electricity tomorrow or they are not going to have it.
    We are in the sixteenth or eighteenth day, depending on how 
you count it, of stage 3 emergencies this year. We have had 
rolling blackouts twice in San Francisco in this month of 
January. We have interrupted our interruptible customers 12 
times already in the month of January, and clearly businesses 
cannot run being interrupted 12 times, and in fact businesses 
are very clearly reluctant to locate or expand anything in 
California, and Senator Burns, I believe, was making a pitch 
for some of our businesses already this morning. He would not 
be the first one to do that.
    The darndest thing about it is, all of this is happening 
when usage is really running about 65 percent of peak. This is 
not the time when you would expect shortages. It is not the 
time when you would expect high prices. We in our company have 
done about all of the self-help things we think we can find, 
and there are not a lot more rabbits to pull out of these 
particular hats.
    Now, we have gone through a lot of the reasons this 
morning, and they are pretty familiar, the over-reliance on the 
spot market, the lack of long-term contracting authority for 
sales generation, the one-price auction, which we have not 
talked about too much, but I think is a clear issue, the lack 
of new supply and, maybe most importantly, the fact that there 
has been absolutely no price signal to our customers.
    The blackouts that have occurred in San Francisco have not 
been experienced by Southern California Edison customers, 
albeit we have come very, very close a couple of times, so in 
effect our customers have felt absolutely nothing, either from 
a cost standpoint or from a usage standpoint, throughout all of 
this crisis.
    Now, there is not any lack of blame, and I think it is easy 
to find ways to point fingers at a lot of people, but I, for 
one, do not believe that is a particularly worthy exercise any 
further. We need at this point strong and decisive leadership 
to deal with this issue. After too long a period of indecision 
in our State I think we are seeing leadership exercised in the 
legislature of the State today. There are discussions going on 
now that I hope will bear some fruit, but the situation I guess 
I would say is still very, very fluid.
    I know it is tempting to just say, California, you guys 
screwed it up, so you guys fix it, but this clearly has 
regional and national implications, and I believe it requires 
action at the Federal level as well. Only the Federal 
Government has the authority over wholesale rates, and 
wholesale rates have to be moderated, at least in the short-
term, as part of this fix.
    Now, FERC, as has been pointed out many times this morning, 
has found wholesale rates to be unjust and unreasonable, but 
they have declined to remove market-based pricing authority in 
reaction to that finding. Now, I believe in markets, too, but 
where they have already been deemed to be not workably 
competitive, some action is required until they are workably 
competitive.
    We believe that a temporary return to a cost-based 
approached, not caps necessarily, but a cost-based approach 
until the market is workably competitive is fair to both buyers 
and to sellers, and when we talk about a cost-based approach we 
are talking about reasonable rates of return as part of that 
cost.
    We are not asking sellers, or suggesting that sellers 
should sell into the marketplace at a loss, and therefore we 
support S. 26 that Senator Feinstein introduced last week as an 
effective approach to bringing immediate relief from the 
excessive wholesale prices that we see in the marketplace.
    I will save the rest of my remarks for questions, but I do 
appreciate your having this hearing so early in the session, 
Mr. Chairman, and I also appreciate very much the leadership of 
Senator Feinstein in introducing this bill last week. Thank 
you.
    [The prepared statement of Mr. Frank follows:]
 Prepared Statement of Stephen E. Frank, Chairman, President and CEO, 
                Southern California Edison, Rosemead, CA
    Good morning. I am Stephen E. Frank, Chairman, President, and CEO 
of Southern California Edison. I appreciate the opportunity to testify 
before you today on the problems which threaten not only California's 
electric system, but the economic well-being of the state and 
potentially the entire country.
    Eight months ago, my company was financially healthy. Our credit 
rating was A+ and our market capitalization was approximately $6.5 
billion, based on a share price of $20. Today, our credit rating is 
deeply speculative grade or ``junk.'' We have temporarily suspended 
payments for borrowed funds totaling $480 million. In addition, we also 
deferred making power purchase payments totaling approximately $360 
million. Our stock price dropped to a low of $6.25, but has risen in 
the recent week to approximately $13. We have eliminated common 
dividend payments to our shareholders for the first time in our 100-
year history. Not by coincidence, as I sit before you today, California 
is enduring the 16th day this month of Stage 3 Emergency alerts, the 
most serious level leading to rolling blackouts.
    Southern California Edison has found itself in a precarious 
situation where we had to buy wholesale electricity at artificially 
high prices and resell at artificially low prices. As a result, we 
incurred $4.5 billion in under-collections as of the end of 2000.
    We initially financed this massive revenue shortfall by borrowing 
in unprecedented amounts. However, we have now exhausted our credit, 
and have limited cash reserves. As a result, we have suspended payment 
for power and some of our outstanding debts. We are implementing major 
cost reduction measures totaling nearly half a billion dollars 
annually, which will reduce our workforce by approximately 1,850 
positions and limit critical investments in the electric system. If 
sustained, these reductions in staff and operating budget will 
certainly jeopardize the reliability of our system and our ability to 
adequately serve our customers. In addition, as I mentioned earlier, we 
have suspended dividend payments to our shareholders for the first time 
in our 100-year history.
    These measures are not enough, however. With the widening gap 
between wholesale and retail prices, even the most drastic cutbacks we 
could possibly make would only generate enough cash to buy another few 
weeks' worth of wholesale electricity. Earlier this month, in response 
to seller concerns about the creditworthiness of the state's major 
utilities, the California Department of Water Resources began buying 
power in the wholesale markets in an effort to avoid massive blackouts.
    During this past year, California has seen wholesale electricity 
prices skyrocket. In 2000, California paid nearly $21 billion more for 
wholesale electricity than it paid the year before--a nearly four-fold 
increase. In 1999, the bill for areas served by the Independent System 
Operator (ISO) was $7.4 billion; in 2000, it rose to $28 billion.
    As staggering as this increase is, it does not reflect the true 
cost of the electricity crisis to California. The high prices we have 
been paying have not ensured adequacy of supply. Power emergencies have 
become an everyday occurrence. There are several power plants under 
construction or in the permitting stages in California, but not nearly 
enough for the state to pull ahead of the current supply shortage--not 
to mention the substantially higher demand anticipated next summer. 
Neither is there sufficient power to sustain the state's economic 
growth. Without dramatic action to accelerate the provision of new 
supply to the market, the problem has the potential of continuing for 
years.
    However, the problem is not entirely one of supply shortage. 
Ironically this winter, during a time of relatively low load, we 
experienced the well publicized rotating blackouts in Northern 
California on January 17 and 18. In addition, both we and PG&E have 
been forced to repeatedly curtail ``interruptible'' customers--those 
who agreed during a supply crisis to a limited number of interruptions 
in exchange for lower rates. These customers include schools, small 
businesses and larger manufacturers. While the California Public 
Utilities Commission (CPUC) last week decided to suspend the fines for 
this program and make it purely voluntary, this has increased the 
likelihood of rotating blackouts. The uncertainty about the state's 
power supply has led some businesses such as Intel to announce they 
will avoid further expansion in the state and consider relocating 
outside of California entirely, while other businesses, such as Miller 
Brewing Company, have announced layoffs and curtailed operations due to 
lost productivity.
    The shortfall this winter has been caused both by problems in the 
California market structure, and worries about the creditworthiness of 
the California utilities. As a result, generators have decided to 
either not run their plants or send their supply elsewhere, creating 
artificial shortages and the constant threat of more rotating 
blackouts, even when there is no shortage of supply.
    How did we get here? What has gone wrong? No participant in this 
crisis is free of blame: Everyone can now see that the market structure 
adopted in California's electricity restructuring is terribly flawed, 
even though the intent was to introduce competition and ultimately 
lower prices for consumers. The Federal Energy Regulatory Commission 
(FERC) over-relied on competitive markets to control consumer prices, 
even when it became obvious that California's market was not 
competitive and that prices consumers will inevitably pay were 
rocketing out of control. The CPUC only reluctantly gave the utilities 
limited authority to hedge and refused to declare an end to the retail 
rate freeze. All of us, including the utilities, were not as insightful 
as we should have been about the way the market would work and the way 
demand and supply would get out of balance in the California economy. 
Generators and other suppliers took advantage of a situation that 
obviously gave them significant economic gains.
    Everyone involved, private companies and public agencies, 
undoubtedly believed they had good reasons for what they did. 
Predictably, there has been a lot of finger pointing and casting of 
blame. None of this fixes the problem, however; and the longer it goes 
on, the deeper the crisis becomes. What is needed now is strong and 
decisive leadership directed to solving the problem.
    What needs to be done? At the state level, California officials 
need to take a combination of actions including raising rates, finding 
ways to finance both the past and future utility undercollections, and 
other actions to reestablish the creditworthiness of California's 
utilities. This is critical, because the reality is that the electric 
grid requires substantial capital investment for modernization and 
expansion. Financially crippled utilities will not be in a position to 
make the required investment that is critical to the health of this 
vital infrastructure industry. Furthermore, increased rates similar to 
those implemented in neighboring states will send the appropriate price 
signals to consumers and encourage conservation.
    California officials, working in cooperation with federal 
regulators, need to implement market structure reforms, including 
reduced reliance on the spot market by encouraging long-term contracts. 
New methods of compensating peaking units, through bilateral contracts 
with buyers or the ISO, are needed so these plants can recover their 
costs without inflating the overall cost of generation. The state also 
needs to consider ways to streamline the siting of new plants.
    While there is much that California can and should do, there is 
also a clear need for immediate federal action. Under the Federal Power 
Act, only the federal government has authority over wholesale rates. 
Clearly something must be done about the current wholesale rates. The 
FERC found the rates in the California market to be unjust and 
unreasonable on November 1, 2000, and prices have only gone up since 
then. The law unequivocally requires that FERC set just and reasonable 
rates; the courts have made clear that FERC may depart from cost-based 
pricing and permit market-based pricing only where it finds that the 
markets will restrain prices to just and reasonable levels. The FERC 
cannot continue to rely on an overly doctrinaire approach to 
competitive markets when the markets are not sufficiently competitive 
to control prices and ensure fair rates.
    We believe that the imposition of temporary cost-based price caps 
or load-differentiated price caps is fair to both consumers and 
sellers. Those sellers who truly have high costs will be allowed to 
recover those costs, including a reasonable return on their investment, 
but only when their high priced power is needed to keep the lights on. 
We recognize that price caps may be only a temporary solution. However, 
longer term solutions take time, and immediate relief is needed now. 
Therefore, we support Senator Feinstein's S. 26, introduced last week, 
as an effective approach to bringing immediate relief from the 
excessive wholesale rates throughout the West.
    In conclusion, I would like to thank the Committee and you, 
Chairman Murkowski, for holding this hearing so early in the new 
Congress. I also would like to thank Senator Feinstein for the 
tremendous leadership she has demonstrated throughout this crisis and 
in introducing S. 26, an effective vehicle to address the problems in 
the California wholesale electricity market.

    The Chairman. Thank you, Mr. Frank. Our next witness is Mr. 
Steve Kline, PG&E.

     STATEMENT OF STEVEN L. KLINE, VICE PRESIDENT, FEDERAL 
     GOVERNMENTAL & REGULATORY RELATIONS, PG&E CORPORATION

    Mr. Kline. Thank you, Chairman Murkowski, Senator Bingaman. 
This is truly an opportune time to be having a hearing on 
California and the Western issues related to electricity 
crises. I am going to stipulate to a lot of what Mr. Frank said 
about our current financial situations. Our situation in terms 
of financials is identical, with the exception, I think our 
exposure number is $1 billion more, but at this phase in the 
game I would say we are all generally in the same situation.
    I am also going to not belabor some of the points that were 
made earlier by Mr. Frank on the cause of this problem, but I 
would like to make a couple of comments that I think have not 
been fully developed earlier this morning.
    I would like to just focus for a moment on the fact of 
higher gas prices across the Nation in terms of higher 
electricity prices across the Nation and in California. I asked 
our folks to do an analysis of, assuming deregulation or 
restructuring, whatever California's process is called, had not 
occurred, what would the cost impacts that would be running 
through traditional regulation with fuel cost adjustments that 
were routinely made in the context of rate-making through the 
eighties and nineties?
    Our folks came up with an estimate that the power produced 
by PG&E's plants that are now divested would be about 23 
percent higher than the embedded cost component that exists in 
our rates today, so it is clear a large component of what is 
going on is gas price impacts that we are seeing in the 
marketplace.
    I also want to stress that the problems here are not the 
result of the overall concept of opening markets, and this is 
clearly, as you have heard, not a deregulation problem. Basic 
economics tells us that under any regulatory system, under the 
conditions that have been described today, higher prices would 
prevail. That said, it is true that California's approach to 
restructuring, combined with short supplies, have had a huge 
effect in terms of producing these extraordinarily high prices.
    I would just second the notion that frozen rates are 
causing us several problems, financial problem for some, but 
they are also causing a huge problem in terms of sending price 
signals to customers and sending them signals to make the 
necessary investments in energy efficiency and conservation, 
which further reduce demand.
    Clearly, this problem cannot be solved until supply and 
demand are back in balance. In order to increase supply we 
clearly need to invest in clean and efficient new powerplants, 
together with natural gas pipelines and infrastructure, and I 
would really stress the impact of natural gas as a way to solve 
this problem, and we need clearly to construct new high voltage 
transmission power lines, and that is not easy politically, but 
it needs to be done.
    What I would like to conclude with, there are a few things 
that we have identified that the Federal Government can clearly 
do as the State works around the clock to resolve this problem. 
We believe that the Federal Government needs to do everything 
it can to continue to encourage regional transmission 
organizations and open access to the transmission systems. It 
needs to:
    Accelerate permitting of natural gas pipeline 
infrastructure. This is a big issue, and can have a big impact.
    Encourage the efficient use of energy through research and 
processing standards. That process is underway.
    Encourage continued development of renewables by 
maintaining the existing renewables production tax credit.
    And finally, increase funding for low income energy 
assistance to assure that those least able to pay are not left 
out in terms of access to reliable energy.
    Thank you.
    [The prepared statement of Mr. Kline follows:]
    Prepared Statement of Steven L. Kline, Vice President, Federal 
         Governmental & Regulatory Relations, PG&E Corporation
                              introduction
    Good morning Chairman Murkowski, Senator Bingaman, and members of 
the Committee. I'm Steven Kline, Vice President for Federal 
Governmental & Regulatory Relations of PG&E Corporation. Thank you for 
the opportunity to testify before you today. This is truly an opportune 
moment to be having a hearing on California and the Western Region's 
energy crisis.
                             where are we?
    As widely reported, California's electricity distribution 
companies, including Pacific Gas and Electric Company, teeter on the 
brink of bankruptcy, because we are unable to recover the 
extraordinarily high prices for the power we must purchase in the 
wholesale market, to fulfill our public utility obligation to serve.
                          how did we get here?
    California's problem is fundamentally one of supply and demand: 
statewide, between 1996 and 1999 electricity demand grew by 5,500 MW, 
while supply grew by only 672 MW. The effects of this extreme imbalance 
between supply and demand have been exacerbated by reduced hydropower 
supplies and rapid economic and population growth across the West.
    In addition, higher natural gas prices across the nation are 
contributing to higher electricity prices. As a comparison, suppose we 
were to turn back the clock for a moment to pre-restructuring times. 
Under traditional regulation with fuel cost adjustments, power costs 
from Pacific Gas and Electric's now divested gas-fired plants would be 
23 per cent higher than the frozen commodity cost included in today's 
rate, simply due to gas price increases alone.
    The problems in California are not the result of the overall 
concept of opening electricity markets to competition. Basic economics 
tells us that under any regulatory system, wholesale power costs would 
be substantially higher under the conditions I have just described. 
That said, it is true that California's approach to electricity 
restructuring, combined with short power supplies, have undoubtedly led 
to the unexpected 500 to 1,000 percent wholesale power cost increases 
experienced over the last eight months and to the resulting financial 
crisis for the utilities.
    California's restructuring approach required utilities to divest 
their power plants and to purchase all of the power needed to serve 
their customers on the volatile spot market. Further, until recently, 
the use of long-term bilateral contracts or other price hedges were 
also precluded. Designed to work in an environment of abundant power 
supplies, California's market structure has not served customers well 
under short supply conditions.
    In addition, frozen retail customer prices have shielded consumers 
from the real costs of electricity, nearly eliminating price signals to 
make energy efficiency investments or to conserve, and thus reduce 
demand.
                       where do we go from here?
    California's energy crisis cannot be resolved until supply and 
demand are back in balance. In order to increase supply, new clean and 
efficient power plants must be sited and built, together with natural 
gas transmission and distribution pipelines and high voltage power 
transmission lines. In order to reduce demand, energy efficiency 
investments need to be made and customers need to see accurate price 
signals. In the short-term, efforts to squeeze additional power from 
existing power plants and greatly expanded demand-side management need 
to be encouraged for better or worse, summer, which is California's 
peak season for energy demand, is only months away.
    As we speak today, California's Governor and legislature are 
working round the clock to craft a satisfactory resolution that assures 
reliability and public safety, stabilizes retail rates to customers, 
addresses the longer-term infrastructure needs while protecting 
California's environment, and returns the State's utilities to 
financial health.
    Both the Clinton and Bush Administrations have been very helpful: 
continuation of the Emergency Orders created a window for the State to 
act. We recognize that the Orders are not without cost, and we 
therefore appreciate even more the efforts that our neighboring states 
have made to assist California during this critical and unprecedented 
time.
    Beyond the necessary State actions, the Federal government should 
do everything it can to:

  <bullet> encourage Regional Transmission Organizations and truly open 
        access transmission systems;
  <bullet> accelerate permitting of natural gas pipeline 
        infrastructure;
  <bullet> encourage efficient use of electricity through research and 
        efficiency standards;
  <bullet> encourage continued development of renewable energy 
        resources by maintaining the existing renewables production tax 
        credit; and
  <bullet> increase funding for low-income energy assistance to help 
        assure that those least able to pay are not left without access 
        to reliable energy.

    Thank you for the opportunity to appear before you. I would be 
happy to answer any questions you might have.

    The Chairman. Thank you.
    Mr. Fred John.

STATEMENT OF FREDERICK E. JOHN, SENIOR VICE PRESIDENT, EXTERNAL 
             AFFAIRS, SEMPRA ENERGY, SAN DIEGO, CA

    Mr. John. Mr. Chairman, Senator Bingaman, Senator 
Feinstein, thank you for the opportunity to speak this morning. 
SDG&E, which is a subsidiary of Sempra Energy, is in a somewhat 
different situation than PG&E and Edison, but it is not that 
dissimilar. We came out of our rate freeze in 1999, when we 
sold off our powerplants and eliminated our stranded assets, 
and then in June 2000, when rates increased dramatically in our 
service territory, the State legislature imposed a new rate 
freeze, but did give us the opportunity to recover those costs 
over time through a bill called AB 265.
    The problem is, at this point the California commission has 
not yet taken any action on that legislation in order to manage 
the balancing account that is growing rather dramatically in 
our area. The same issue, you are capped at 6.5 cents per 
kilowatt hour, and you are paying wholesale prices approaching 
22 to 25 cents per kilowatt hour, and no business on a 
sustained basis can charge customers far less than what it pays 
for the product.
    To add to this, SDG&E is now subject to what we call the 
zip code effect when it attempts to borrow money to finance the 
cost of buying wholesale electricity. Our ability to obtain 
financing is being negatively affected by the poor financial 
health of both PG&E and Edison.
    If rate relief is not granted soon, the financial community 
will start to doubt SDG&E's ability to amortize its under-
collection, which could put us at the financial crossroad that 
the State's other investor-owned utilities face today. What we 
basically have is a promissory note from the State of 
California, and what we are trying to do is collect on that 
note without having to go to court to litigate it.
    We support the positions that Steve Frank and Steve Kline 
have said on a variety of issues. Our view is there is a four-
pronged approach to this issue. One is, you need long-term 
contracts, but as Mr. Makovich said on the prior panel, those 
contracts have to be the right kinds of contracts, and they 
have to be reasonably priced.
    The problem right now is, whether you are a utility 
negotiating with the suppliers or the State of California 
negotiating with the suppliers, we have absolutely no leverage, 
because nobody in the Federal Government is willing to step up 
to the plate and say, if you do not come to the table with just 
and reasonable prices, we are going to either impose cost-based 
rates, or we are going to require refunds, or a combination of 
both.
    So that is one part that needs to be done, and by the way, 
do not take this lightly. We are not a company that 
historically has liked any kind of price caps, but you reach a 
point where enough is enough.
    Second is, the State of California has to be willing to 
bite the bullet and allow increased retail rates, otherwise the 
utilities are not going to be able to stay solvent.
    Third, there has to be an expedited siting process in the 
State dealing with generation, with electric transmission, and 
with gas transmission, and that also involves, especially with 
respect to transmission facilities, cooperation between the 
Federal agencies and the State agencies as you are going 
through the SEPA process or the NEPA process.
    Finally, there has got to be a much more aggressive effort 
on the demand-side management, energy efficiency, something 
equivalent to a Marshall Plan, in order to capture those 2,000 
to 5,000 megawatts that Senator Feinstein referred to earlier, 
if you are going to get any handle on the short-term problems 
facing the State.
    With that, I will end my comments.
    [The prepared statement of Mr. John follows:]
    Prepared Statement of Frederick E. John, Senior Vice President, 
             External Affairs, Sempra Energy, San Diego, CA
    Good morning. I am Fred John, Senior Vice President of External 
Affairs at Sempra Energy. Sempra Energy is a Fortune 500 energy 
services holding company whose subsidiaries provide electricity and 
natural gas services. Sempra Energy's two California regulated 
subsidiaries are San Diego Gas & Electric Co. (SDG&E) and Southern 
California Gas Company (SoCalGas). Together, these utilities serve a 
population of 21 million in southern California.
    Mr. Chairman, I commend you for holding this hearing today to 
enable the Committee to hear first hand of the scope and enormity of 
the energy crisis in California. I also appreciate your insightful 
comments in the Congressional Record regarding this issue.
    In short, California's energy crisis is the culmination of serious 
supply and demand imbalances and flaws in the market structure created 
by state legislation and regulation. These imbalances have contributed 
to the skyrocketing wholesale price of the electric commodity that 
Californians are being asked to pay by suppliers who presently have no 
incentive to negotiate to bring costs in line with those in the rest of 
the country. While the high electric rates are the immediate issue that 
must be addressed for us to fix the system, they are but one symptom of 
a system that is badly broken. Today in California we face a 
dysfunctional electric market that needs immediate repair by both state 
and federal regulators and legislators. A solution to the existing 
electric crisis involves four areas:
    1. The need for long-term contracts for wholesale electricity at 
reasonable prices.
    2. State approval of appropriate retail rate relief to help the 
state's investor-owned utilities manage their growing balancing account 
under-collections caused by the differential between the wholesale 
prices charged to the utilities and the retail rates that the two 
utilities are permitted to charge their customers.
    3. An expedited siting process for new electric generation, 
electric transmission and gas transmission facilities.
    4. An aggressive energy efficiency program that provides real 
incentives for customers who conserve energy and penalties for those 
who don't conserve energy.
    These solutions must take place on an integrated basis. All of them 
are necessary if California is to overcome the present crisis.
    Some in Washington have characterized the issue simply as a 
California problem, created by California, for California to solve. 
However, as recognized by Federal Reserve Chairman Alan Greenspan in 
testimony last week before the Senate Banking Committee, this is an 
issue of national importance and one that must be addressed by federal 
and state government officials working together. As Chairman Greenspan 
stated: ``it is scarcely credible that a problem can exist in 
California which does not feed to the rest of the 49 states. The energy 
crisis in California threatens the economic well-being of the nation.''
                 overview of deregulation in california
    In hindsight, it's clear that the market created by AB 1890, (the 
state legislation deregulating the electric industry) and the CPUC's 
orders implementing AB 1890 were flawed. They imposed a retail price 
cap but not a wholesale price cap, required that utilities bid for 
power exclusively through a state-created Power Exchange, federalized 
the state's transmission system, removed electricity providers from 
state oversight, and severely restricted the ability of the investor 
owned utilities to enter into long term contracts. These restrictions 
exacerbated the flaws in the fledgling market as problems with supply 
and demand imbalances in the western region surfaced over the past 
year.
    This is not a purely California problem. While California's demand 
growth over the 1999-2000 period (when price spikes began) was 
relatively flat, demand growth throughout the interconnected grid of 
the western region has been strong. In fact, it has been estimated that 
nearly 85 percent of the growth in electricity demand over the past 
five years in the western region has occurred outside of California.
    While it has been widely noted that no major power plants have been 
built in California over the past 10 years, that is generally true 
throughout the region. And the reason is simple. In 1992, Congress 
initiated the move toward deregulation with the Energy Policy Act. 
Until decisions were made regarding market structure and the ownership 
of generation, investment was frozen. Once California completed its 
legislative and regulatory shift to the new market, many proposals for 
power plant construction were submitted to the state. While the state's 
process for siting of plants is long and burdensome, the delay in 
proposed investment in powerplants over the prior decade should not be 
treated simply as a bureaucratic problem in one state. Rather, the 
problem is a symptom of the investment community's reaction to a 
significant change in regulation affecting the entire western region.
    The now obvious flaws in AB 1890 and the regulatory orders 
implementing it did not surface until after July 1999, when SDG&E was 
the first utility in the state to pay off the debt on its stranded 
assets (as required by AB 1890 to enter the competitive market). Once 
SDG&E opened its market to competition, the utility passed through to 
its ratepayers the market cost of the electric commodity. Initially, 
retail prices were in alignment with wholesale costs. However, during 
the summer of 2000, electric wholesale commodity prices skyrocketed and 
SDG&E's ratepayers were subjected to the highest and most volatile 
prices in the nation--prices that were 500 percent higher than at the 
same time in 1999.
    The extraordinarily high prices being paid by San Diego customers 
created a politically untenable situation. In an effort to ``fix'' the 
problem, for SDG&E the Legislature's cure became worse than the 
disease. In short, AB 265 was passed and capped at 6.5 cents per kwh 
the amount that ratepayers would be charged for the electric commodity. 
Yet, SDG&E continued to pay upwards of 22 cents per kwh to its 
suppliers. SDG&E was required by AB 265 to place the difference, or 
under-collection, in a balancing account to be repaid in 2002 or 2003. 
How the under-collection would be repaid was not outlined in the bill. 
The immediate problem facing SDG&E today is that the balancing account, 
which exceeds $450 million (far beyond the original projections of the 
AB 265 proponents), and there is no end in sight. While AB 265 
guarantees the utility recovery of its prudently incurred costs, the 
growing balancing account under-collection has become a balloon payment 
that must be paid in the future by our customers.
    SDG&E has sought rate relief from the CPUC in order to help manage 
the balancing account under-collections. This relief is similar to that 
proposed by the other two investor owned utilities--PG&E and Southern 
California Edison--whose balancing account under-collections have 
reached levels proportionately equivalent to SDG&E based on each 
utility's sales of electricity.
    At the present time SDG&E is subject to the ``zip code'' effect 
when it attempts to borrow money to finance the cost of buying 
wholesale electricity. SDG&E's ability to obtain financing is being 
affected negatively by the poor financial health of PG&E and 
SoCalEdison.
    Whatever views one holds regarding the current crisis and who may 
be responsible for it, the reality is that neither PG&E, nor Edison nor 
SDG&E can continue indefinitely to provide electricity to consumers at 
a loss. What business could operate in that manner? We have argued 
before the CPUC that if rate relief is not guaranteed soon, the 
financial community will doubt SDG&E's ability to amortize the under-
collection. We are trying to work with decisionmakers at every level of 
government to avoid a point in the not too distant future when SDG&E 
will face the financial crossroads the state's other utilities are 
facing today.
    Let me be clear--we have reluctantly come to the federal government 
to participate in solving this crisis at the wholesale level. In fact, 
we continue to seek commercial solutions with the parties directly 
involved in the issue, including the generators and marketers. While 
some issues can and must be solved by California, the issue is clearly 
larger than the state's ability to solve on its own.
                           california actions
    The Legislature has continued its efforts to solve the energy 
crisis during a special session devoted entirely to the issue. The 
State has appropriated $400 million (which has almost been exhausted) 
to the Department of Water Resources (DWR) for short term purchases of 
power. The Legislature is also considering how the DWR can act as the 
procurement agent for the utilities' customers for long term power. The 
DWR recently conducted an on-line auction to buy power to see if lower 
priced energy was available. However, it is not clear how much long 
term power will be available to DWR as a result of the auction or the 
actual price of the power or the duration of the contracts. While these 
efforts are an initial attempt to solve the problem, it is not certain 
that the State of California will be able to execute long term 
contracts with suppliers that provide sufficient amounts of electricity 
at reasonable prices to assure Californians affordable and reliable 
power until new generation and transmission capacity is built in the 
state.
    That is why Sempra Energy is proposing the following actions that 
must be taken to solve California's energy crisis.
                            proposed actions
1. Long Term Contracts
    As part of implementing AB 1890, the CPUC refused to allow 
utilities to enter into long term contracts as a hedge against price 
spikes. The Legislature directed electricity to be bought and sold on 
the spot market. We now know that the bidding process into the state 
Power Exchange drove up prices for last minute energy demands, and 
helped to create the high rates we are experiencing today. Long term 
contracts represent a critical tool in helping to control price 
volatility and ensure reliability.
    The problem that exists under the current structure is that there 
is little incentive for suppliers to negotiate reasonable prices to 
stabilize the system. The state has taken actions to ensure the 
financial ability to continue to purchase needed power as two of the 
investor owned utilities have been driven to the point where they are 
unable to purchase power. If the pricing problem is not addressed, this 
situation will quickly exceed even the state's ability to provide 
financing. As Standard and Poor's recently stated, ``the failure to 
find a long term cure to this energy crisis could put the state's long 
term credit at risk.''
    We need a sanctioned ``time-out'' so that market participants can 
work together to reach agreement on a reasonable price for the electric 
commodity. The solution is to provide an incentive structure for the 
supply side of the market to negotiate in good faith with the demand 
side to get the state through the current crisis. For that we need 
federal action.
    The suppliers must be required to enter into long term contracts 
for a reasonably priced electric commodity, or face federal sanctions: 
either a federally-imposed fixed hard cap on the wholesale price of 
electricity or cost based rates. Simply put, neither the state of 
California nor its investor owned utilities have the ability to control 
the actions of the suppliers or the leverage to bring them to the 
negotiating table.
    Sempra Energy has reluctantly supported the imposition of fixed 
hard price caps on the wholesale price because it has become apparent, 
newspaper reports to the contrary, that there is no incentive for the 
suppliers to negotiate with either the utilities or the state on long 
term contracts. While long term contracts won't allow the generators to 
continue to reap the profits of the past seven months, these contracts 
can provide profits that are higher than the projected future market 
value for the electric commodity. Although imperfect, long term 
contracts provide all market participants with something while the 
dysfunctional market is corrected. If the Federal Energy Regulatory 
Commission (FERC) continues its unwillingness to impose hard caps on 
the wholesale price, we believe Congress must intervene and direct FERC 
or the Secretary of Energy to take such action immediately.
    A more stringent measure to reduce rates would impose cost based 
rates on the generators. Through this process, the generators would be 
subject to FERC proceedings that would establish ``just and 
reasonable'' rates for serving California. The problem with this 
solution is that while it might ultimately establish reasonable rates, 
it would be a slow process and would prevent more immediate action from 
occurring.
II. Retail Rate Relief
    California's investor owned utilities must be permitted to pass 
through the costs of procuring electricity for their customers.
    As described above, the utilities have sought rate relief from the 
CPUC. However, to date the CPUC has either granted a very limited rate 
increase in the case of PG&E and SoCalEdison, or no rate increase in 
the case of SDG&E.
    The lack of trust by the financial community of California's 
willingness to do what is necessary to maintain the financial integrity 
of the state's investor owned utilities grows each day that neither the 
CPUC nor the Legislature nor the Governor are willing to step to the 
plate and take the actions necessary to manage the huge and growing 
balancing account under-collections caused by the mismatch between 
wholesale prices and retail rates.
    PG&E and Edison are at the financial precipice and SDG&E is trying 
to make sure that it doesn't get there.
III. Expedited Siting Procedures
    Immediate action must be taken to expedite the siting of electric 
generation, electric transmission and gas transmission facilities in 
California. Although virtually no new power plants have been built in 
the past ten years, steps are underway to immediately increase 
generation. Since April 1999, six power plants (representing 4,700 MW 
of new generation) have been approved; five of the plants are under 
construction and the sixth is scheduled to begin construction by April 
2001. Twenty more plant applications are being reviewed by the state 
Energy Commission. These developments and the creation of the 
Governor's Green Team (charged with accelerating the siting and 
permitting of generation and coordinating local, state and federal 
government agency review and action) represent important steps to 
increasing much needed supply. However, even with these changes, it 
takes the State of California much longer to site new generating plants 
than many other states. Also, when it comes to new electric or gas 
transmission facilities there must be greater coordination between 
state and federal agencies as they process permits to comply with the 
California Environmental Quality Act and the National Environmental 
Protection Act. In addition federal, state and local air quality 
requirements pose challenges to the siting process. Finally, often 
local opposition to a generating plant or transmission line can either 
block or substantially slow down approval of a project. State and 
federal regulators must work together to develop creative solutions to 
increase electric supply and the capacity to transport this supply.
IV. Conservation
    Successful management of the demand side of the market must include 
conservation efforts. Historically, utilities have played a critical 
role in helping customers to reduce usage through the use of 
fluorescent light bulbs, new appliances, weather-stripping and other 
incentive programs. However, recent efforts to diminish the role of the 
utilities in conservation efforts has resulted in a decrease in actual 
conservation. While it makes sense to devise new and better ways to 
encourage conservation, the fact is that energy is going to cost more, 
at least in the short term. Utilities can and should play an integral 
role in managing conservation programs.
    In California, the state government has agreed to reduce energy use 
during Stage 2 alerts. The federal government is taking similar action. 
We believe that the state and federal government should continue to set 
an example for load reduction efforts and should work with the business 
community to develop voluntary demand reduction programs. In the Energy 
Policy Act of 1992, Congress created mechanisms to enable the federal 
government (the nation's largest energy consumer) to tap private 
capital to upgrade outmoded facilities and reap energy and cost 
savings. However, federal facilities have been slow to take advantage 
of this law and should be held accountable by Congress for inaction.
    Also an increase in the retail price of electricity will provide 
appropriate incentives to reduce energy consumption. This is especially 
true if rate designs are developed to charge more for increased usage 
of electricity and if customers, especially the larger customers, had 
energy meters that allowed them to see on a real time basis the impact 
of higher usage on the price they will pay for electricity.
                               conclusion
    The energy crisis in California is real. The Governor and state 
legislators are working around the clock to devise a solution. However, 
until more plants are built, the supply and demand imbalance will 
continue. Until the market is fixed and the utilities are financially 
stable, the skyrocketing energy prices will continue to wreak financial 
havoc on California and, in time, the nation.
    Federal intervention is necessary to give the suppliers an 
incentive to negotiate reasonably priced long-term contracts. To 
develop a truly workable market, the suppliers must be part of the 
solution. The utilities cannot continue to negotiate among themselves 
and with state policy makers. For the system to work, a fair and 
workable market must be created.
    We need an immediate mid-course correction to maintain the solvency 
of the state's utilities, protect customers, and create a market that 
truly is competitive. The federal government is in the unique position 
to bring together these seemingly disparate interests to forge a 
consensus on how to best more forward. I think we can all agree that an 
electric market in California that works well into the future is in all 
of our interests. Thank you. I am pleased to answer your questions.

    Senator Bingaman. Thank you very much. Why don't we just 
keep going down the line.
    Steve Kean.

 STATEMENT OF STEVEN J. KEAN, EXECUTIVE VICE PRESIDENT & CHIEF 
                  OF STAFF, ENRON, HOUSTON, TX

    Mr. Kean. Thank you. I appreciate the opportunity to speak 
to you today about California's problem and the potential 
solutions. I think it is interesting to note a lot of this 
ground has already been covered. You keep hearing the same four 
things, we need to increase supply, we need to get demand to 
respond, we need to have more long-term contracting and less 
reliance on the spot market, and we need to make sure that the 
State's institutions are financially sound.
    I am just going to hit on a couple of subtleties to those 
that I do not think have been covered yet. First, on the supply 
side, California has to expedite its siting process. It takes 5 
to 7 years to build new powerplants in California. It takes us 
10 months in other States. Now, the process is insane. An 
outside observer cannot look at this and reach the conclusion 
that this is a sane process. It may have been developed for 
good reasons, it may be administered by people acting in good 
faith, but the results that it produces are insane. It takes 
too long, and that is a California problem, and it needs to be 
addressed by California.
    On the demand side, California has to enable demand to 
respond when supplies are tight, and that means the best way to 
do that is real competition and real choice. When buyers and 
sellers get together in a marketplace they will look for ways 
not only to reduce the cost of supply but also to reduce 
demand, because what matters to those customers is the overall 
bill. If you allow buyers and sellers to meet you can work on 
that problem. Today in California, 99 percent of the customers 
are still served under utility service. That is not 
competition. That is not deregulation. That has to change.
    On the long-term contracting, one more thing on demand, and 
this I think goes to your question, Senator, you are right, we 
cannot get additional powerplants online by this summer, but 
one thing that could be done is, we could have whoever the 
buyer of power is, whether it is the utility or another State 
institution, be willing to pay as much for a demand reduction 
as for a supply increase.
    In other words, if you are willing to pay $150 for a 
megawatt, if you also offered $150 for every megawatt of 
reduced consumption, you could start to work down the demand 
side. That creeps the price down, and you could get that done 
in the time that we have between now and this summer.
    Long-term contracting, I think California is putting itself 
on the right track. It excessively relied on spot markets. It 
is beginning to focus on long-term contracting, and it is the 
right thing to do. There is an important sequencing issue here, 
though. We need to have credit-worthy entities in the State. 
Really, all solutions depend on that. You have to have 
financially solvent entities. Nothing is gained by allowing 
utilities to go bankrupt.
    Secondly, we need to have real progress on the siting 
front. There has to be credible steps taken so that the market 
believes that in fact additional generation is going to be 
coming online. You can see real progress. You can see real 
expedition in the way permits are processed. That will push 
forward prices down so long-term contracting, as you do it in 
later periods, will produce even better pricing, so there is an 
important sequencing issue there that I do not think has been 
touched on yet.
    Just as importantly, there are a number of things that do 
not work. Price caps do not work. They simply--they have been 
tried in California. They do not work. Hard ones, soft ones, 
they simply have not worked. What happens with price caps is, 
the market ends up being bifurcated, because unless you are 
willing to say, I am going to turn lights off, you still have 
to go out into the market to buy the supply you need, and that 
is what has happened.
    You have had the institutions of the State forced into the 
market at the last minute to buy the supplies you need, so the 
price caps have not worked, and extending them around the West 
would simply extend that problem, or export that problem to the 
rest of the West.
    It has also resulted in the cancellation of some peaking 
power facilities in California which could have come online as 
early as this summer but were unable to because of the way 
price caps were set. The caps have not worked. They have not 
worked really in any context, and if they did work, I would 
tell you so, and I would say, let us go do it right away, but 
it simply will not work, and it will just extend the problem to 
the rest of the region.
    A second solution that has been discussed that also will 
not work is State control of the power business. There is no 
reason to believe, and there is every reason to doubt, that 
Governments would do a better job than private firms in rapidly 
constructing and efficiently operating new facilities. State 
takeover of the power system is simply a bad idea.
    My final point is, and particularly for this committee, the 
problems we are now seeing in California are not limited to 
California. Can California happen again? The answer is, yes, it 
can. It can happen in regulated States. It can happen in States 
which have restructured their power business.
    What we need to do to prevent local emergencies from 
proliferating and becoming national disasters is build new 
generation and interconnect it. Get the interstate transmission 
system open and expanded to enable power to move from where it 
is to where it is needed, and give customers the freedom to 
choose. We cannot stand still. We cannot go backwards. We have 
to go forward.
    Thank you.
    [The prepared statement of Mr. Kean follows:]
Prepared Statement of Steven J. Kean, Executive Vice President & Chief 
                      of Staff, Enron, Houston, TX
                                i. enron
    Enron develops and operates networks around the world, primarily in 
energy and communications. We combine physical assets and contract 
access to the physical assets of others to make markets in, among other 
things, energy commodities, pulp and paper, steel and other metals, and 
broadband capacity. Our primary products are contracts which protect 
end users and producers from price volatility.
    Enron is the largest buyer and seller of electric power in North 
America and participates in power markets around the world. As a market 
maker in power markets, we post prices at which we will buy and prices 
at which we will sell.
    Enron's role as a market maker gives us a uniquely objective 
perspective on the problems in California.
    With the exception of a few megawatts of wind facilities, Enron is 
not a generator in the state of California.
    We sell protection from price volatility to both producers and end 
users. Consequently our interest in California's power market (and the 
rest of the markets we operate in) is to ensure that the market works 
effectively. That's what enables us to do business.
    We post both purchase and sales prices. To the extent a market 
participant thinks our price is too high, they can sell to us.
    Contrary to what you may hear or read, our success is linked to 
efficient markets, not higher prices in California, or anywhere else 
for that matter. What we are interested in is competitive and well 
functioning markets. Our financial success is not built on California's 
back. Our business grew dramatically around the world and across 
commodities in part because we migrated our market making activity to 
an online platform and because there is increased demand for risk 
management in many markets. Our volumes have grown and so have our 
earnings. We do not have uncommitted generation to profit from in 
California. But, for the first time, many market participants have 
begun to see the benefits of hedging against their commodity price 
risk. Many people purchased our products--both producers and customers.
    These distinctions are important ones because they uniquely 
position us to identify the facts and the solutions objectively.
                             ii. california
    A. The problem. California's current crisis has very 
straightforward causes:

  <bullet> Economic growth spurred growth in the demand for 
        electricity.
  <bullet> New supply additions did not keep pace with this growth in 
        demand.
  <bullet> The state placed excessive reliance on a state-created spot 
        market, which meant that utility buyers were exposed to price 
        fluctuations across their entire portfolio.
  <bullet> The state did not deregulate; that is, the state did not 
        enable new entry into the supply (generation) business and did 
        not in fact give customers choices.

    The combination of these factors squeezed utilities between a 
volatile spot market and regulated customer rates, leading at first to 
rapid recoveries for utilities (when wholesale prices were low) and 
later to gigantic deficits and near bankruptcy (when wholesale prices 
moved up).
B. The Solutions
    Just as the problems in California are straight forward, so are the 
solutions.
            Supply
    California must allow supply to catch up with demand. It generally 
takes 5-7 years to build new generation facilities in California. Enron 
and other companies have done it as quickly as 10 months in other 
states. California's process must be streamlined. California needs more 
power now. It must become a state priority to rapidly site and 
interconnect new generation. Another way of getting at this same 
problem is approving and siting new and expanded transmission 
facilities.
            Demand
    California must enable demand to respond when supplies are tight. 
In a true competitive market, buyers and seller are free to set 
mutually beneficial terms. In California's regulated retail environment 
less than 1% of customers are served by competing suppliers (the rest 
are still regulated utility customers). A market place where buyers and 
sellers meet would change the demand picture in the following ways:
    --real time price signals would encourage conservation or shifting 
of demand to off peak times.
    --suppliers would offer products to encourage conservation (energy 
efficient equipment for example). Demand reductions at key times drive 
market prices down for everyone. To get a demand response, however, 
customers must see price signals from the marketplace. In the long run, 
prices must be allowed to reflect the market. In the near term, such 
prices would have to be introduced gradually and combined with 
``purchased demand reductions.'' Paying for demand reductions makes 
sense. If utilities, the ISO, or the state, are willing to pay $500 for 
a megawatt, they ought to be willing to pay the same for a 
``negawatt.'' New capacity cannot be brought on in time for this 
summer's peaks. But, demand reductions could be purchased with a 
minimum of disruption to businesses, workers and the economy.
    Long term contracting: California has recognized the importance of 
reducing reliance on the spot market and has started an auction process 
designed to shift more of the state's demand to long term contracts. 
This is sensible. Forward power prices are ``backwardated,'' meaning 
that power prices are lower for future deliveries than they are for 
current deliveries. This means that longer term contracts will produce 
average prices lower than today's spot price levels, immediately 
reducing utilities' costs. However, these markets are shallow and 
skittish today. Price caps and active government intervention in 
California's power markets combined with financial uncertainty about 
the utilities' ability to pay has built large risk premiums into bids 
in those markets. If California entered into forward contracts after an 
active program to site new transmission and generation, forward prices 
would be lower and more bidders would bid in greater supplies. The 
sequence of the reforms needed in California is therefore critically 
important: the institutions of the state must be financially stabilized 
and clear, credible steps must be taken to give the market confidence 
that new supplies will be brought on line. Forward contracting in that 
environment will produce better results.
    Financial stability: The creditworthiness of the state's 
institutions must be reestablished. Without credit worthy buyers of 
power, it will be difficult to attract new generation and long term 
supply commitments. The sobering fact is this: unless the state is 
willing to cut off significant load in the state, it has only two 
``choices''--it can buy the power the state needs in the short term, or 
it can let the utilities become insolvent and then buy the power the 
state needs. Nothing is gained by letting the utilities in the state 
become insolvent. The state appears to be on the right track with 
recently introduced legislation designed to ensure collection of past 
amounts and provide support for future purchases.
    The introduction of real price signals to bring supply and demand 
into balance can and should be tempered by phasing in rate increases 
and market pricing and by insuring that low income customers are 
protected through continuing subsidies.
    Just as importantly, there are a number of proposed ``solutions'' 
which will not help the situation in California or the rest of the 
West.
    Price caps: price caps are bad for consumers, the economy and the 
environment. Price caps in the West have not worked and will not work. 
Price caps have led to the cancellation of peaking power projects which 
could have brought additional supply to California in the near term. 
[Attachment 1] * Price caps have succeeded only in disrupting and 
bifurcating the market for power, sending the states' institutions into 
the real time market to buy the power needed beyond the amounts 
purchased at or below the caps. Price caps merely export California's 
problems to neighboring states, discourage investors from developing 
needed supply resources, disrupt the market, and force a last minute 
scramble for power which endangers reliability.
---------------------------------------------------------------------------
    * The attachments have been retained in committee files.
---------------------------------------------------------------------------
    State control of the power business: There is no reason to believe 
(and every reason to doubt) that governments will do a better job than 
private firms in rapidly constructing new facilities and operating 
those facilities efficiently. Competition in the generation sector has 
produced faster construction, more efficient facilities and has placed 
the risk of those facilities on investors not taxpayers or consumers. 
Government resources would be best focused on streamlining siting and 
interconnection rather than building and operating facilities with 
taxpayer funds.
    Repeal Choice: Consumers are never better off with fewer choices. 
The only consumers that were protected in San Diego were those who 
chose alternative suppliers. It would be a mistake to repeal choice.
   iii. implications for the west and the rest of the u.s.: the need 
                        for federal involvement
    California's problems have already spilled over into neighboring 
states. California is a significant importer of power. As demand has 
grown so has its need for imported power, particularly from the 
Northwest. [Attachments 2 and 3] In past years, abnormally high 
hydroelectric capacity has masked some of the underlying supply/demand 
imbalance. [Attachments 4 and 5] Normal or even lower than normal hydro 
conditions mean that California's demand is taxing Northwest resources.
    Moreover, California is just the latest of several disruptions in 
U.S. power markets and, unless we act quickly, it will not be the last. 
Reliability problems and price spikes have occurred with increasing 
frequency across the country. Some of the underlying causes are the 
same (e.g. higher demand spurred by economic expansion throughout the 
country).
    To prevent reliability and pricing of power from becoming a problem 
throughout the nation, policymakers must act now. Power plants are not 
built in a day.
    The solutions which will prevent local emergencies from becoming a 
national disaster are straightforward:

  <bullet> New generation must be built and interconnected.
  <bullet> The interstate transmission system must be opened to enable 
        power to move from where it is to where it is needed, reducing 
        the need for new supplies.
  <bullet> Customers must be free to choose. Choices mean not only 
        lower prices but greater innovation in products and services 
        which can reduce demand at critical times.

    Policymakers need to remove the barriers which inhibit these 
solutions. Federal lawmakers should enact legislation to enable all 
Americans to have better access to reliable, affordable supplies of 
power, which can best be achieved by providing them with access to the 
nation's interstate grid. In addition, the Federal Energy Regulatory 
Commission (FERC) should act. It should fully unbundle transmission 
service and provide for nondiscriminatory access to that service. It 
should ensure open access transmission through the ``seams'' (the 
administrative borders separating parts of the grid). It should also 
expedite the interconnection of new generation with clear rules and 
deadlines to prevent foot dragging by utilities who don't want to 
connect with competitors' generation. FERC should also require the 
nation's transmission owning utilities to join Regional Transmission 
Organizations (RTO) which will ensure that this access and 
interconnection continue to occur on a nondiscriminatory basis.
    The answer to the question: Can California happen again? is ``yes 
it can,'' though perhaps not in precisely the same way. What began as 
an effort to increase competition, customer choice and innovation ended 
as a heavily compromised and half-baked new regulatory regime. (This 
has happened in other states and jurisdictions as well.) California did 
not deregulate its power market. The FERC has not deregulated wholesale 
markets. Instead, policy makers have chosen (or are forced by political 
realities) to negotiate with incumbent monopolies over the terms of 
restructuring. The result is the worst of both worlds.
    What is required is a rededication to introducing real competition 
into power markets. Access to transmission and customer choice should 
be a top priority. It must be swift and complete. The nation cannot 
afford to stand still on this issue. Electricity is too important. The 
needs of customers--particularly in the high tech sector--have outpaced 
the existing regulated monopoly model. Regulation in the old style does 
not work and California demonstrates that heavily compromised 
restructuring does not work. What is needed now, more than ever, is an 
unwavering commitment to an open and competitive power market.

    The Chairman. Thank you very much, Mr. Kean.
    Mr. Joe Bob Perkins.

  STATEMENT OF JOE BOB PERKINS, PRESIDENT AND CHIEF OPERATING 
      OFFICER, RELIANT ENERGY WHOLESALE GROUP, HOUSTON, TX

    Mr. Perkins. Mr. Chairman, Senator, thank you very much. 
The panel and the previous panel have described much of the 
supply and demand situation. I will try to just provide 
additive comments while echoing that my analyses and the 
analyses of my firm is very similar to theirs.
    The Chairman. You might comment on the supposition by some 
that there has been unfair pricing within the wholesale market 
and that there should not be, if you want to take that on in 
your presentation.
    Mr. Perkins. I will put that in my comments. Am I starting 
my 5 minutes now?
    The Chairman. You are starting now. Go ahead.
    Mr. Perkins. Reliant Energy entered California in 1998, 
when we purchased five plants, 3,800 megawatts. Now, that is 
one of the larger positions. The largest positions are in the 
hands of the utilities. Some 55 percent of the market of 
generation is still held by the utilities. That position is 9 
percent of the California market and 3 percent of the Western 
interconnect market.
    Our role since that time has been an active market 
participant, and I am proud of that role, working closely with 
the ISO, the PX, and FERC to try to improve a market situation 
that we inherited. We went into AB 1890 with purchasing after 
it had already been written. We thought it was a reasonable 
model, but even in 1998 we were working on long-term contracts 
and offering long-term contracts to the market.
    I am also proud of our record, particularly our record of 
performance in plant operations over the last couple of years. 
In the year 2000 we produced 10,900 million megawatt hours, and 
in the summer of 2000 we ran at rates that were 200 percent 
that of the average of the previous 5 years, 35-year-old plants 
that we had figured out how to run twice as much as they had 
run over the last 5 years, and that helped keep the lights on 
in California. The in-State generation was leaned on very 
heavily in the summer of 2000, and we are proud of our 
performance.
    The supply-demand picture has been described very well 
here, and I am just going to add a few supply clarifications, 
and I heard some questions asked. First of all, the statements 
of intent of California legislators and the administration in 
California were right on target, and they need to achieve those 
goals. However, if we start working on generation in California 
today, a new development project, it will be 2004 until we have 
it on the ground for any project of significant size.
    Secondly, the president of the GE Turbine Division was 
recently quoted as saying, some 868 turbines are ordered to 
bring supply to this wholesale market, and 21 of them are 
pointed to California. I think that is a very dramatic 
statement about the industry's evaluation of regulatory and 
political risk associated with California, even though supply 
and demand are very tight.
    There was a question about whether we were using up 
generation for next summer. As an industry, we are using up 
generation for next summer. Hydro will not be replaced by then 
because it is so very low, and the emissions caps on emissions-
limited facilities are being limited, or being run up right 
now, so that they may not be available in the summer.
    An example would be our Coolwater plant, which has an 
overall capacity utilization restriction of some 56 percent, 
and it is running flat out now. If we keep running it between 
now and summer, there will not be anything left by the time we 
get to the middle of the summer. I know other producers have a 
similar situation.
    One solution to that is to run it right up until we are out 
and then get emergency relief, but we should be thoughtful 
about that and we should recognize that as the rules currently 
state, both hydro and emissions credits are being used.
    Now, this is a big problem. The FERC December order 
established a framework for market reform and for solutions. It 
was a well-thought-out framework. Do we agree with every single 
element of it? No, but it was a well-thought-out framework. 
However, the State of California has been slow to act against 
the recommendations that FERC could act on.
    Worse, we still have, and it has been referred to often, 
the retail subsidy issue in California. I am not going to 
elaborate on that, but I would like those members of the 
committee and the people looking at my testimony to turn to the 
second-to-last page in the testimony. It will be easy to find, 
Exhibit A-4, which very sort of graphically states increases 
over 2000 rates for a number of utilities across the country, 
including many of the Western States represented on this 
committee. It shows utilities in California with a 9-percent 
rate increase.
    I would remind people that that is a 9-percent rate 
increase on top of a 10-percent rate decrease that was put in 
place in 1998, and so we are talking about a flat rate since 
1996, when gas prices have increased incredibly, and most of 
the generation out here on the margin is fired by natural gas.
    Secondly, there is a range of 15 to 50 percent rate 
increases in those other States, many of them Western States, 
and you could characterize that as helping to pay for the rate 
subsidy in California.
    Now, since I have got you looking at page A-4, I am going 
to get you to turn to page A-5 as well, please, because there 
is some inaccurate perceptions about market price behaviors, 
and I hope this is responsive to your direction, Mr. Chairman. 
In fact, our testimony, written testimony includes a detailed 
explanation of June 29 supply and demand, comparing 2000 and 
1999. That particular period of time, Mr. Chairman, is used by 
the California PUC, used by the oversight board to say, look, 
supply and demand is about the same, but something has changed 
in pricing, $50 to $500.
    This morning, I saw a copy of a fax that I know was sent to 
many of your offices. That fax had a handwritten comment on it, 
probably by one of the staffers, that said, how can this be 
when supply and demand have been about the same, but it is not 
a complete analysis. It is missing part of the facts, and those 
facts are on page 5. Supply and demand in the California ISO 
was about the same. Demand was about the same in the California 
ISO, but imports from other States was not showing up in 2000 
to the same extent it did in 1999.
    What you can see on this chart is that 4 p.m., peak time on 
that date, and the situation occurred for most of the summer, 
and it is all documented in public by the ISO, 4,500 megawatts 
short of imported net supply, on top of a peak demand at the 
time of about 41,500. Supply and demand was not the same.
    If you add those two together, it was essentially a demand 
on California generation of some 46,500 megawatts, or the 
equivalent of the highest peak demand they have seen. What you 
had is demand competing for supply, and running the price up 
during that period of time.
    Those are my additive comments, Mr. Chairman. Thank you.
    [The prepared statement of Mr. Perkins follows:]
 Prepared Statement of Joe Bob Perkins, President and Chief Operating 
          Officer, Reliant Energy Wholesale Group, Houston, TX
Summary
    I. Reliant Energy is the owner of approximately 3,800 megawatts 
(MW) of California generation and is an active participant in the 
Western power markets. We also own an additional 5,600 MW of generation 
across the country (including approximately 4,200 MW in the Mid-
Atlantic (PJM) region), have 6,500 MW of generation in construction or 
advanced development, control 2,000 MW through multi-year contracts, 
and participate in most domestic gas and power markets. Additionally, 
Reliant Energy's regulated subsidiaries own and operate 14,000 MW of 
generation in Texas, and its European subsidiary owns and operates 
3,500 MW in Western Europe.
    II. Reliant Energy has been working diligently to be a part of the 
California solution since entering this market in 1998; our efforts 
have included attempting to improve flawed market structures through a 
leadership role with the California Independent System Operator (CAISO) 
and Power Exchange (PX), working with the Federal Energy Regulatory 
Commission (FERC) to establish market rules that will attract new 
capital investment, providing an unprecedented amount of power from an 
aged fleet of units in 2000 to help meet California's demand, and 
cooperating with all investigations attempting to address market 
solutions.
    III. Our market perspective, which is that of a participant who has 
invested heavily in learning this and other mature power markets, can 
be summarized as follows: a) the current crisis in California is a 
product of supply/demand fundamentals; b) responses to the market 
situation have yet to address the underlying supply/demand problem; and 
c) the risk of supply shortages and outages will become more severe as 
hotter Summer temperatures significantly increase the demand for 
electricity in the Summer 2001.
    California supply/demand fundamentals. The supply shortages 
experienced in California have been brought on by years of neglecting 
supply/demand fundamentals. No significant generation has been built in 
California in more than a decade while California's economy, and hence 
its electric demand, has surged dramatically. This fragile supply/
demand balance became evident in the Summer of 2000 due to increased 
temperatures and reduced hydro electric capacity. In addition, high 
natural gas prices along with flawed market rules have exacerbated the 
extent of the crisis.
    Responses to the current market situation. The FERC's December 15 
Order established a framework for needed market reform; however, the 
State of California has been slow to adopt measures that would 
alleviate the supply/demand problem (particularly by increasing retail 
rates to better reflect market costs). Instead, the state has focused 
on an inaccurate perception of market manipulation. This reluctance to 
raise retail rates has lessened consumer incentives to reduce 
electricity consumption and has intensified the IOU credit crisis, 
which in turn worsens the supply crisis.
    The California market outlook for Summer 2001. In a worst case 
scenario, California could face power generation emergencies this 
Summer with far more serious consequences than those experienced to 
date. Unfortunately, there is no ``silver bullet'' for the near-term 
supply shortage; demand reduction initiatives are required across the 
entire Western region to mitigate the high risk of forced blackouts. 
However, because many of these demand reduction initiatives will 
require extended lead times to implement, immediate action is required.
    IV. Market-based solutions and competition will provide the 
fastest, most effective relief and remedies to California's supply/
demand problems--if state, local and federal laws and regulations are 
adopted that remove existing impediments to siting new generation 
facilities and facilitate the development of regional market-based 
solutions.
Testimony
    I. Reliant Energy is the owner of approximately 3,800 megawatts 
(MW) of California generation and is an active participant in the 
Western power markets. We also own an additional 5,600 MW of generation 
across the country (including approximately 4,200 MW in the Mid-
Atlantic (PJM) region), have 6,500 MW of generation in construction or 
advanced development, control 2,000 MW through multi-year contracts, 
and participate in most domestic gas and power markets. Additionally, 
Reliant Energy's regulated subsidiaries own and operate 14,000 MW of 
generation in Texas, and its European subsidiary owns and operates 
3,500 MW in Western Europe.
    An established energy provider. Reliant Energy, based in Houston, 
Texas, is an international energy services and energy delivery company 
with approximately $20 billion in annual revenue and assets totaling 
more than $28 billion. The company also has a wholesale energy trading 
and marketing business that ranks among the top five in the U.S. in 
combined electricity and natural gas volumes. It also has wholesale 
trading and marketing operations in Western Europe. The company has 
nearly 27,000 MW of regulated and unregulated power generation in 
operation in the U.S. and Western Europe and has announced acquisitions 
and development projects that will add nearly 6,500 MW.
    Reliant's presence in the Western region, including California. 
Reliant Energy entered the California market in 1998 acquiring 3,800 MW 
of generation, consisting of 5 plants in Southern California, in three 
transactions from Southern California Edison. We also have an 
additional 1,400 MW of generation in construction or advanced 
development in the Western region. Using an often quoted rule of thumb, 
Reliant's generation fleet could provide power for approximately 4 
million homes in California.
    A fragmented market in California. Although we are one of the 
larger merchant generators in California and across the country, our 
share of the market is only 3% of the WSCC (the Western System 
Coordinating Council)--which is the market that includes California, 
most of the other Western states, and western Canada--and we have no 
more than a 10% share in any other market. We make this point to show 
the fragmented nature of supply ownership in WSCC and most markets. 
Additionally, the ownership of generation in California still resides 
largely in the hands of the regulated electric utilities, which are the 
three utilities represented on the left side of the following chart.*
---------------------------------------------------------------------------
    * The exhibits and appendix have been retained in committee files.
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    II. Reliant Energy has been working diligently to be a part of the 
California solution since entering this market in 1998; our efforts 
have included attempting to improve flawed market structures through a 
leadership role with the ISO and PX, working at the FERC to establish 
market rules that will attract new capital investment, providing an 
unprecedented amount of power from an aged fleet of units in 2000 to 
help meet California's demand, and cooperating with all investigations 
attempting to address market solutions.
    Attempting to improve flawed market structures. While multi-year 
contracts have existed in California since 1998, the IOUs in California 
were largely precluded by legislative and regulatory restrictions from 
participating in these markets. Reliant has been a proponent of 
expanded forward contracting by the IOUs to mitigate exposure to the 
price volatility associated with the spot market. We have also been an 
active participant and contributor to the processes for improving the 
CAISO and PX, working closely and communicating well with both 
agencies, as well as gaining the respect of staff and management at 
both agencies.
    Working with FERC to establish market rules. With respect to FERC 
proceedings governing the evolution of the wholesale markets, we have 
been very active, frequently assuming a leadership role in terms of 
addressing and improving market structures. We were very active in the 
recent efforts including 1) the DOE/Treasury Department ``Energy 
Summits,'' 2) FERC's forward contract proceeding with the California 
utilities, and 3) workshops to lay out the facts and to try to develop 
solutions.
    Providing an unprecedented amount of power from a 35-year-old 
fleet. The average age of Reliant's generating units in California is 
more than 35 years. The average heat rate of our California generating 
units is more than 10,000 British thermal units per kilowatt hour (Btu/
kWh). This is an older and relatively inefficient fleet of generating 
units compared to the efficiencies associated with new generating 
technologies, which have heat rates as low as 7,000 Btu/kWh. In fact, 
at the time Reliant acquired its California units it anticipated 
retiring a number of these units. But with electric demand soaring 
Reliant has had to pour millions of dollars in new capital into these 
units to keep them operating and extend their operating lives.
    We are proud of our contributions to keep generation running to try 
to meet the demand for power in California. Reliant Energy's plant and 
technical staffs have worked hard to maximize the performance of our 
generation. During the Summer of 2000 for example, we ran this fleet at 
double the rate of the prior 5-year average--despite the age of the 
fleet and the fact that necessary maintenance had been deferred on a 
number of these units prior to their sale by SCE. To achieve this 
result, maintenance on many of these units has now been deferred to the 
point that more serious availability problems may result in upcoming 
months unless the units are taken down soon for needed maintenance. 
While the existing supply problems in California are serious, the 
potential for even greater problems exists for this Summer, especially 
if required maintenance is not performed soon.
    We went to extraordinary efforts in overtime, innovation, and 
assumed risk to achieve these results. Unfortunately, many parties do 
not understand that these generation units are being run far harder and 
for more extended periods of time than historically. The total energy 
production from Reliant Energy's California generation fleet was 10.9 
million MWh in 2000 compared with 6.1 in 1999 and 3.6 in 1998 (see 
Chart A-1 in the appendix). We are confident that the results of the 
various investigations into the so-called withholding issue will verify 
the above statements. We welcome such investigations to the extent that 
they can disabuse people of flawed notions and get everyone focused on 
the real problem at hand--a serious lack of capacity in California.
    Our energy production could be further increased were it not for 
the most restrictive emission limitations in the country imposed by 
local California air boards, which limit the operating hours of some 
units:

  <bullet> At our current higher-than-normal operating rate, these 
        restrictions will idle significant capacity (approximately 900 
        MW of Reliant Energy's portfolio) this Summer when really 
        needed for peak demand.
  <bullet> There have been some allowances made by local California air 
        boards to date. Broader temporary relief of these most 
        restrictive emissions limitations could increase overall energy 
        production by up to 20% for our portfolio and potentially even 
        more for some of the other generation owners in California. 
        Temporarily lifting emissions restrictions may be necessary 
        given the supply shortage California faces this Summer 
        (discussed further in Section III).
    III. Our market perspective, which is that of a participant who has 
invested heavily in learning this and other mature power markets, can 
be summarized as follows: a) the current crisis in California is a 
product of supply/demand fundamentals; b) responses to the market 
situation have yet to address the underlying supply/demand problem; and 
c) the risk of supply shortages and outages will become more severe as 
hotter Summer temperatures significantly increase the demand for 
electricity in the Summer of 2001.
    California supply/demand fundamentals. The supply shortages 
experienced in California have been brought on by years of neglecting 
supply/demand fundamentals. No significant generation has been built in 
California in more than a decade while California's economy, and hence 
its electric demand, have surged dramatically. This fragile supply/
demand balance became evident in the Summer of 2000 due to increased 
temperatures and reduced hydro electric capacity. In addition, high 
natural gas prices along with flawed market rules have exacerbated the 
extent of the crisis.
    Note: Our perceptions of supply/demand tightness in the California 
energy environment are consistent with similar conclusions from the 
recent FERC investigation (in connection with the Staff Report issued 
in November) and the Treasury Department analyses (in connection with 
the early January ``Energy Summits'').
    The current situation in California results from years of 
neglecting supply and demand fundamentals, which have dramatically 
increased the risk for power shortages in California. As the demand for 
electricity has increased, California has relied increasingly on power 
from volatile sources (e.g., imports and hydro electric), rather than 
developing internal power generation to support the state's needs.

  <bullet> Reserve margins before imports in California have shrunk 
        from 15% in the early 1990's to near zero today.
  <bullet> California rules for siting and permitting plants have 
        curtailed the development of necessary internal supply.
  <bullet> The percentage of California's power supplied by imports has 
        doubled from 13% to 26% since 1990.
  <bullet> Heavy dependence on hydro power (24% of capacity) increases 
        the uncertainty of supply given the dependency of this resource 
        on precipitation levels.
  <bullet> Limitations caused by the transmission infrastructure can 
        significantly limit importing supplies from other Western 
        states (import transmission was congested 36% of peak time in 
        Summer 1999).

    The limitations of the existing system became transparent when the 
high risk of power shortages finally hit California full force during 
the Summer of 2000:

  <bullet> Summer energy demand increased by 13% due to high 
        temperatures, while imports were reduced by 53% versus 1999.
  <bullet> Hydro electric output was reduced by 28% versus 1999 as a 
        result of lower precipitation.
  <bullet> Forced outages on generation plants more than doubled as a 
        result of higher operating hours (run times almost doubled for 
        Reliant plants from 1999 to 2000). In the Fall of 2000, outages 
        remained high primarily due to nuclear refueling and 
        retrofitting of plants with better emissions reduction 
        technology.

    Acute supply shortfalls combined with a fly-up in natural gas 
prices and flawed market rules have exacerbated the extent of the 
crisis.

  <bullet> California gas prices have increased from $2.37 (January 
        2000) to $14.33 per million British thermal units (MMBtu) 
        (January 2001), and have exceeded $50.00/MMBtu at times (see 
        Chart A-2 in the appendix).
  <bullet> The Competitive Transition Charge (CTC) design discouraged 
        retail competition and long term risk management.
  <bullet> IOUs were required to buy almost all power from the more 
        volatile spot market.
  <bullet> Retail rate freeze prevented California IOUs from passing on 
        energy purchase costs.
  <bullet> The current credit crisis, which has had an additional 
        impact on supply, is a direct result of flawed market rules.

    Responses to the current market situation. The FERC's December 15 
Order established a framework for needed market reform; however, the 
State of California has been slow to adopt measures that would 
alleviate the supply/demand problem (particularly by increasing retail 
rates to better reflect market costs). Instead, the state has focused 
on an inaccurate perception of market manipulation. This reluctance to 
raise retail rates has lessened consumer incentives to reduce 
electricity consumption and has intensified the utility credit crisis, 
which in turn worsens the supply crisis.
    FERC's December 15th Order attempts to address many market defects, 
such as, elimination of ``hard'' price caps and facilitating more 
forward contracting. In addition, the Order clearly identifies certain 
actions that the State of California must take to implement the market 
reforms identified by FERC.
    The State of California has created a retail consumer subsidy by 
failing to raise rates to reflect market conditions and pass on the 
increased costs of energy generation to consumers. In the year 2000, 
natural gas costs increased significantly, but the California utilities 
could not recoup these costs from the consumers that they are obligated 
to serve.

  <bullet> Gas-fired generation constitutes 51.5% of California's 
        energy production (see Chart A-3 in the appendix).
  <bullet> The high cost of natural gas underlies much of the current 
        price increase issue.
  <bullet> The $14.33/MMBtu price compares to $1.63/MMBtu price in 1996 
        when retail rates were frozen by California's deregulation 
        legislation.
  <bullet> Many states (e.g., Texas) with better access to fuel and no 
        supply shortage have raised retail rates more than 20% in 
        recent months to address increases in natural gas costs while 
        California only recently raised rates approximately 10% (after 
        a 10% decrease in 1996) (see Chart A-4 in the appendix).
  <bullet> Filed rate doctrine supports the flow through of wholesale 
        power costs approved by FERC to reflect increases in fuel and 
        emission costs. The California Public Utility Commission (PUC) 
        has so far refused to recognize this judicially approved 
        doctrine.

    Unfortunately, attention has been diverted from the supply problem 
by the incorrect perception of market manipulation. The PUC, along with 
the California Electricity Oversight Committee, has compared prices 
from June 29, 1999 to June 29, 2000 in an effort to demonstrate the 
dysfunctional market. The PUC's analysis shows that under similar 
demand conditions of approximately 41,500 MW, PX prices for power 
during peak hours averaged $50/MWh on June 29, 1999 and $500/MWh on 
June 29, 2000. However, upon closer analysis, this example does not 
support market manipulation charges and demonstrates a failure to 
properly analyze and understand three key factors: 1) the balance of 
supply and demand in the Western region (not just California), 2) 
increases in natural gas and emissions credits prices, and 3) bidding 
behavior on the part of the buyer (not the supplier).
    Regional supply and demand balance. The June 29 example illustrates 
how, in similar demand situations, the availability of imports can have 
a tremendous impact on California supply. In the given scenario, the 
net imports on June 29, 2000 at 4 p.m. were 4,500 MW (see Chart A-5 in 
appendix) lower than on June 29, 1999, which was over 11% of the 41,500 
MW demand. This reduction in net imports, resulting in a leftward shift 
in the supply curve (see Exhibit 2: CAL-PX Aggregate Supply/Demand Bid 
Curves at 4 p.m. on June 29), put upward pressure on PX prices as local 
generation capacity struggled to meet demand.
    Increases in natural gas/emissions credit prices. Gas prices on 
June 29, 2000 were $5.11 per MMBTU versus $2.37 on June 29, 1999. 
Emissions credits prices were $23.00/lb on June 29, 2000 versus $2.00/
lb on June 29, 1999. These higher operating costs result in a further 
steepening of the supply curve (Exhibit 2).
    Buyer bidding behavior. Faced with a tight supply/demand balance, 
buyers dramatically altered their bidding behavior in 2000. The demand 
bidding curve jumped by 300-500% (see Exhibit 2) from June 29, 1999 to 
June 29, 2000. This is a clear example of how buyer behavior can have a 
major impact on market price during periods of scarcity of supply.
    The California market outlook for Summer 2001. In a worst case 
scenario, California could face power shortages this Summer with far 
more serious consequences than those experienced to date. 
Unfortunately, there is no ``silver bullet'' for the near-term supply 
shortage; demand reduction initiatives are required across the entire 
Western region to mitigate the high risk of forced blackouts. However, 
because many of these demand reductions initiatives will require 
extended lead times to implement, immediate action is required.
    Worst case scenario. The potential for shortages and blackouts is 
very real for the Summer of 2001. A downside scenario includes 1) low 
hydroelectric availability (Bonneville Power Administration estimates 
are currently 68% of average--one of the worst hydro years on record); 
2) loss of imports due to credit concerns (with the California 
Department of Water Resources or other purchaser); 3) warmer than 
normal weather (current long-term weather view); 4) continued high 
demand (strong economic outlook for California and the entire West); 5) 
plant outage rates at 2000 levels (although the hard running 2000 
levels may cause additional outages in 2001); and 6) continued strict 
local environmental constraints (recent news stories show that despite 
the crisis, ``NIMBY'' and ``BANANA'' activity is still at very high 
levels). The combined impact of these factors could mean as much as 
1,100 hours of blackouts for the rest of the year.
    Our analysis shows that even in the case of normal weather, the low 
hydro generation availability and base/optimistic assumptions for other 
factors could still result in approximately 50 hours of blackouts. 
Essentially, California will have to be incredibly fortunate with 
respect to cool weather, high hydro generation availability, and 
unprecedented conservation offsetting demand growth to avoid blackouts 
this Summer.
    Potential consequences. Recent blackouts, which were only the 
result of a 500 MW shortfall, have demonstrated the potential for 
serious economic and social disruptions. Events include the loss of 
power to 500,000 California residents. Businesses were forced to send 
thousands of employees home. Schools had to close or hold classes 
without power. Power shortages led to traffic light outages and the 
shutdown of ATMs. Dairy farmers had to dispose of milk, while citrus 
farmers feared the power losses would lead to a failure to protect the 
crops from freezing. Power shortages during the Summer of 2001 could 
lead to more serious repercussions:

  <bullet> Blackouts could be ten times worse, at up to 5,000 MW;
  <bullet> Outage duration could be up to 6 hours per day;
  <bullet> The blackouts could affect as many as 20-30 million people; 
        and
  <bullet> Economic cost of outages can be estimated in the multiple 
        billions of dollars.

    Need for immediate action. There is little time left to take 
action, and very little new generation is coming on line before we hit 
the Summer peak in approximately 90 days. Historically, Summer peak 
demand increases by approximately 40% over current levels. Current 
actions are severely exacerbating the potential Summer supply 
shortfall:

  <bullet> Generators with run time limits which are typically 
        allocated to the Summer are running now and will exceed their 
        limits by the Summer peak season;
  <bullet> PG&E and SCE are utilizing limited load curtailment rights 
        normally reserved for peak Summer loads--essentially 
        eliminating interruptible load as a source of future relief for 
        the rest of the year; and
  <bullet> PG&E has had to access natural gas from its storage 
        inventory which reduces available volume for the remainder of 
        the year--reportedly now at critical levels.

    Emergency solutions for the short term. Given the short time until 
Summer 2001, major supply additions are not likely to be forthcoming. 
Potential solutions must focus on region-wide demand reduction 
programs. A set of solutions limited only to California, not 
encompassing the West region, is very likely to be inadequate.

  <bullet> Significant construction of new generation by this Summer is 
        not likely given the 2-4 years permitting and construction 
        cycle.
  <bullet> Averting high risk of supply shortages and forced blackouts 
        will require unprecedented demand reduction programs throughout 
        the West region.

                --Continued exercise of involuntary interruptions of 
                industrial customers in California under interruptible 
                tariffs could add approximately 2,800 MW. Rights under 
                these tariffs need to be extended by creating economic 
                incentives to continue to allow interruptions.
                --Voluntary curtailments of new interruptible customers 
                in the West region, outside California, could add 
                approximately 1,800 MW.
                --Buying back power from industrial customers across 
                the West region at prices they voluntarily accept could 
                add approximately 3,000 MW.
                --Buying back power from aluminum smelters in the 
                Pacific Northwest could add 3,100 MW.
                --Very aggressive conservation by California 
                residential customers has the potential to add 
                approximately 600 MW in the near term; however, the 
                lack of accurate retail price signals prevents consumer 
                incentives to conserve energy.

  <bullet> In addition, California must fix the credit problems in the 
        state in order to incent neighboring states to sell their 
        excess power which could add 4,800 MW.
  <bullet> Local air board environmental restrictions should be relaxed 
        temporarily to add approximately 1,900 MW.

    IV. Market solutions and competition will provide the fastest, most 
effective relief and remedies to the supply/demand problem--if state, 
local and federal laws and regulations are adopted that remove 
impediments and facilitate regional solutions.
    Remedies must address supply/demand issue. The supply/demand 
problem California is currently experiencing is rooted in a variety of 
interrelated factors, several of which have been driven by shortsighted 
desires to artificially depress prices below market levels:

  <bullet> A decade of resource planning neglect has resulted in demand 
        rapidly overtaking supply and reducing reserve margins to near 
        zero with little advance notice.
  <bullet> Market intervention, both in terms of California's failure 
        to allow retail rates to increase to reflect increases in 
        energy and emission costs and in the CAISO's misguided use of 
        price caps, has resulted in flawed pricing signals on both the 
        demand and supply side.

                --Retail consumers receiving artificially low retail 
                price signals have not been encouraged, and have had no 
                incentive, to conserve usage contributing to higher 
                demand levels than would otherwise have been the case.
                --Suppliers have looked at California skeptically in 
                terms of additional capital investment in new 
                facilities given numerous efforts to intervene in the 
                market. These efforts have created a level of 
                uncertainty that makes suppliers reluctant to invest 
                significant amounts of incremental capital in 
                California.

  <bullet> The lack of statewide siting criteria has created a ``not in 
        my backyard'' attitude when it comes to siting new generation 
        facilities, making California one of the most difficult and 
        time consuming states in which to site and permit a new 
        generation facility in the United States.

    Addressing demand issues. From the demand side, increasing retail 
rates to reflect the true cost of supply will encourage necessary 
conservation and the development of demand side management tools to 
mitigate the need for additional generation capacity.
    Addressing supply issues. From the supply side, assuming the siting 
and permitting impediments described above are addressed by the State 
of California, market forces, without heavy handed price cap 
intervention, will result in new capacity being built in California. As 
additional capacity is built, prices will inevitability fall. For this 
to happen, however, suppliers must perceive California as a stable 
market for incremental investment--not a state whose policies are 
driven by short-term considerations.
    Removing impediments to regional solutions. To accomplish the 
foregoing there will also need to be a greater emphasis on dealing with 
energy issues in the West on a regional basis. As the present situation 
demonstrates, California's failure to address its energy problem has 
regional implications. The energy interdependence of the region is 
undeniable and solutions need to be crafted that take regional 
implications into account, especially in the near term.

    The Chairman. Thank you very much. We appreciate your 
statement, and we will review your written statement in its 
entirety.
    Mr. Keith Bailey, president and chief executive officer, 
the Williams Companies, Tulsa, Oklahoma.

 STATEMENT OF KEITH BAILEY, CHAIRMAN, THE WILLIAMS COMPANIES, 
                        INC., TULSA, OK

    Mr. Bailey. Thank you, Mr. Chairman. I will attempt to be 
brief, and I appreciate you putting my filed testimony in the 
record.
    As you saw from the filed testimony, what we have attempted 
to do as we participated actively in the dialogue with the 
State leaders as well as the Federal participants is to focus 
not on how we got to where we are, but rather how we get from 
where we are to where we would like to be, and so the comments 
I will make will be in that context. Where do we go, really, 
from here?
    We acknowledge that where we are is at a point, with 
California having a significant shortfall of available 
capacity, when it looks at all of the sources that it can draw 
on and that is a function of--why we are here has been I think 
pretty well documented by the prior panel, and the prior 
panelists on this panel, but in the short term we think the 
most important thing that can be accomplished--by short term I 
mean immediately, is that the State needs to step in and become 
the credit-worthy buyer of the net short position, and it needs 
to do that in unambiguous way, not trying to do just enough, or 
using half measures. It has to do it clearly and decisively.
    The reason is, as you pointed out in your opening comments, 
California is a major importer of power and people that sell to 
import nations or import States will simply not sell to 
uncredit-worthy buyers. There is also a practical benefit to 
that, because the forward price curves for power today, and the 
current cost of power today, carry with them a credit risk, and 
the elimination of that credit risk in a decisive way will 
immediately, in our judgment, reduce both the current cost and 
the forward cost of power.
    In the medium term, and by this I mean between now and 
summer, we think it is absolutely essential that there be a 
lifting of the air quality regulations that are preventing the 
installation of new facilities, or the running of existing 
facilities, and panelists to my right have described some of 
those impacts.
    We look at it in the aggregate, and it is our belief that 
that act alone, and it will probably take a combination of 
Federal and State action, would add 4,000 megawatts to the 
available capacity during the summer months that otherwise 
might not be there and, as Senator Feinstein pointed out, that 
is as significant amount of power at the margin that can make a 
difference.
    Finally, in the long term, we need to have an investing 
climate in California that is not built from the standpoint of 
bankrupting utilities, retroactive rule changes, price caps, or 
expropriation of private assets. That sounds a whole lot more 
like a third world country than it does our most prosperous 
State, and the practical impact of that kind of rhetoric, 
whether it is ultimately where we end up or not, and I do not 
believe it is where we will end up, but the practical impact of 
that rhetoric is increased risk perception and that, in turn, 
translates very directly into the pricing curves that people 
trade around.
    So again, a clear road map that the utilities' financial 
strength is going to be restored, that California is going to 
do the kinds of things that make it a place that people want to 
invest, will also have a short-term benefit of making the power 
markets more reasonably priced and that will also then ensure 
that private investors continue to put capital into the State.
    Hopefully I have given you a little time back, Mr. 
Chairman.
    [The prepared statement of Mr. Bailey follows:]
 Prepared Statement of Keith Bailey, Chairman, The Williams Companies, 
                            Inc., Tulsa, OK
    I am Keith Bailey, President, CEO and Chairman of The Williams 
Companies. Williams is a Tulsa based energy and communications company 
with some $33 billion in assets and about 22,000 employees. We entered 
the competitive communications market some 16 years ago with the 
breakup of AT&T and have seen first hand the benefits that competition 
has brought to that market. We recently completed a major expansion of 
our national fiber optic network which now spans some 33,000 miles in 
the continental United States and is considered by many industry 
observers to be the most innovative and leading edge fiber network in 
the world.
    Of course I am here today before the Committee because of our 
energy business. On the energy side we operate across the spectrum of 
businesses that exist from the wellhead to the end user. We are a top 
25 independent exploration and production company. We are one of the 
largest natural gas pipeline companies with five wholly owned systems, 
which literally span the country in all directions. We also have 
minority interests in two major import pipelines serving the United 
States with Canadian gas. On any given day our systems transport some 
17% of the nation''s demand for natural gas. We are among the very 
largest North American natural gas gathering and processing companies 
and are a market leader in the natural gas liquids area. We have two 
refineries and a series of retail gasoline outlets. Williams owns a 
major petroleum pipeline company and owns and operates the largest 
independent petroleum storage operation in the country.
    More recently, we have entered the power business and currently own 
or dispatch in excess of 9000MW of power generation facilities spread 
across the United States, including nearly 4000MW in the Los Angeles 
basin. In addition, we are a major marketer and trader of a full range 
of energy commodities, including power. Finally, as an asset intensive 
company, we are also a major consumer of energy. We believe this range 
of activities and experience in the energy business gives us a good 
platform from which to understand both the current problems in the 
California power markets and the best pathway to correcting those 
problems.
    From a broad perspective, the factors that have contributed to the 
current situation in California appear clear and many press articles 
and media reports have discussed them extensively. In the attempt to 
deregulate power markets and reduce prices, policies were adopted that 
at the time offered some short-term appeal but which have proved over 
the longer term to have actually driven the outcome in the opposite 
direction of what the policies were intended to produce. The fatal flaw 
was to attempt to mix artificial pricing constraints with a partially 
deregulated market. The fundamental problem was a system that did 
little or nothing to provide true market based price signals to the end 
user. This essentially allowed demand to grow in an artificial and 
unconstrained way that likely would not have occurred to the same 
degree had market forces been allowed to work fully.
    But while understanding the past is instructive, as a participant 
in the California market, our focus is on helping to chart a path that 
takes us from where we are today to where the State believed it was 
going when it set out down the path of deregulation. Obviously, 
overarching all of this is an ongoing emphasis on intelligent power 
consumption through aggressive conservation measures. In addition, we 
believe there are three elements operating in different time frames 
that must ultimately be part of that solution.
Short Term:
    First, there must be a creditworthy buyer in California to purchase 
the power necessary to meet demand. At present the utilities in the 
State are unable to do so, given their financial constraints. At this 
point the only creditworthy buyer is the State of California or one of 
its agencies.
    Second, everything possible must be done to enable the dispatching 
of the maximum amount of generating capacity, which can be made 
available each and every day. That may, and probably will, involve a 
temporary waiver of some of the environmental limitations that prevent 
that from happening today.
    Finally, the purchasers of power must be able to use the full range 
of contracting options available in today's market both from the 
standpoint of duration of purchases (long, intermediate and short-term) 
and the type of power being purchased (base load, standby, peaking).
Medium Term:
    All barriers to installing new power generating capacity must be 
re-examined with the objective of expediting the permitting process and 
bringing as much new capacity on line as early as possible. We recently 
brought a plant online in another part of the country that went from 
concept to operation in 9 months. It can be done if everyone involved 
is committed to the task.
    In addition, the short term environmental waivers discussed above 
may need to be extended on existing facilities. Deadlines to retrofit 
these facilities with more stringent emission controls may also need to 
be deferred to preserve the maximum possible generating capacity 
availability until new units can be brought on stream.
Long Term:
    The financial viability of the state's utilities must be restored. 
Failure to do so would create an environment that would deter needed 
private investment. The competitive market and the private sector can 
and will work to bring demand and supply back into balance, but only as 
long as California remains an attractive place to invest.
    Williams appreciates the opportunity to share its views in this 
matter with the Committee and looks forward to being a constructive 
part of finding the solutions that we all seek.

    The Chairman. Thank you very much for that very concise 
statement and specific recommendations relative to the 
immediate, intermediate, and long term.
    Next, we will call on Mr. Richard Ferreira. Mr. Ferreira is 
the executive advisor for the Sacramento Municipal Utility 
District, Sacramento. Please proceed.

 STATEMENT OF RICHARD FERREIRA, EXECUTIVE ADVISOR, SACRAMENTO 
           MUNICIPAL UTILITY DISTRICT, SACRAMENTO, CA

    Mr. Ferreira. Thank you, Mr. Chairman, for the invitation 
to speak here today. I would also like to say a special hello 
to Senator Feinstein of California and to thank her and her 
staff for all the time and effort they put in trying to solve 
this problem.
    I would like to begin by just making a couple of brief 
comments about the Sacramento Municipal Utility District, or 
SMUD. SMUD serves about 1.2 million citizens in the county of 
Sacramento, and it is a community-owned or municipal-owned 
system. During the State restructuring debate, community 
utilities argued that we should be allowed to retain local 
control and make their own decisions about retail access. All 
of the California municipal utilities, including SMUD, 
determined that it was in the best interests of the consumers 
to keep the obligation to serve and retain ownership of 
generation and transmission.
    The California restructuring law respected our right to 
local control and allowed us to maintain ownership and to 
mitigate risk by buying power in the forward markets to reduce 
our exposure to spot prices. This is not to say that SMUD and 
its customers were not hurt by the market. Runaway wholesale 
prices have caused us to spend more than $60 million more than 
what we had budgeted during last year. We have no financial 
reserve left, and we are facing higher prices in the market.
    We believe the problem is a regional issue not limited to 
the borders of California. Neither California nor any of the 
surrounding States can be considered a gated community in the 
electrical market. We already know that it is affecting all the 
Western markets, including Canada. We are beginning to see 
signs in other parts of the States, such as New York, in which 
we have a critical imbalance between supply and demand. We 
think California is not an isolated incident, but rather is the 
proverbial canary-in-the-coal-mine warning that we need changes 
in our national energy policy.
    We believe there are actions that Congress can and should 
take in both the short and the long term to address the 
immediate crisis and lead to a workably competitive market. 
Clearly, there are steps that California should take on its 
own, and you have heard some of those comments this morning, 
including lessening demand, building more generation and 
transmission, and stabilizing rates. My written testimony 
describes these steps in more detail.
    While these are important measures, they are only part of 
the solution. We also think there is a need for Federal action 
to get California, the West, and the Nation back on track. 
Specifically, first, we suggest a temporary regional price cap 
on wholesale prices until there is an adequate supply in the 
region. A price cap is necessary to stabilize market conditions 
and to allow time for generation and transmission investment 
and market improvements to bear fruit.
    SMUD would be the first to admit that price caps are not an 
ideal solution. However, we must face facts. You cannot have 
competition without an adequate supply. The alternative is 
runaway high prices for a significant period of time, which 
causes tremendous social and economic disruption.
    While additional generation is planned for California and 
the region, only a small percentage will come online this year. 
The majority of the new supply will not be available to 
consumers over the next 2 or 3 years. SMUD is concerned that if 
prices do not stabilize, political leaders of, in our case 
California, or the voters, will simply pull the plug on 
electric competition.
    We recognize that there are valid objections to price caps. 
For example, some argue that price caps will inhibit new supply 
or not fully compensate suppliers. SMUD believes a price cap 
can be fashioned to address this objection by ensuring that the 
cap is high enough to allow the generator to recover its 
capital cost and to earn a reasonable profit.
    I would also like to make a few comments on market power. 
Both as a short-term remedy and long-term solution we need 
Federal action to deal with market power abuses. Independent 
studies conducted by the California ISO and others show 
evidence of market manipulation. SMUD believes FERC has the 
authority and needs other resources to identify potential 
market power abuses and impose sanctions and penalties if, in 
fact, that occurs.
    I can assure the committee that you would not see prices in 
California every hour of every day, including 3 o'clock in the 
morning, if we truly had a competitive market. To provide a 
longer term solution we desperately need a national energy 
policy that promotes fuel diversity, energy efficiency, 
conservation, and new supply technologies. Currently, the 
United States is betting its entire energy future on natural 
gas. We have been a leader in Sacramento----
    The Chairman. I would ask you to summarize the balance of 
your statement, please. Your time has expired.
    Mr. Ferreira. Thank you, Mr. Chairman. I would like to just 
finally urge the committee to continue its efforts in reforming 
the existing hydro relicensing process. Relicensing currently 
results in higher cost and some degradation, as we have heard 
earlier. We think this can be done and still respect our 
environmental commitments.
    In conclusion, the California energy crisis has already 
caused significant economic dislocation in the entire West. 
Certain solutions are within California's grasp and 
responsibility. Long term and more effective remedies require 
Federal action, and in the long term we can use the attention 
generated by the crisis in California to increase emphasis on 
energy efficiency and diversity and promote alternative 
sources.
    Thank you.
    [The prepared statement of Mr. Ferreira follows:]
 Prepared Statement of Richard Ferreira, Executive Advisor, Sacramento 
               Municipal Utility District, Sacramento, CA
                        introduction and summary
    Mr. Chairman and Members of the Committee, thank you very much for 
the opportunity to appear before you today. The fact that you have 
convened this hearing shows that you understand how important 
resolution of the current energy crisis is for California, and the 
entire Western United States.
    Frankly, the current situation is bleak. We are experiencing 
outages in the middle of January. Utility operators are dreading what 
might happen in a few months when we near our summer peak. We face 
razor-thin reserve margins on a daily basis, and routine plant or 
transmission line failures can trigger rotating outages. In the 
wholesale power markets, the apparent floor for spot market energy 
prices is higher than peak prices of the not-so-distant past. 
Manufacturers have already postponed planned expansions due to energy 
price and reliability concerns, adding to fears of an economic 
downturn. And there are no easy solutions. Based on our best estimates, 
it will take years to get the needed transmission and generation 
facilities built to support a competitive market.
    The current situation in California has national import as well, as 
Federal Reserve Chairman Greenspan has already recognized. I was 
pleased to hear this week that President Bush has formed a Task Force 
under the leadership of Vice President Cheney to tackle what has become 
a regional problem. California will take certain steps to ameliorate 
the current crisis, but many of the problems must be addressed on a 
regional basis. Only the federal government can accomplish regional 
solutions.
    By way of introduction, let me tell you a little about the 
Sacramento Municipal Utility District, or SMUD, on whose behalf I 
appear before you today. SMUD is a consumer-owned municipal utility 
that serves approximately 1.5 million persons in the greater Sacramento 
area. During debates on AB 1890, California's restructuring law, SMUD 
and other municipal utilities fought for and retained local control 
over our energy choices in the competitive market.
    This local control has significant practical manifestations. 
Because of local control, SMUD retained its obligation to plan for and 
serve the electricity needs of our consumer-owners. It has never been 
SMUD's belief that competition relieved SMUD of its responsibility to 
ensure that its customers had sufficient electric supply at stable 
prices. As a consequence, SMUD and other municipal utilities retained 
their power plants dedicated to serve native load customers. This is in 
direct contrast to our investor-owned colleagues in California who, 
because of regulatory orders and business decisions, sold a high 
percentage of their generation assets and declined to build new 
generation. We have also not transferred away rights to use regional 
transmission facilities, built at great expense, to deliver economic 
energy from other parts of the Western region to our customers. This 
has given us further ability to mitigate market risk for our customer-
owners.
    All things considered, SMUD has been able to weather the market 
volatility and high prices relatively well as compared to our investor-
owned neighbors. However, there is no escaping the market forces that 
have been unleashed. SMUD, like most businesses and consumers in 
California, is exposed to high market prices. Today, SMUD is about to 
commence a rate proceeding due to high market prices for both 
electricity, and the natural gas that powers our local power plants.
    As I will discuss in more detail later in my remarks, there are 
steps California can take to help itself. A series of well-chronicled 
events, exacerbated by well intentioned but mistaken market experiments 
in California, have contributed to the current situation. However, the 
solution will not arrive overnight, just as the problem did not arise 
overnight. Needed investments and market improvements will take some 
time to bear fruit. Further, the one overarching lesson from the 
California experiment is that a piecemeal, state-by-state approach to 
market development and market oversight will simply not work. A 
regional approach to markets is required, and only the federal 
government can make this happen. Therefore, SMUD believes that the 
federal government does have a role to:

  <bullet> help stabilize the current regional wholesale market until 
        needed investment in generation and transmission is made;
  <bullet> act as the steward for regional market reforms that have the 
        best chance to make the promise of competition a reality; and
  <bullet> encourage investment in energy efficiency and supply through 
        a reinvigorated national energy policy.
             background--a road paved with good intentions
    As I stated above, we have a regional energy crisis on our hands. 
Actions taken by California have exacerbated the situation. You have no 
doubt read and heard much about California's failure to build new 
generation and transmission in the face of growing demand. This is 
certainly true. What is also true is that investment in generation and 
transmission has not kept pace with demand throughout the West. Lack of 
facility investment is not a uniquely California phenomenon. What we 
did in California, however, is adopt market structures that laid the 
infrastructure inadequacies bare for market participants to exploit. I 
would make the following additional observations regarding the road to 
competition in California.
    First, California opened up its markets at a time when reserve 
margins throughout the Western United States were dropping. It has been 
well chronicled that increased demand in the growing West has caused 
surpluses in regions such as the Pacific Northwest and Desert Southwest 
to diminish. California was already a net importer of electricity, and 
it saw its traditional suppliers with less power to export to 
California during peak summer periods. At the same time, as California 
demand grew, less power could be returned from California to the 
Pacific Northwest during California's off-peak winter periods, as had 
been the traditional practice. Therefore, tighter reserve margins 
affected the entire Western region. On occasion this year, prices 
outside California have exceeded prices inside California, due to 
several factors. In a regional market, if the highest price in the West 
is in California, buyers in Portland and Phoenix will be forced to pay 
close to the California price. Likewise, if the price in the Northwest 
is the highest, that price is likely to prevail throughout the West.
    The difference is that California adopted a market design that paid 
all bidders the highest, or marginal, price paid for electricity. This 
raised the overall amount paid for energy exponentially. Elsewhere in 
the region, markets worked the ``old fashioned'' way, and the highest 
price was only paid for that last increment of energy needed. Thus, the 
overall affect on consumers in California was much greater. The lesson 
that was reinforced over the past year is that California is not a 
``gated community'' when it comes to electrical supply. What we have 
also learned is that no other individual state is likely to succeed in 
building a fence at its borders due to West-wide supply tightening and 
overall market forces. Price is a regional matter, and remedies for 
high prices must be regional in scope.
    Second, California's road to restructuring can be characterized as 
a ``Wait, Then Hurry Up'' approach. This had an adverse affect on 
utility infrastructure investment. Serious restructuring discussions 
began in California in the early 1990's. Over a period of years, 
California regulators issued Yellow Books and then Blue Books after 
entertaining endless comments from stakeholders. The state legislature 
then joined the fray, and AB 1890 was signed into law in 1996. Already 
California had endured several years of regulatory uncertainty, 
contributing to the lack of investment in both needed generation and 
transmission facilities.
    Once AB 1890 was enacted, however, it seemed things could not be 
done fast enough. The law directed that the entire industry, from 
trading of power to operation of transmission, be radically altered in 
less than eighteen months. Since the March 1998 start-up of the 
markets, there have been over forty filings at the Federal Energy 
Regulatory Commission making major or minor changes to market rules. 
Uncertainty due to regulatory inaction was, therefore, followed by 
instability of market rules, further dampening investment in a capital-
intensive industry. Thus, California managed to combine the worst of 
regulatory delay and inaction, with the worst of hasty implementation. 
This approach exacerbated already poor market fundamentals of short 
supply.
    Third, California implemented radical changes to the rules of 
wholesale power trading that ignored prevailing regional practices. 
Instead of the old model of an industry based on relatively predictable 
behavior by buyers, sellers, and operators of the Grid, California 
implemented a system that encouraged last minute trading of electricity 
in an effort to extract efficiencies from the market. Attractive on the 
chalkboard, it did not work when put into practice. The inability of 
customers to say ``no'' when prices were too high gave more leverage to 
suppliers in an already tight market, because buyers were looking to 
meet their needs in real time, rather than locking in supply months or 
years in advance, as had traditionally been done. The rest of the 
Western region also resisted California's approach. The result is that 
rules governing trading and grid operation vary greatly between 
California and the rest of the West. In hindsight, this could have been 
easily avoided. It also points to the need for regional solutions.
    Thus, California made several errors that contributed to the market 
dysfunction witnessed today. We not only have a crisis brought on by a 
supply/demand imbalance, but we unintentionally aided and abetted this 
fundamental imbalance by the manner in which we implemented 
restructuring, despite the best intentions of California stakeholders.
Avoiding California's Mistakes--Lessons Learned
    Other states can try to avoid the mistakes of California. I would 
make the following observations on lessons learned from our painful 
experience.
    First, competition in the electric utility industry will not just 
happen with a wave of the so-called ``invisible hand.'' Workable 
competition requires certain preconditions be met before markets can be 
relied on to reach competitive outcomes. There must be sufficient, and 
probably a surplus, reserve margin of supply in order to discipline 
price. In a tight market, because of the essential nature of the 
commodity and the inability to effectively store electricity, demand 
behavior is predictable and sellers can essentially name their price. 
Without adequate reserve margins, it may be virtually impossible to 
discipline prices charged by suppliers. Lesson Number One from 
California may be that, in a competitive era, we need much more 
generation on line ready to serve consumers than we built in a 
vertically integrated, regulated industry, in order to maintain price 
discipline in markets. This lesson must work its way into how we 
examine regional markets when determining the potential for the 
exercise of market power by suppliers.
    Second, markets will not work if, no matter what the price level 
is, demand remains almost the same. Demand responsiveness is taken for 
granted in most other markets. Implementation of demand responsiveness 
in electricity markets presents a greater challenge. I have not seen 
great strides in this area in California or elsewhere. While 
regulators, including FERC, talk about customers bidding their demand 
into markets just like suppliers bid their output, these programs are 
in their infancy and are far from fruition. The California ISO 
continues to try to implement such programs, with limited success. We 
are a little closer to making demand responsiveness a reality today 
than before our troubles began. Yet everyone agrees that demand 
responsiveness is necessary to control prices, especially during 
periods of tight supply. Common sense would indicate that other regions 
contemplating a market approach should carefully consider whether they 
have meaningful demand-side approaches in place before they move 
forward.
    Third, someone must be responsible for serving customers, and that 
responsibility must be well defined. I mentioned earlier that SMUD and 
other California municipals never wavered from the obligation to serve 
their customers, and they planned accordingly. We can argue about 
whether our investor-owned utilities were relieved of the legal 
obligation to serve; it was certainly hinted at. Many expected that new 
Energy Service Providers would be climbing over each other fighting for 
IOU customers. At a minimum, the existing IOUs were not given clear 
direction about whether or not their obligation to serve remained in 
full force. This mistake simply cannot be repeated.
    Fourth, it is important to take the time necessary to ensure the 
fundamental components of a workable market, like those cited above, 
are in place before proceeding with full-fledged competition. Progress 
should be made in measured steps. In California, we turned operation of 
the utilities and wholesale markets inside out in less than eighteen 
(18) months. In retrospect, it should not come as a surprise that it 
did not work precisely as planned. We have spent the last three (3) 
years in a vain attempt to correct flaws in the system exposed by 
market participants. We learned that regulators and market makers 
couldn't keep pace with power marketers and brokers when it comes to 
closing loopholes in system design. Given the importance of the 
electricity industry to the well being of the nation, the final lesson 
to be learned from California is that a measured pace of change may be 
preferable to an overnight overhaul.
``California Only'' Solutions Will Be Band-Aids
    There are immediate steps that can be taken in California, without 
federal assistance. However, these will merely be band-aids until 
regional solutions are forthcoming.
    First, California must take all practicable measures to lessen 
demand for the coming summers. The most promising means to ensure 
reliability and mitigate high prices in the immediate future is to 
reduce the demand for electricity. Frankly, it is our only option, 
because generation planned to come on line in the next two years will 
allow California to keep up with demand growth, and little more. At 
SMUD, this week our elected Board will consider augmenting our demand-
management efforts, including a more flexible and aggressive air 
conditioning cycling program that allow us to cut demand from our 
summer peak usage. We are also discussing how our largest industrial 
and commercial customers can change manufacturing process and work 
schedules to allow energy conservation during peak periods. In the very 
near term, demand side efforts such as these hold the most promise of 
reducing the threat of outages due to insufficient supply, as well as 
mitigating price spikes during periods of high usage.
    Second, we must overcome the NIMBY (Not in My Back Yard) and NOPE 
(Not on Planet Earth) syndromes so that both generation and 
transmission can be built. I am hopeful this can be accomplished 
without abandoning environmental goals. New generation facilities have 
much smaller footprints than old units currently in place. Physically 
they are much smaller. They are more efficient, and their affect on air 
quality is much less than existing units that they would replace. New 
generating units would not only bring more supply to electricity 
markets, they would also improve air quality, and their relative 
efficiency would lessen demands on natural gas supply caused by older, 
less efficient units.
    Transmission system improvements may be more difficult, but are no 
less necessary. The current transmission system was built to be part of 
a vertically integrated utility run as a cohesive whole. It was not 
built to support a disaggregated competitive industry, a so-called 
``interstate highway'' approach to transmission access and competition. 
Not only is more transmission necessary to ensure reliability, but it 
is also necessary to ensure suppliers cannot exercise market power, or 
charge rates above competitive levels for sustained periods, because 
inadequate transmission limits access to supplies from competitors in 
localized areas.
    One factor overlooked when examining siting reforms is that fellow 
competitors are often the most vocal opponents of siting new generation 
or transmission projects. A new generator may cut into profits of 
existing facilities, and will therefore be ardently opposed. Likewise, 
a new transmission line can reduce the monopoly power a generator has 
on serving customers in a constrained area of the grid, and therefore 
will also be opposed. We have seen both examples in California. It is 
simply not fair or accurate to lay frustrations of siting delays solely 
at the feet of environmentalists or intransigent residents.
    Third, we must stabilize wholesale rates. As has been much 
publicized, suppliers and buyers, with the help of the State of 
California, are currently in the process of attempting to negotiate 
long-term contracts. If successful, these contracts have the promise of 
being able to avoid immediate rate shock for California consumers by 
locking in lower-than-spot-market prices through contracts with longer 
terms. I would caution, however, that long-term contracts and low 
prices for electricity are not necessarily synonymous.
    Long-term contracts for electricity can ensure stable prices, but 
they cannot ensure low prices. In fact, the ability to enter into long-
term contracts at reasonable rates is predicated on functioning short-
term wholesale markets. One cannot be accomplished without the other. 
You can be sure that a supplier will only enter into a contract if it 
believes the return on the contract will be favorable as compared with 
spot market outcomes for the length of the contract. I cannot emphasize 
strongly enough that long-term contracts are not a substitute for 
properly functioning wholesale energy markets. They are a merely a 
``deodorant'' to mask dramatic retail rate hikes.
             regional and national solutions are essential
    While California has received the bulk of the attention, it is 
merely the ``canary in the coal mine.'' California has its own unique 
set of problems, but California may be the first indicator of a broader 
national energy crisis. As your hearing indicates, California market 
problems have already contributed to high prices and economic 
dislocation in the rest of the West. Other energy markets, such as 
those in New York, appear to be on the brink of supply inadequacy and 
price volatility, perhaps this coming summer. Thus, the energy crisis 
is a federal concern. Moreover, some things, such as regulation of 
wholesale energy markets, are exclusively federal. Here are things the 
federal government can do.
An Interim Regional Price Cap
    First, and for the shorter term, the federal government, through 
FERC or Congress if necessary, can stabilize markets in the West with 
an interim regional price cap.
    A regional price cap is necessary to stabilize market conditions 
and allow time for generation and transmission investment, and market 
improvements, to bear fruit. Today, prices in wholesale markets are 
persistently at levels that are 3-5 times what retail customers are 
used to paying for energy. A crisis mentality has developed, and this 
mentality does not allow constructive discussion on meaningful market 
reforms. SMUD is concerned that if prices don't stabilize, political 
leaders in the West will simply end the move to competitive markets. We 
need help from leaders in Washington, D.C. to implement a regional 
approach to bring order to wholesale markets.
    SMUD would be the first to admit that price caps are not an ideal 
solution. Managing competitive markets is exceedingly difficult. 
However, we must face facts; the alternative is run away high prices 
for a significant period of time. While additional generation is 
planned, only a small percentage will come on line this year. There 
continue to be barriers to entry for new supply and transmission. 
Indeed, the entire planning process for the Western United States has 
eroded due to competitive pressures. Suppliers are much less willing to 
share information regarding planned generation that they regard as 
commercially sensitive, as compared to the close voluntary coordination 
that characterized the regulated industry. Meanwhile, demand continues 
to grow at a considerable rate.
    Transmission additions are also needed, not only in regional 
transmission corridors that have been identified as bottlenecks, but 
also in highly populated areas to deliver the electricity to consumers. 
Even if permitting and related concerns were solved tomorrow, it will 
literally take years to build the necessary transmission. Until then, 
the ability of new supply to get to consumers will be thwarted.
    Finally, we have learned that the ability of the consumer to say 
``no'' to high prices is a prerequisite to a functioning competitive 
market. Facilitating demand responsiveness will take federal investment 
in technologies such as real-time metering and pricing, as well as 
changes in consumer behavior to become more attuned to when energy is 
consumed. These three things, new supply, new transmission, and demand 
responsiveness, are necessary for workably competitive markets. Yet 
they are not on the near-term horizon. The consequences of allowing 
unfettered price levels without meaningful competitive discipline are 
unconscionable consumer hardship, and economic dislocation to small and 
large consumers alike.
    There are valid objections to price caps. For example, it is argued 
that caps will inhibit new supply, or will not fully compensate 
suppliers. SMUD believes a price cap can be fashioned to address this 
objection by allowing exemptions for certain higher priced suppliers 
that are necessary for reliability, and by implementing a flexible cap 
that allows for changes in input prices, such as increases and 
decreases in the price of natural gas.
    Further, the cap can be designed so that marginal costs of new 
efficient units fall well below the cap, thus providing additional 
incentives for new generation to replace old. SMUD has advocated such a 
price cap before the Federal Energy Regulatory Commission. A more 
detailed description of the SMUD proposal is attached to my remarks.*
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    * The proposal has been retained in committee files.
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    Again, remedies such as price caps are not the ideal solution. 
However, we are long past ideal solutions. Interim price caps can be 
made consistent with the goal of continuing to move the industry 
forward on the path toward real competition, while ameliorating the 
certain consumer hardship that will be felt if no action is taken and 
prices remain at record high levels.
A New Look at Policing Market Behavior and Identifying Market Power
    Competitive markets still need policing. For the past decade, the 
electric utility industry, at the urging of regulators, has developed 
increasingly complex markets. With a market the size of California, 
tens of millions of dollars are now won or lost in hourly trading. A 
billion dollars can change hands in a week when market participants 
exploit market rules during periods of tight supply.
    Complex markets require active monitoring and a vigilant policing. 
The old regulatory structure of months-long proceedings followed by 
after-the-fact refunds is not well suited for the new market. 
Traditional measures of market power may not suffice to protect 
consumers from the exercise of market power in product markets that 
were never contemplated as part of integrated utility operation.
    Markets must be examined for the potential exercise of market power 
before they are implemented. FERC and other regulators must have the 
expert staff necessary to monitor energy markets and identify abuses, 
and regulators must have the authority to impose penalties if 
anticompetitive practices are uncovered. These reforms may or may not 
require changes to current law, but they certainly require increased 
attention from responsible regulators. Competitive markets cannot be 
relied upon to police themselves.
Reform the Existing Hydroelectric Licensing Process
    Hydropower is critical to the entire West. SMUD strongly supports 
the efforts of the Committee to streamline the licensing process for 
hydroelectric facilities. SMUD recommends, at a minimum, the following 
legislative reforms in the relicensing process to ensure protection of 
existing, reasonably priced hydroelectric generating resources.
    First, federal and state agencies should adopt least cost 
alternatives to meet environmental objectives identified in 
relicensing. Recognizing the value of existing hydro resources, federal 
and state agencies should avoid, where possible, imposing operating 
conditions through relicensing that would result in reductions of 
capacity. Second, environmental review of federal and state agencies 
under various statutory authorities should be coordinated and 
streamlined. Third, there should be a statutory requirement that all 
license conditions be supported by sound science and subject to 
appropriate administrative review.
National Energy Policy Emphasizing Energy Efficiency, Diversity, and 
        Supply
    There is a desperate need for a national energy policy. The nation 
has enjoyed a long period of relative energy surplus. During that 
period, we lost focus on investment in energy efficiency, conservation, 
and new supply technologies. SMUD is a leader in this area, investing 
considerably more than the national average. Yet, even at SMUD the fear 
of competitive pressures in California resulted in reductions in the 
level of funding for these activities. Aggressive financing programs 
for efficient appliances have been scaled back. Appliance standards 
have stagnated while technologies are available to improve energy 
efficiency. While high market prices have allowed certain existing 
renewable technologies such as wind energy to look more competitive, 
investment in other technologies such as fuel cells and solar has 
lagged.
    Federal energy policy must provide incentives for investment in 
energy efficiency and new supply. We are losing fuel diversity. In 
California and elsewhere, natural gas is virtually the only fuel choice 
for new generation. As we saw in California, electricity prices have 
become dependent on the price of one commodity, natural gas. The lack 
of fuel diversity also jeopardizes reliability due to an over 
dependence on the delivery of natural gas to fuel electric generators. 
Right now in California, there are threats of disruption of gas supply 
to electric generators, due to a lack of pipeline capacity, or to the 
inability of the utility to buy enough gas to keep pipelines full. 
Electric generators are near the front of the line when gas 
curtailments are necessary, which means the electric supply shortage 
will be exacerbated.
    These are matters of national concern. Scattered state or local 
programs cannot generate enough momentum to move new technologies 
forward, or to make significant strides in energy efficiency. A 
cohesive national energy policy is the best way to make meaningful 
improvements in these areas.
                              conclusions
    California's energy crisis has already caused significant economic 
dislocation in California, and has affected the entire Western region. 
Certain solutions are within California's grasp and responsibility. 
Long-term and more effective remedies require Federal action. In the 
short-term, SMUD advocates adoption of a regional price cap on an 
interim basis in order to stabilize regional wholesale markets. A 
regional price cap will provide the breathing room necessary in order 
for new generation and transmission to come on-line, so that the goal 
of a workably competitive market can be realized. In the longer-term, 
Congress can use the attention generated by the current crisis in 
California to highlight the need for a national energy policy, with 
increased emphasis on energy efficiency, conservation, and development 
of alternative energy sources to ensure greater fuel diversity.
    If we take the opportunity to learn from mistakes made in 
California, we can emerge from the current crisis in a stronger 
position than when we entered.

    The Chairman. Thank you.
    Mr. Tom Karier. We look forward to your statement, and he 
comes as council member of the Northwest Power Planning 
Council, Spokane, Washington, and I would encourage you to add 
any reference to what Canada may provide, assuming the price is 
right, BC Power, specifically.

 STATEMENT OF DR. TOM KARIER, COUNCIL MEMBER, NORTHWEST POWER 
                 PLANNING COUNCIL, SPOKANE, WA

    Dr. Karier. Thank you, Mr. Chairman, members of the 
committee. I am testifying today on behalf of the Northwest 
Power Planning Council. My name is Tom Karier, and I am one of 
two Washington members on the council appointed by Governor 
Gary Locke. I also chair the council's Power Committee. The 
council is an agency of the States of Idaho, Montana, Oregon, 
and Washington, and under the Northwest Power Act of 1980 the 
council conducts long-range electric planning and analysis. We 
also prepare a program to protect, mitigate, and enhance fish 
and wildlife for the Columbia River Basin that have been 
affected by hydropower dams.
    Clearly, what started out as a California crisis has 
quickly expanded into the entire West Coast, and I know we have 
a very distinguished number of panel members from the Northwest 
who will address the specifics, but last year the council 
reviewed the West Coast electricity supply and high market 
prices at the request of Northwest Governors and identified the 
key events that were contributing to the crisis, many of which 
have been mentioned in more detail, but obviously high on the 
list was the California electricity restructuring.
    Second was the lack of new plants and new conservation and 
renewable resources. We also had below-average rainfall and 
snow pack in 2000. There is the price of natural gas rising, 
and clearly the unplanned and scheduled maintenance of a large 
amount of capacity in California.
    Currently, we are most concerned about the present 
conditions of the Federal Columbia River power system, a 
system, as you know, largely fueled by water. Precipitation so 
far this winter is 63 percent of normal, and Columbia River 
run-off between January and July is predicted to be only 68 
percent of normal, and the elevation of Lake Roosevelt in my 
State, behind Grand Coolee Dam, is the lowest in 25 years. The 
weather forecast, in a word, is dry. Without normal or above-
normal rainfall for the remainder of the winter and spring, our 
power supply will be stressed even more than it is already.
    This winter, poor hydro conditions in the region, combined 
with California's supply crisis, are exacerbating the imbalance 
between supply and demand and causing significant hardship. The 
power crisis is affecting Northwest utilities and ratepayers as 
well as those in California, and particularly businesses and 
industries. Northwest utilities are raising their rates 
dramatically in some cases. 30 to 60 percent increases are not 
uncommon. Businesses and industries are shutting down or 
cutting back. Aluminum smelters can make more money selling 
their power back to Bonneville than selling aluminum.
    I would like to comment briefly on our recommendations for 
alleviating the problem. First, we need to treat electricity 
like the commodity it has become and encourage market 
mechanisms that manage risk of exposure to high prices. 
Certainly the long-term contracts would be part of that.
    Second, we need to evaluate the shortage of generating 
plants in the competitive marketplace. Can we rely on the 
market to provide sufficient capacity to keep the power system 
reliable? The council plans to investigate this question.
    Third, we need to develop a robust market on the demand 
side of the meter. We see great opportunities in price-
responsive demand management, such as reducing or shifting 
loads during periods of high prices.
    Fourth, California obviously needs to fix its deregulation 
law. This attempt, in our view, at retail competition was a 
failure and needs to be corrected.
    Fifth, we need better information on which to base regional 
power decisions. Better, more timely information about loads 
and resources will improve decisionmaking and reduce the sense 
of panic in the market.
    Sixth, Western utilities need a workable procedure for 
dealing with emergencies when they develop. I am pleased to say 
that the Power Planning Council, along with Northwest 
utilities, Western Systems Coordinating Council, Bonneville and 
others, have been working on creating an emergency response 
team since last December that has functioned very well in the 
last few weeks.
    Seventh, while there is no consensus among Northwest 
Governors on the need for price caps, my Governor, Gary Locke, 
supports interim price caps as a means of cooling the 
superheated power market. We think that this offers the best 
chance of avoiding even more serious problems in the near 
future.
    We do not support the Department of Energy's emergency 
order to sell to California. There is a significant credit risk 
in selling to California, and correcting that problem would do 
much to improve the trade between our two regions. The 
Northwest also needs to protect its ability to meet future 
loads.
    Finally, we all need to continue our efforts to use energy 
more efficiently. From our studies in the Northwest, 
conservation is cost-effective, and it works.
    In summary, the council recommendations amount to a call 
for the West to fix their current problems while investing in 
the future. We must ensure that utilities and consumers remain 
financially solvent until new sources of generation and demand 
reduction moderate prices.
    The Chairman. I would ask you to wind up your statement, 
please.
    Dr. Karier. Thank you, Mr. Chairman. That does complete my 
testimony.
    [The prepared statement of Dr. Karier follows:]
 Prepared Statement of Dr. Tom Karier, Council Member, Northwest Power 
                     Planning Council, Spokane, WA
                              introduction
    Good morning, Chairman Murkowski and members of the Committee, and 
thank you for the opportunity to testify today on behalf of the 
Northwest Power Planning Council. My name is Tom Karier and I am one of 
Washington State Governor Gary Locke's two appointees to the Northwest 
Power Planning Council.
    The Council is an agency of the states of Idaho, Montana, Oregon 
and Washington. Under the Northwest Power Act of 1980, the Council 
conducts long-range electric energy planning and analysis, and also 
prepares a program to protect, mitigate and enhance fish and wildlife 
of the Columbia River Basin that have been affected by hydropower dams.
    In my testimony, I will briefly recount the results of the 
Council's October 2000 analysis of the reasons behind the high 
electricity prices in the West, discuss the current condition of the 
Federal Columbia River Power System, which provides about 40 percent of 
the Pacific Northwest region's electricity, describe some of the 
impacts of the current crisis on Northwest electric utilities and their 
customers, and offer our recommendations for how to address the 
problem.
    To begin, we believe six key events are contributing to the current 
power crisis in the West. These are:
    1. The wholesale power market created by California's electricity 
restructuring is dysfunctional, needs fixing and has affected other 
western states. The remedies ordered by the Federal Energy Regulatory 
Commission have yet to have a significant effect.
    2. Construction of new power plants and new conservation and 
renewable resources during the last decade did not keep pace with 
growing demand for electricity. In the Northwest, for example, demand 
for electricity has grown 24 percent in the past decade while 
generating capacity has grown by only 4 percent. When California is 
factored in, the gap between demand and supply is even greater.
    3. Below-average rainfall and snowpack in 2000 contributed to poor 
hydropower conditions in the Northwest. Snowpack runoff is predicted to 
be 68 percent of normal this year; the elevation of Lake Roosevelt 
behind Grand Coulee Dam is the lowest in 25 years.
    4. The price of natural gas, the fuel of choice for thermal power 
plants in the Northwest, had doubled last summer and now is over three 
times the price it was last year at this time. .
    5. Some California power plants had to shut down for unplanned or 
scheduled maintenance or because they violated air quality regulations.
    6. The loss of flexibility in the operation of the hydroelectric 
system due to Endangered Species Act requirements has derated the 
system by more than 1,000 megawatts.
    I will explain these in more detail later in my testimony, but for 
now let me say that each of these events would cause problems in 
isolation, but in combination they have created ``The Perfect Storm'' 
for western utilities and their customers. Of these key events, we are 
most concerned at the moment about the outlook for hydropower 
generation.
    In a normal year, the volume of the Columbia River runoff between 
January and July is 106 million acre feet, measured at The Dalles Dam. 
In early January, the forecast for January through July 2001 was 80 
million acre feet, or 75 percent of normal. Last week, the forecast was 
revised downward to 72 million acre feet, or just 68 percent of normal. 
By way of comparison, the worst January-July period on record was 50 
percent of normal.
    Obviously, this is a dry winter in most of the Northwest. 
Precipitation in the Columbia River Basin so far is 63 percent of 
normal, and the weather forecast for the next two weeks is, in a word, 
dry. Reservoirs behind dams in the Columbia River system currently are 
about 49 percent full; typically in January, the reservoirs would be 
about 65 percent full.
    As for hydropower generation, in a normal year the Federal Columbia 
River Power System will produce about 15,500 average megawatts. This 
year, with current predictions of runoff, the system is expected to 
produce much less. To put that in perspective, given the driest 
conditions on record, which are 50 percent of normal, the current 
system would produce about 11,500 average megawatts. We may be 
dangerously close to that this year.
    We can hope for above-average precipitation for the remainder of 
the winter and no unusually cold weather that would boost electricity 
consumption. But clearly, the outlook is not good.
    Meanwhile, many electric utilities in the Northwest recently 
announced substantial rate increases in response to high market 
prices.\1\ In fact, several utilities have raised rates to their retail 
customers as much or more than utilities in California. Businesses and 
industries that use large amounts of power are suffering. To better 
understand the impacts, the Council recently convened a panel 
representing four Northwest utilities that have been affected 
differently by the current crisis.
---------------------------------------------------------------------------
    \1\ Market prices for the last year at the Mid-Columbia trading hub 
are displayed in the figure attached as the last page of this document.
---------------------------------------------------------------------------
    Briefly, here is what we learned:

  <bullet> Tacoma Public Utilities implemented a 50-percent rate 
        surcharge, which amounts to a 43-percent increase to 
        residential customers and 75 percent to industrial customers. 
        Dry weather is impacting Tacoma's hydropower operations, 
        forcing the utility to make purchases in the spot market. 
        Tacoma spent $60 million for power in December and is facing 
        continuing high prices with cash reserves of only $130 million. 
        The utility has secured diesel generators with 50 megawatts of 
        capacity, called for conservation, imposed the rate surcharge, 
        and is also planning to take on $100 million in debt to get 
        through the rest of the winter.
  <bullet> Tillamook Public Utility District in rural western Oregon is 
        facing market exposure of $20 million, while the utility's 
        total annual budget is about $11 million. Tillamook joined with 
        several other rural utilities to buy a portion of its load on 
        the market several years ago, and today the utilities' combined 
        power bill has ballooned to $117 million. While Tillamook 
        recently announced a new agreement with Bonneville, Tillamook 
        has asked its large customers to discuss cutting back 
        electricity consumption. But these customers have orders to 
        fill and are reluctant to jeopardize their production.
  <bullet> Puget Sound Energy of Bellevue, an investor-owned utility 
        with some 900,000 customers, reported it is in a precarious 
        stage of load/resource balance. Rising prices for natural gas 
        are squeezing the utility's finances while Puget is operating 
        with a five-year residential rate freeze. The utility may ask 
        the state Utilities and Transportation Commission for emergency 
        rate relief. High prices have caused some of Puget's industrial 
        customers who are on market-indexed rates to shut down or 
        curtail production.
  <bullet> Clark Public Utilities, which serves about 130,000 customers 
        in the Portland suburb of Vancouver, Washington, recently 
        raised its rates 20 percent to meet the increased price of 
        natural gas and power from its generating plant, which supplies 
        about half its load. Currently, the remainder comes from 
        investor-owned utilities under long-term contracts, but those 
        expire in July and Clark anticipates another rate increase in 
        the fall when it goes back on the Bonneville system.
  <bullet> Last week the Bonneville Power Administration announced that 
        a vastly increased demand for its products, beginning in 
        October, will force the agency to make significant market 
        purchases to augment the federal system. As a result, 
        Bonneville is proposing an average 60-percent rate increase 
        over the next five-year rate period, beginning October 1, 2001. 
        Bonneville acknowledged that the first year could be 
        significantly higher than 60 percent, and some Bonneville 
        customers are anticipating rates as much as 100 percent higher. 
        Given the current market situation and the projected spring 
        runoff, Bonneville believes it needs revenues that average 
        annually about $1.3 billion more than its estimates made just 
        last May.

    There is other bad news, as well. Idaho Power Company recently 
announced its power purchases are $121 million above expectations and 
may require a 24-percent rate increase. Utah Power & Light is proposing 
a 19-percent rate increase. Moody's Investor Service recently changed 
the credit rating of Seattle City Light to negative because of concerns 
that low water levels will impact the utility's hydropower generation 
and force more power purchases on the spot market.
    Industries are hurting, too. Recent news stories report on 
smelters, paper mills, chemical makers and mines in the Northwest that 
either are shutting down or curtailing production in response to high 
electricity prices. These include six aluminum smelters in Oregon, 
Washington and Montana, and also other major industries in Tacoma, 
Seattle, Bellingham, Butte, Portland, and elsewhere. Ironically, some 
can make more money selling their contracted power back to the supplier 
than they can by operating. In turn, this allows the supplier to avoid 
purchasing more expensive power on the market.
    Not all the news is bad, however. Bonneville has been able to 
exchange surplus power with California on a two-for-one basis, and 
California has already returned significant amounts of that power. This 
has helped Bonneville avoid running the hydrosystem harder to meet its 
load. However, other utilities in the Northwest, which have been 
ordered to sell surplus power to California, remain concerned that they 
will not be paid for their power.
    Mr. Chairman, as I noted earlier in my testimony, there are 
multiple reasons for the current power crisis on the West Coast. Two 
years ago, the Northwest Power Planning Council initiated a study of 
the adequacy of the Northwest's power supply. This study was motivated 
by the observation that while the region had enjoyed several years of 
robust economic growth and, consequently growth in the demand for 
electricity, there had been very little in the way of new generation 
development. At the same time, efforts to improve the efficiency of 
electricity use in the region had been reduced dramatically because of 
the uncertainty of utility restructuring. This raised the concern that 
under conditions of high stress, the system might not be able to fully 
meet the region's power needs to serve load and to maintain the 
reserves essential to a reliable system. Conditions of high stress 
involve combinations of high weather-driven loads, poor hydropower 
conditions and forced outages of thermal and hydropower generating 
units.
    The study, which we completed in early 2000, concluded that:

  <bullet> There is an increasing possibility of power supply problems 
        over each of the next few winters (December, January, 
        February), reaching a probability of 24 percent by 2003. This 
        takes into account both regional resources and the availability 
        of imports. The level and duration of the possible shortfalls 
        could be relatively small--a few hundred megawatts for a few 
        hours--or quite large--a few thousand megawatts for extended 
        periods.
  <bullet> The region would need the equivalent of 3,000 megawatts of 
        new capacity to reduce the probability to a more acceptable 5-
        percent level. That new capacity should take the form of new 
        generation, conservation and economic load management, i.e., 
        reductions or shifts in consumer loads that make economic sense 
        for the consumer and the power system.
  <bullet> It was unlikely that market prices would be sufficient to 
        stimulate the development of sufficient new generation in that 
        time frame. This meant that in the near-term, an even higher 
        priority needed to be placed on developing economic load 
        management opportunities.

    While this study generated a good deal of interest, it is difficult 
for people to get too excited about probabilities generated by arcane 
computer models. However, last summer, and again this winter, 
developments in the power system captured the attention of the industry 
and the public. Those developments resulted in unprecedented high 
prices in Western power markets, including the Northwest. Average 
prices for power were well over $200 per megawatt-hour, occasionally 
reached $700 per megawatt-hour or more, and peaked on December 11 at 
$5,000 per megawatt-hour on the Mid-Columbia trading hub. At the low 
end, that is more than 10 times the previous high, and at the high end 
more than 100 times. In short, prices are phenomenally higher than in 
past years.
    The Council believes that high spot-market prices are a tangible 
manifestation of the fundamental problems identified in the Council's 
power supply adequacy study of last winter. That is, the prices are an 
indicator of current scarcity. Last summer, the system, which already 
was facing tight supplies, was further stressed by combinations of 
unusually high loads, poor hydropower conditions and forced outages of 
thermal units. There is little in the way of price-responsive demand to 
mitigate these prices. Those who had available supply were able to ask 
for and receive high prices. This combination of factors is precisely 
what led to the power supply adequacy problems identified in the 
Council's study. These factors apply not only to the Northwest but also 
to the entire Western Interconnection. There are some additional 
factors related to the design of the California electricity market, but 
they should not obscure the basic underlying problem. Absent some 
action, the next similar event could result in not only high prices but 
also a failure of the Northwest system to meet loads.
    In the following paragraphs I will summarize the evidence regarding 
the factors affecting Western market prices, focusing in some detail on 
the last week of June 2000, the period in which the highest prices of 
the summer were observed. While prices at times were higher in 
December, we believe the reasons for the high prices last summer and so 
far this winter are the same. I will also offer our recommendations for 
actions to mitigate future price excursions and potential power supply 
adequacy problems.
             demand growth without similar growth in supply
    As noted above, the Council believes the high prices are 
symptomatic of an overall tightening of supply, exacerbated by a number 
of factors. Some of these factors are physical and economic, others are 
related to the relative immaturity of the competitive electricity 
market and the uncertainties involved in the transition from a 
regulated structure. The physical and economic factors include 
unusually high weather-driven demands throughout the West, an unusual 
pattern of hydropower generation, a high level of planned and forced 
outages of thermal generating units, and high natural gas prices. The 
factors related to market immaturity and transitional uncertainties 
include the lack of a demand-side price response in the market, 
inadequate utilization of risk mitigation strategies, insufficient 
investment in new generation, and other factors related to the design 
and operation of the California market.
    Between 1995 and 1999, peak loads in the Western Systems 
Coordinating Council area increased by nearly 12,000 megawatts, or by 
about 10 percent. The increase would have been even more if 1999 hadn't 
been a relatively mild weather year. Generating capacity available 
during peak load months did not keep pace with peak load growth, 
increasing only 4,600 megawatts.
    When growth in demand outpaces growth in power resources, the 
result is a narrowing of reserve margins. This implies more efficient 
utilization of existing capacity and was an anticipated benefit of 
moving to a competitive generation market. However, if it proceeds to 
the point of putting reliability at risk and destabilizing prices, it 
is a problem. The period of the highest prices in the summer of 2000 
coincided with a period in which loads in the Northwest, California and 
the Desert Southwest were at high levels as a result of high 
temperatures throughout the West. In the Northwest last June, peak 
loads were approximately 3,400 megawatts greater than one year earlier 
while in California loads were approximately 1,400 megawatts higher. As 
we moved into the winter, high heating loads, poor hydro conditions and 
an extraordinary amount of generating capacity out of service in 
California drove prices even higher.
                    lack of new energy conservation
    We also know that efforts to improve the efficiency of electricity 
use, that is, conservation, have fallen off considerably in recent 
years. This is largely the result of the uncertainty created by the 
restructuring of the electricity industry. Utilities, which were the 
primary vehicle for conservation development, generally reduced their 
efforts because of concerns about creating potentially stranded 
investment. They also expressed concerns about the need to raise rates 
to cover conservation costs and the revenues lost as a result of 
conservation. Council staff has estimated that if the Northwest had 
maintained its level of investment in conservation at its 1995 level 
through the last three years of the decade, we would now be using the 
equivalent of the total output of a combined cycle combustion turbine 
less electricity. The average cost of saving that electricity is a 
fraction of the current market price of power.
                      unusual snowpack and runoff
    An unusual pattern of Columbia River runoff last summer also 
contributed to the power problem. While runoff was expected to be 
normal, in fact the spring runoff came somewhat earlier and higher than 
normal. By May and June, runoff and hydropower generation were less 
than normal. Hydropower generation in late June was approximately 6,000 
megawatts less than the previous year. As I noted earlier, runoff this 
spring is expected to be far below normal.
                         thermal plant outages
    Outages at thermal plants also contributed to the problems last 
summer. Maintenance at thermal plants frequently is planned for the 
May-June period when abundant hydropower typically is available. In 
addition, plants do break down, sometimes when it is least desirable to 
do so. We have attempted to identify Northwest thermal units that were 
either on planned outages or forced outage status during the last week 
of June. This was done by examining the generation data reported to the 
Western Systems Coordinating Council and supplemental data that was 
provided by Northwest generators. These combined data sets represent 
about 85 percent of the thermal capacity in the Northwest. From these 
data it appears that approximately 1,500 megawatts of capacity were out 
on a long-term basis, either planned or extended forced outages, and 
another 2,400 to 2,700 megawatts were on short-term forced outage 
status in late June, when temperatures--and power prices--peaked. As 
noted earlier, power plant outages in California this winter have 
exacerbated an already tight supply picture.
                       rising natural gas prices
    Rising prices for natural gas, a primary fuel for thermal power 
plants, also contributed to the high power prices. Between the summer 
of 1998 and the summer of 2000, natural gas prices at Sumas on the 
Washington/British Columbia border increased from about $1.50 per 
million Btu to $3.30. Prices in Southern California increased over the 
same period from about $2.40 to $4.18. Prices moved substantially 
higher during late August and September. During mid-September, prices 
at Sumas were $4.60 and prices in Southern California were over $6.00, 
although the California prices were affected by a serious pipeline 
explosion. Prices have stayed approximately at those levels, or 
slightly higher, since then. Current prices at Sumas exceed $6 per 
million Btu.
    Depending on the gas-fired generating technology used, for every $2 
increase in natural gas prices the cost of generating electricity 
increases between $15 per megawatt-hour and $22 per megawatt-hour. 
However, the increase in natural gas prices, while contributing 
significantly to higher electricity prices, cannot come close to 
explaining the increase in peak electricity prices.
               the lack of a market for demand reduction
    Our analysis of the western market also disclosed a systemic 
problem associated with the immaturity of the competitive electricity 
market, which is the lack of a demand side to that market. Demand 
responsiveness to price is important to an efficiently operating 
market. Demand responsiveness is an essential mechanism to balance 
supply and demand. Without some degree of demand responsiveness, there 
is no check on the prices that can be charged when supplies are tight, 
except for artificial caps. This is particularly critical when supplies 
are stretched to their limits. Under those circumstances, a relatively 
small degree of price responsiveness can have a relatively large 
reducing effect on prices, and could also mean the difference between 
maintaining service and curtailing it.
    Currently, at any given hour, the amount of electricity demand is 
virtually independent of wholesale price. This is because the vast 
majority of electricity consumers do not see market prices in anything 
approaching real time and, for the most part, have done little if any 
thinking about how they could reduce their demand if power were very 
expensive. The Council is not advocating retail access as a means of 
achieving price responsiveness. The states are making their decisions 
about when and how much to open their retail markets to competition. 
But developing price-responsive demand does not require passing real 
time market prices on to all consumers. It does mean, however, that 
those suppliers who see wholesale prices should act as intermediaries 
between the market and consumers to effect load reduction or shifting 
that is in the mutual economic interest of the consumer and the power 
system. We believe this will develop in time, and that the current high 
prices will help motivate that development. In the past several months 
several hundred megawatts of price responsive load reduction have been 
put under contract by Northwest utilities. However, given the tight 
supplies and high prices now affecting the market, the Council believes 
that continued effort should be devoted to encouraging and facilitating 
the demand side of the market.
                         the california effect
    Among the Western states, California's electricity industry is 
farthest down the restructuring path. California's path is, in many 
ways, quite different than most other examples. California created a 
market structure that is quite centralized and complex. For most of its 
life, the California market has yielded competitive power prices. 
However, under periods of stress, we believe that the sheer size of the 
California market, in combination with the characteristics of its 
structure and the incentives it creates, clearly have resulted in 
prices that are higher than they might be otherwise.
    The problems associated with the California market have been the 
subject of intense scrutiny in recent months. We generally believe that 
the steps ordered by FERC to shift California investor-owned utilities 
out of reliance on a spot market for the majority of their supplies and 
into longer-term contracts for supply is the right direction. As you 
know, however, implementation of such steps is clouded by the potential 
insolvency of these utilities. Quick resolution of these problems is 
essential.
                            recommendations
    Mr. Chairman, based on our analysis of the West Coast market, we 
offer the following recommendations:
1. Encourage Greater Use of Risk Mitigation Mechanisms
    One of the characteristics of a commodity market is the emergence 
of mechanisms to manage risk, and electricity is rapidly becoming a 
commodity market. These mechanisms include actual physical forward 
contracts for supply, futures contracts, financial hedging mechanisms, 
and so on. These mechanisms can limit exposure to high prices. At the 
same time, however, there is always the risk that they will prove more 
costly than the spot market. As noted earlier, we believe the 
limitations on forward contracting by California utilities was a 
contributing factor to the price extremes of this summer and fall.
    We believe the same is true of other market participants in the 
Northwest and elsewhere. While opportunities to enter into forward 
contracts and other hedging arrangements have existed, it may be that 
the protracted period of low market prices for electricity lulled some 
market participants into believing they had no need for such 
mechanisms. The extreme volatility of the market has been revealed. We 
believe this will spur the development and use of risk mitigation 
tools. Every effort should be made to encourage their development and 
use.
    Had more market participants been able to take steps to protect 
against risk, it is likely that the price volatility impacts would have 
been moderated. Forward contracting is also a vehicle by which new 
entrants in the generation market can limit their downside risk, 
thereby facilitating the development of new generation.
2. Monitor the Market for its Ability to Provide Sufficient Capacity 
        and Fuel for Reliability Purposes
    The Council's analysis of power supply adequacy indicated that 
market prices would not be sufficient to support the development of 
``merchant'' power plants, which sell into the spot market exclusively, 
until 2004. Current prices have changed that situation. The Council has 
also done analyses looking at actual market prices over the past year 
to see if they would be sufficient for a new entrant to cover its 
variable operating costs and its fixed costs and earn a reasonable rate 
of return. Until last summer, the answer was ``no.''
    Since then, however, given the electricity and gas prices 
experienced over the past year, the answer has become ``yes.'' With 
higher prices, a couple of plants not considered in the Council's 
adequacy study have begun construction. In the Northwest, there are now 
1,276 megawatts of capacity under construction that should come on line 
in 2001 through 2002. There are another 2,977 megawatts that already 
have site certificates, 1,291 megawatts of which we judge to be 
``active'' projects, and another 3,060 megawatts that are in or have 
begun the siting process. The major factor that will determine how many 
of these plants go forward will be the developers' assessments of 
future market prices and the willingness of potential purchasers to 
enter into longer term contracts.
    Almost all of these plants are natural-gas-fired combustion 
turbines, although the developer of a 24-megawatt wind farm in 
northeastern Oregon recently announced plans for a 300-megawatt 
expansion of that site. Nearly all of the proposed thermal plants are 
located within reasonable proximity to natural gas pipelines. There is 
a similar story to be told elsewhere in the West.
    The degree of developer activity is encouraging. However, if we 
were to experience a few years of relatively warm, wet winters and cool 
summers, market prices probably would fall, and many of the active 
projects might become inactive. If followed by a dry spell and a hot 
summer or a cold winter, we would be up against the supply limits 
again. Similarly, we are concerned about this hydro-induced volatility 
on the market for development of new gas pipeline capacity. New 
pipeline capacity is needed to fuel most new generation. We must ensure 
that mechanisms in both electricity and gas markets can signal pipeline 
expansions when needed.
    The question this possibility raises is whether we can rely on the 
market, and various risk-mitigation mechanisms, to provide sufficient 
capacity for reliability purposes. And if not, what are the options for 
ensuring that there is capacity and fuel available to ensure 
reliability and mitigate excessive price spikes. The Council intends to 
pursue this question.
3. Initiate Efforts to Develop the Demand Side of the Market
    While the lead time for the development of new combined-cycle 
generation is relatively short, there will be a period during which the 
region and the West are vulnerable to further price spikes and possible 
reliability problems. Developing the demand side of the market has the 
potential for somewhat shorter lead times. Price-responsive demand can 
help mitigate price spikes and potentially avert reliability problems.
    The Northwest has a great deal of successful experience in 
increasing the efficiency of electricity end-use as a resource. The 
region needs to reinvigorate those efforts in light of the market 
prices we are experiencing. However, the region in particular needs to 
move aggressively to implement price-responsive demand management--
reducing loads during periods of high prices or shifting the loads to 
periods of the day when prices are lower. The bad news is that this 
region has relatively little experience with these approaches. The good 
news is that there should be significant untapped potential.
    As noted earlier, the Council is not advocating retail access as 
means of achieving price responsiveness. The states are making their 
decisions about when and how much to open their retail markets to 
competition. However, the Council believes that market-like mechanisms 
in which the consumer receives a significant part of the benefit will 
be most effective. Pilot programs were initiated last year in the 
region in which the serving utility and the load-reducing consumer 
share the cost savings of avoided power purchases (or the revenues from 
selling the freed-up power on the market). These programs appear to 
have been successful, although limited in scope. The greatest potential 
for such partnerships probably exists within industry and large 
commercial buildings. What can be done will vary from building to 
building and process to process. Nevertheless, if provided the 
incentive, the Council believes people will rise to the challenge. 
Creating these incentives should be a priority for the utilities of the 
region.
4. California Should Correct the Incentives in Its Market Structure 
        That Contribute to Excessive Prices and Volatility
    Quick implementation of the FERC's order for reforming the 
California market is essential.
5. Until the Market Stabilizes, Data for Monitoring and Evaluating the 
        Performance of the Market Should Be Available on a Timely Basis
    One thing we learned last summer was that it is difficult to obtain 
the data necessary to monitor and evaluate the performance of the 
market. Despite the fact that utilities in the Northwest were extremely 
cooperative, there was a delay of many weeks before the relevant data 
could be obtained. We understand the possible commercial sensitivity of 
this information. We believe, however, that there should be 
arrangements possible that both protect the commercial value of the 
information and make it possible for independent parties to evaluate 
market performance on a timely basis. Until the market has stabilized 
and the public has greater confidence in its operation, this should be 
a high priority for market participants and organizations like the 
Western Systems Coordinating Council, California authorities and 
regional transmission organizations as they are formed.
6. Electricity Emergency Processes and Procedures Need To Be in Place
    The Council determined in its October report that getting the 
processes and procedures in place that would be used in the event of an 
actual supply emergency should be a priority. Until new generation 
comes on line and demand-side programs can be implemented, there is 
significant probability that our emergency readiness will be tested. 
Necessary elements include an inventory of the actions that could be 
taken, the trigger points for taking these actions, clear definition of 
roles and responsibilities, and a communications plan to inform the 
public. We are pleased that efforts to accomplish this were 
established--and successfully utilized--this winter involving the 
Pacific Northwest Utilities Conference Committee, the Northwest Power 
Pool, Bonneville, the Power Planning Council, the Northwest states, and 
the region's utilities.
7. Conserve Energy
    We all can do our part by conserving energy. In recent months, 
electric utilities and the news media have bombarded us with energy-
saving ideas--insulate your attic, caulk around your windows, install a 
programmable thermostat and replace incandescent light bulbs with 
compact fluorescents. Each of these will save energy. On a larger 
scale, the Power Planning Council, Bonneville and others have developed 
an exhaustive list of more than 1,000 energy-saving techniques and 
applications that could be implemented in homes, businesses and 
industries. The list was developed by an association of energy 
conservation experts known as the Regional Technical Forum and will be 
utilized by Bonneville to calculate energy savings under the 
conservation discount proposed for the 2002-2006 rate period. The 
measures and information about their energy savings are posted on the 
Council's website, along with their estimated cost.
    In summary, our recommendations amount to a call for the West to 
fix the current problems while investing in the future. We must ensure 
that utilities and consumers remain financially solvent until new 
sources of generation and demand reduction moderate prices. Perhaps the 
only good thing that can be said for the current crisis is that it 
offers the West an opportunity to think carefully about our future 
power supplies and take steps to ensure adequate investments in 
conservation, renewable energy and new base-load generation. These 
developments would be aided by a coordinated effort to streamline 
siting processes throughout the West so that we retain the essential 
environmental and community safeguards while avoiding unnecessary 
delays.
    Mr. Chairman, that completes my testimony, and I would be pleased 
to answer any questions.

    The Chairman. Thank you very much.
    Mr. John Gale. Mr. Gale comes to us as general manager of 
pricing and regulatory services of Idaho Power in Boise, Idaho.

    STATEMENT OF JOHN R. GALE, GENERAL MANAGER, PRICING AND 
      REGULATORY SERVICES, IDAHO POWER COMPANY, BOISE, ID

    Mr. Gale. Thank you, Mr. Chairman and Senators. I am 
speaking today from the Idaho Power Company's perspective, a 
small utility operating in the Pacific Northwest. Idaho Power 
is generally known for two things. It is predominantly 
hydroelectric, probably relying the most on hydro facilities of 
any investor-owned utility, and consequently it supplies 
service to its retail customers at the lowest rates of all 
investor-owned utilities.
    Hydro is a mixed blessing, however. Hydro availability for 
production varies from season to season and year to year. 
Managing the supply situation is a challenge for a 
hydroelectric company. We try to address this challenge through 
adding to our portfolio thermal plants and purchasing from the 
Northwest market. The Northwest market has proven to be a very 
good tool for both public and private utilities for a number of 
years, going back as many as 20. It helps the utilities in the 
Northwest optimize their resources and provides a market for 
them to sell into when they are in surplus situations.
    Another way we try to manage our power supply situation is, 
we have a rate-making mechanism within the State where we flow 
through both the benefits and the cost of supplying power to 
our customers. This benefit is flowed through on a sharing 
basis so the shareholders of the company are responsible for a 
portion, but we are able to let our customers see the price as 
costs are imposed upon us.
    We see this as an advantage in our rate-making process over 
that in California, because our customers are able to see the 
price, act on the price, make business decisions, decide crops 
and so forth, based upon their power supply cost, and it also 
provides a good signal for conservation efforts that they would 
want to make.
    Another advantage of having the rate-making mechanism is 
that our creditors also know that we have that behind us, and 
as they sell power to us, they know that they stand to be paid.
    A last comment on the mechanism is the sharing mechanism 
between the customers and the company provides an economic 
alignment so all decisions about power supply are made for 
everyone's best interest.
    I talked about earlier this year. It could be the biggest 
challenge for power supply in the Northwest. It is a bad 
situation, and we are looking at a dry year with high prices. 
For my company we are at 60 percent snow pack expected stream 
flows in our Snake River Basin.
    As far as prices are concerned, looking for the balance of 
year of prices we could obtain today, we are looking at $350 a 
megawatt hour for the balance of 2001. That is 35 cents a 
kilowatt hour, to put it in a retail customer's perspective, 
and we typically sell at 3 to 6 cents an hour. Excuse me, 3 to 
6 cents per kilowatt hour.
    What does that mean? As Senator Craig said earlier today, 
we are already looking at a 24-percent increase going into the 
spring. That will only get worse with the drier year, and could 
easily double. The forecast, as we have said, is dry, and 
typically in the Northwest once you get into a dry year you 
stay in a dry year. Assumptions about returning to normal have 
not been proven historically.
    That leads me to some observations about California, and 
specifically to the executive orders from the Secretary of 
Energy. What is distasteful for other Northwest utilities is 
that it prioritizes California in the market above other 
States. We are in the same market. We are facing the same 
problems and the same high prices.
    A second problem with the executive order is that it makes 
it uncertain on how to treat reservoirs as far as the drawdowns 
to produce power. The reservoirs become our energy source for 
next summer.
    Lastly, as we approach spring we will hit a time when we 
should have generation surplus. We would love to sell to 
California at that time, love to sell into the best market we 
possibly could. The reason is, at that time that is our chance 
to offset our high cost we have incurred all winter, a chance 
to reduce our customers' rates.
    I will conclude on that remark.
    [The prepared statement of Mr. Gale follows:]
   Prepared Statement of John R. Gale, General Manager, Pricing and 
          Regulatory Services, Idaho Power Company, Boise, ID
    Mr. Chairman and Members of the Committee, thank you for the 
opportunity to address the Committee today on behalf of the Idaho Power 
Company. Idaho Power's comments are based upon our perspective as a 
hydro-based, investor-owned utility operating in the WSCC grid and 
serving retail customers in Idaho, Oregon, and Nevada. We intend to 
provide a northwest regional perspective on the California energy 
situation and its impact to other states operating in the west. I am 
John R. Gale, General Manager of Pricing and Regulatory Services for 
the Idaho Power Company.
                               background
    The Idaho Power Company, established in 1916, is an investor-owned 
electric utility currently serving more than 380,000 customers in a 
20,000 square-mile area including parts of southern Idaho, eastern 
Oregon, and northern Nevada.
    The Company presently operates seventeen hydroelectric plants, 
including the 1,167-megawatt Hells Canyon Project and shares ownership 
in three coal-fired plants located in Oregon, Nevada, and Wyoming. 
During a normal water year, approximately 60% of the total power 
generated by the Company is hydroelectric. This substantial commitment 
to and investment in renewable hydroelectric resources allows Idaho 
Power to provide its customers with electricity at some of the lowest 
rates in the nation. In fact, among investor-owned utilities, the 
Company has the lowest combined rates (residential, commercial, and 
industrial) in the country.
     characteristics of the california market at the beginning of 
                              deregulation
    At the outset of electric industry restructuring in California, 
wholesale prices were well below retail prices. Excellent water 
conditions in the Pacific Northwest further enhanced a substantial 
regional surplus. At that time, California was dependent on imports for 
approximately 20% of the load.
    Demand for electricity was growing by 1,500 MW per year, however 
new generating capacity and meaningful transmission were lagging 
behind. Increased demands without additional generation within the 
state or new transmission pathways for importing generation into the 
state led to California's steadily declining reserve margins.
              the new market structure proved to be flawed
    As part of the restructuring, the California investor-owned 
utilities divested of up to 50% of their generation without ``buy-
back'' provisions from the new owners. In addition, the new market 
formed without the stabilizing effect of long-term energy contracts. 
Consequently, 85% of the retail supply was necessarily acquired from 
the spot market. Residential retail rates were reduced by 10% and all 
rates were frozen through 2002, or until stranded generation costs 
could be paid.
    The expectation was that wholesale prices would continue to stay 
below the retail prices with the net difference directed towards paying 
off the above-market (or stranded) utility generation costs. What was 
not contemplated, however, was the possibility that wholesale prices 
for purchased power could increase in magnitudes and for sustained time 
periods threatening the very structure of the new California market.
    ``California Travails, A Chronology of Events in California's 
Energy Crisis'', a draft document prepared by the Edison Electric 
Institute is included for reference purposes as Attachment 1 * to these 
comments.
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    * The attachments have been retained in committee files.
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                         what happened in 2000?
    A combination of factors led to demand overtaking supply during 
2000. Weather became more severe in the west with both a hotter summer 
and a colder winter. In addition, the Pacific Northwest was confronted 
with the first low hydro year since 1992. Excessive thermal plant 
outages combined with decreased hydro generation capabilities further 
reduced regional supply. To make matters worse, natural gas prices hit 
record highs at $60 per MMBtu. Since most new electric generation 
utilizes natural gas as its fuel, the two energy prices began to move 
in parallel. Electric prices also hit record highs reading as much as 
$5,000 per MWh and averaging $300 per MWh for the year.
    Attachment 2 and Attachment 3 are graphs indicating fourth quarter 
2000 market price changes for natural gas and electricity respectively.
  the california electric system gets stretched to the breaking point
    In order to continue serving their respective retail customers, the 
California utilities continued buying power at expensive spot market 
rates although their retail prices were fixed. After eight months the 
combined debt reached $12 billion. The debt, in turn, caused counter-
parties to be concerned about the ability of the California utilities 
to pay for their purchased power. As suppliers became reluctant to sell 
into the California market, the Secretary of Energy began to issue 
executive orders applicable to most western generators and marketers 
requiring sales to continue.
    In early January 2001, the CPUC authorized some interim rate relief 
to the utilities through increased retail rates. Ultimately the 
increased rates proved insufficient as the utilities' stock prices 
plunged, their credit rating devalued, and bankruptcy looms.
                          is there a solution?
    Idaho Power realizes that no state enjoys hearing advice from other 
states on how to fix its problems. Our comments are given as 
observations from an entity somewhat removed from the immediate crisis. 
In our view, there appears to be certain actions that, if taken, could 
begin addressing some of the structural problems in the California 
market.
    First, it is our belief that showing customers the true cost of 
electric energy will help to reduce the demand for electricity. When 
retail rates accurately reflect cost, then customers can make 
appropriate economic decisions regarding energy usage, conservation 
measures, load control programs, alternative energy sources, and new 
sources of supply. When retail prices do not cover costs, the utilities 
are left with a shortfall that cannot be made up on volume. In 
addition, existing suppliers and new generation developers will respond 
favorably when the retail prices rise to a level that allows for 
recovery of wholesale costs because they have more confidence in the 
utilities ability to pay for their product.
    Second, the California market would function more efficiently with 
some reforms such as credit support for the existing debt from either 
the state or federal government. Additionally, the settlement process 
could be shortened to time periods that are more typically prevalent in 
the industry. Faster settlement would ease some liquidity pressure on 
suppliers. The introduction of forward contracts would also provide 
some risk management tools for those buying on behalf of retail 
customers.
    The third recommendation is to incorporate a long-term view to the 
supply of power. For instance, generation siting needs to be more 
flexible and expeditious. Grid expansions also would facilitate a more 
fluid electric market with potentially additional participants. A 
diversified fuel mix, including renewables, will contribute to the 
stabilization of price volatility. Finally, increased applications of 
customer and utility distributed generation will provide further supply 
options for the future.
                            impact to idaho
    Idaho Power's strong reliance on hydro generation produces both 
benefits and detriments to the Company and its customers. Under normal 
water conditions and markets, Idaho Power is the least cost provider 
among all investor-owned utilities. The abundant supply of inexpensive 
energy consequently has contributed to the growth of an industrial and 
agricultural base across southern Idaho.
    On the other hand, hydro generation causes both supply and cost 
management problems for Idaho Power due to the variability of stream 
flows and their corresponding effect on hydro generation output. The 
management challenge is further contingent on additional demands for 
river operations such as recreation, flood control, and fish 
restoration.
    In order to respond to wide fluctuations in hydro generation, Idaho 
Power supplemented its hydroelectric production with coal-fired 
generation plants that supply reliable resources from an availability 
aspect but tend generally to be more expensive to operate relative to 
hydro due to the addition of fuel costs. Furthermore, both seasonal and 
annual fluctuations in stream flow conditions led Idaho Power to early 
and active participation in the northwest wholesale power market. The 
active northwest energy market benefited Idaho Power and its customers 
for a number of years because our peak energy loads and surplus 
generating opportunities came at different time periods than our 
neighboring utilities.
    As power purchases and fuel costs became increasingly more 
important to Idaho Power's financial well being, the Company, along 
with its customers and regulators, developed a ratemaking mechanism 
that allowed for the transfer of most, but not all, of the power supply 
costs and revenues to the Idaho retail customers. By leaving a portion 
of the costs and benefits for absorption by the Company's shareholders, 
the mechanism aligned the customer's and the Company's economic 
interests at all times. Therefore, whenever Idaho Power is in the 
market, either to buy for its system requirements or to sell its 
surplus generation, its customers have the major interest in optimizing 
the transactions that is, receiving the lowest price when buying and 
the highest price when selling.
    The California energy situation impacts Idaho Power in multiple 
ways. To begin with, Idaho Power, along with many other western 
utilities, frequently accesses the same energy markets as California. 
Current California demands ripple throughout the whole western grid. 
The increased prices we pay for power reflects the effect of the 
California situation on the market. Idaho Power Company's power supply 
costs during the last eight months have hit levels previously unheard 
of or even contemplated. At this point in time our Idaho retail 
customers are looking at a 24% overall rate increase this spring with 
possibly even greater increases if our currently dry winter continues. 
Attachment 4 shows Idaho Power's actual net power supply expenses over 
the last eight months compared to expected expenses and normal 
expenses. In December alone, the Company spent $70 million more than 
expected. Attachment 5 demonstrates the cumulative effect of increased 
power supply expenses over the eight-month period.
    The Secretary of Energy's executive orders compound the problem for 
us in several ways. First, they create uncertainty in market operations 
as western energy suppliers sort through their California obligations 
before responding to others in need of power. Second, the executive 
orders create additional uncertainty for hydro operators who 
contemplate whether to draft reservoirs in the middle of winter to 
serve California loads. Drafting reservoirs now could prove to be 
extremely detrimental to our native retail customers as the Company 
faces its own system deficiencies this summer with below normal water 
conditions. Under the direction of our governor and our state 
commission, Idaho Power has not drafted its reservoirs to date.
    However, as this spring progresses there will be the possibility 
that Idaho Power's system generation could exceed our retail customers' 
needs. River operations, due in part to flood control considerations, 
usually require the Company to draft reservoirs in late February and 
March. At these times, Idaho Power will have the opportunity to sell 
its surplus power on the market. The Company and its customers would 
like to obtain the best possible price at this time because the 
revenues from surplus sales offset the high power purchase costs the 
Company has been experiencing. Obviously after buying all winter 
without the benefit of wholesale price caps, the Company does not 
desire to sell into a market where they are imposed. Furthermore, 
should Idaho Power generate surplus power to sell in the market, it is 
imperative for both its customers and shareholders that it be paid for 
those sales.
    As stated above, Idaho Power and its customers are looking at a 
challenging year from a power supply perspective with significant rate 
increases likely for this spring. The Snake River agricultural base 
will be hit particularly hard because of their dependence on high load-
factor electric pumps to irrigate fields. Asking these farmers to pay 
for power supply costs driven up by the action of others is not an 
acceptable solution.
                           hydro relicensing
    Another contributor to supply and reliability problems is the loss 
of non-federal hydroelectric power due to the cumbersome and costly 
hydroelectric relicensing process. Hydroelectric power plays a critical 
role in western energy supply, particularly as it relates to meeting 
peak demand. In the Idaho Power system and in other parts of the 
Northwest, hydropower contributes to over half of our energy supply. In 
a recent government study, it was revealed that hydroelectric plants 
are losing on average approximately 8% of their generation capacity due 
to conditions placed on the licensee. These are conditions that Federal 
natural resource agencies can place on a licensee without regard to how 
it effects the loss of generation, economics, recreation, or other 
ancillary attributes of a facility. Hydropower is a clean, renewable, 
and efficient generation resource and we can ill afford to lose this 
valuable asset. I urge you to support legislation, such as that 
introduced by Senator Larry Craig (S. 71) that restores balance into 
the relicensing process. Three attachments are included in support of 
hydroelectric Relicensing reform. Attachment 6 is a copy of testimony 
the company recently submitted at informational hearings conducted by 
the Federal Energy Regulatory Commission. Attachment 7 and Attachment 8 
are two background papers outlining basic facts about hydropower and 
examples of some of the problems associated with the current 
relicensing process.
                                summary
    Rising natural gas prices, poor streamflow conditions, and a 
disintegrating California power market have combined to create a 
turbulent year for energy providers and their customers. Utilities seek 
to provide essential services while having to purchase shortfalls in an 
unforgiving market. In turn, rates must go up to cover the additional 
costs while customers and utilities both try to optimize their energy 
dollar.
    Idaho and Idaho Power are no exceptions as we and our customers 
face what may be our most challenging year. Additional burdens created 
by federal mandates directing preferential treatment for another 
state's energy crisis are not warranted nor welcome.
    We would ask that additional federal executive orders not be 
extended and that California look to itself first in seeking to resolve 
its energy problems.
    Finally, as a predominately hydroelectric company, we would endorse 
relicensing reform as a means of preserving some of the supply we enjoy 
today.

    The Chairman. Thank you very much. I think you have pretty 
much painted the picture from Idaho Power's point of view.
    We will move to Mr. Brett Wilcox. Mr. Wilcox is chief 
executive officer of the Golden Northwest Aluminum, 
Incorporated, in The Dalles, and I assume you will be prepared 
to tell us whether it is better to be in the aluminum business, 
or the business of reselling power as opposed to making and 
selling aluminum.

 STATEMENT OF BRETT E. WILCOX, CHIEF EXECUTIVE OFFICER, GOLDEN 
            NORTHWEST ALUMINUM INC., THE DALLES, OR

    Mr. Wilcox. We operate two primary aluminum smelters in 
Goldendale, Washington, and The Dalles, Oregon. We employ 1,225 
highly paid workers at full production. Unfortunately, our 
primary aluminum production now is almost completely curtailed. 
The reason is simple. Power prices in the West are simply too 
high to produce aluminum. Some other energy-intensive 
manufacturing companies also have had to curtail production. 
Soon, many more jobs in industry and agriculture will be lost.
    Make no mistake about it, the energy crisis is not just 
about electricity bills, it is also about paychecks. So far our 
company has been able to mitigate the impact of higher power 
cost because we purchase some of our power under long-term 
contract with the right to remarket power we did not use. 
Through agreements with the Bonneville Power Administration and 
our union, we were able to reduce consumption, remarket power, 
and use the net financial benefits to protect our workers, 
share with BPA, and help pay for new conventional and renewable 
power resources.
    The electricity crisis in California has adversely affected 
the entire West Coast. Some of the causes are obvious, shortage 
of generation, low average hydropower, gas and power 
transmission bottlenecks, and increases in natural gas prices, 
but the most frustrating cause is the rules California adopted 
for electricity restructuring have themselves driven up prices 
not only in California but in the Northwest.
    The sharp drop in demand that usually follows a sharp 
increase in the price of any commodity has not yet occurred in 
California because most end users there have not yet received 
price signals of the crises. Instead of higher prices balancing 
the market, Californians have experienced rolling blackouts.
    In the short term there are few ways to increase supply. We 
need to speed up the permitting process required to develop new 
generating resources We can also temporarily relax some 
powerplant emission controls, as Governor Locke of Washington 
has announced, and we need to remove constraints on hydro 
operations, especially spilling water, that significantly 
reduces power generation without really helping endangered 
salmon.
    Near-term responses need to focus on ways to reduce demand. 
Demand reductions will occur. The issue is how to ensure that 
they do not destroy the economic well-being of the West in the 
process. End-use consumers cannot be spared the rate impacts of 
high power costs for long, but the way in which we pass those 
high costs through to them will determine how they affect the 
economy.
    If soaring wholesale power costs drive up the average 
melded cost of every kilowatt hour of power, then residential 
customers will be hit hard not only in their utility bills, but 
even harder in their paychecks. This is because any significant 
increase in the average cost of all power will shut down large 
portions of manufacturing, business, and agriculture. The same 
is true of California as the Northwest. In a competitive global 
economy, even a small increase in the average cost of a 
company's entire power supply could make its entire operation 
uneconomic.
    The alternative is to make end-use consumers feel the full 
impacts of higher wholesale power cost at the margin. This 
gives real price signals. Increase in consumption requires 
someone to buy very expensive power. The end-use consumer 
should feel that cost. Decrease in consumption reduces the need 
to buy expensive power, and end-use consumers should experience 
that savings, too.
    Businesses can conserve energy at the margin, ensuring that 
the bulk of their production continues to be competitive. For 
example, a farmer can take some marginal acreage out of 
production rather than being forced out of business altogether 
because of a large increase in the average cost of its entire 
irrigation load.
    A very practical application of this is possible in the 
Northwest through BPA. Until recently, BPA planned to continue 
selling power to customers for about $25 per megawatt hour. Now 
BPA expects to pay $125 per megawatt hour to buy the power it 
needs to meet its load. This will lead to large increases.
    Instead of melding high cost purchases with low-cost 
supply, BPA should divide each customer's purchases into two 
parts. The larger part could be supplied without buying 
expensive additional power. The smaller part would represent 
the portion that Bonneville has to buy at high cost. Each 
customer would be able to turn the higher cost portion back to 
BPA, allowing BPA either to remarket it at a higher market 
price and credit the proceeds against the customer's bill, or 
to reduce the amount that BPA itself must pay. This not only 
helps the customer and the economy, but also ensures BPA 
repayment.
    I know this idea can work, because our company has already 
pioneered it with BPA. We curtailed our smelting load, returned 
the power to BPA, and are putting the marketing proceeds to 
beneficial use. What I am proposing here is an adaptation of 
that successful effort. It could apply broadly to all BP 
customers. This would significantly reduce BPA's need for power 
and cost. Only a broad effort can spare deep pain.
    Thank you very much.
    [The prepared statement of Mr. Wilcox follows:]
Prepared Statement of Brett E. Wilcox, Chief Executive Officer, Golden 
                Northwest Aluminum, Inc., The Dalles, OR
    Good morning, Chairman Murkowski and Members of the Committee. My 
name is Brett Wilcox. I am the CEO of Golden Northwest Aluminum, the 
corporate parent of Goldendale Aluminum Company and Northwest Aluminum 
Company. We own and operate two primary aluminum smelters and 
associated facilities in Goldendale, Washington, and The Dalles, 
Oregon. We are by far the largest employer in these beautiful but 
economically distressed rural areas. We employ a total of 1,225 highly 
paid workers, at full production.
    Unfortunately, we are no longer at full production. Our primary 
aluminum production is now almost completely curtailed. The reason is 
simple: power prices in the West are currently too high to support 
aluminum production. Other energy intensive manufacturing companies 
that are exposed to the market price for power also have had to curtail 
production. Soon, when high market prices for power purchases are 
passed through rates charged by the Bonneville Power Administration and 
local utilities, other Northwest manufacturing and industrial jobs, as 
well as agricultural jobs that depend on irrigation pumping , will be 
lost. Make no mistake about it: the crisis in the West is not just 
about electricity bills. It is also about paychecks.
    So far, our company has been able to mitigate the impact of higher 
power costs because we purchased some of our power under long-term 
``take-or-pay'' contracts with rights to remarket any power that we 
didn't use. Through agreements with BPA and our union, the United 
Steelworkers of America, we were able to reduce consumption, remarket 
the power made available, and use the net financial benefits in the 
Northwest to protect our workers, share with BPA, and help pay for new 
conventional and renewable power resources to supply a portion of our 
long-term power requirements. I've attached to my testimony our release 
explaining our curtailment and remarketing.
    The electricity crisis in California has adversely affected the 
entire west coast. Some of the causes are obvious: physical shortages 
of generating capacity, below normal precipitation and hydro power, 
bottlenecks in power transmission and gas pipeline capacity, increases 
in the price of natural gas, and resource outages. But the most 
frustrating cause is that the ``rules of the game'' California adopted 
for electric power restructuring--unlike the rules in other states--
have themselves driven up prices not only in California, but in the 
Northwest as well.
    The sharp drop in demand that usually follows a sharp increase in 
the price of any commodity has not yet occurred in California, where 
most end-users have not yet received any ``price signal'' of the 
crisis. Instead of higher prices balancing the market, Californians 
have had to experience rolling blackouts. In the Northwest, however, 
the price impacts are now being felt by end-users. The full force was 
felt first by the aluminum smelters, then by the industrial customers 
of several large utilities. Now it is about to be felt by almost 
everyone in Washington, Oregon, Idaho, and western Montana.
    This crisis has few short-term fixes to increase supply. We do need 
to speed up the permitting process required to develop new generating 
resources and to build new power transmission and gas pipelines. One 
short-term way to increase the supplies of power is to the temporary 
relaxation of some power plant emission controls, as Governor Locke of 
Washington has just announced. We also need to review and remove 
constraints on hydro operations--especially spilling water--that 
significantly reduce power generation without really helping endangered 
salmon.
    Near-term responses need to focus on ways to reduce demand. Demand 
reductions perhaps massive ones--will occur. The issue is how best to 
manage them, and how to ensure that they do not destroy the economic 
well being of the West. End-use consumers can't be spared the rate 
impacts of high power costs for long. But those high costs can be 
passed through in two ways: either by melding costs and raising the 
average rate of every kilowatt-hour, or by passing through actual high 
market prices just on the marginal kilowatt-hours of consumption.
    If soaring wholesale power costs drive up the average cost of 
power, then residential customers will be hit hard not only in their 
utility bills, but even harder in their paychecks. This is because any 
significant increase in the average cost of power will shut down a huge 
portion of Northwest manufacturing, industry, and agriculture--and 
presumably the same is true in California. In a competitive global 
economy, even a small increase in the average cost of its entire power 
supply can make a company's entire production uneconomic.
    The alternative is to make end-use consumers feel the impact of 
higher wholesale power costs at the margin. This gives real price 
signals. Increases in consumption require someone to buy very expensive 
power: the end-use consumer should feel that cost. Decreases in 
consumption reduce the need to buy very expensive power: the end-use 
consumer should experience that saving. Businesses can conserve energy 
at the margin, ensuring that the bulk of their production continues to 
be competitive. In agriculture, for example, a farmer can take some 
acreage out of production for a period, rather than not being able to 
farm at all because of a large increase in the cost of his entire 
irrigation load.
    A very practical application of this is possible in the Northwest 
through the Bonneville Power Administration (``BPA''). BPA supplies 
forty-five percent (45%) of all power in the Northwest. Until recently, 
BPA planned to continue selling power to utilities at $20-$25 per 
megawatt-hour (``MWh''). Now BPA expects to pay $125/MWh to buy the 
power it needs to meet its load growth. As a result, BPA last week 
announced a sixty percent (60%) rate increase for its customers for the 
entire next five years. This comes on top of very large rate increases 
many Northwest utilities have already imposed on their retail 
customers.
    Dividing each customer's purchases into two parts could mitigate 
this situation. The larger and less expensive portion would be power 
that BPA can supply without buying expensive additional supplies in the 
market. The smaller and much more expensive portion would represent the 
portion that BPA must spend huge sums to buy. Each customer should be 
able to turn the latter portion back to BPA, allowing BPA either to 
remarket it at high market prices and credit the proceeds against that 
customer's power bill, or to reduce the amount that BPA itself must buy 
to meet its customer's loads. This not only helps the customer and the 
economy, but also ensures that BPA can meet its treasury payments no 
matter what happens to the wholesale cost of power.
    I know this idea is practical and can work. I know because our 
company has already pioneered this with BPA. We curtailed our smelting 
load, returned the power to BPA for remarketing, and are putting the 
remarketing proceeds to beneficial use. Demand for power is temporarily 
reduced, BPA is on a sounder financial footing, our workers are still 
getting paid, and we are putting money aside to develop new power 
sources, including wind generators. What I'm proposing here is an 
adaptation of that already-successful effort, but one that could apply 
broadly to all BPA customers, reducing overall BPA requirements by 
perhaps ten to fifteen percent (10-15%). Only a broad effort can spare 
everyone deep pain.
    I've attached to my testimony a paper showing how this concept can 
work to save aluminum jobs and other jobs throughout the Northwest 
until the day when power supplies increase and power prices become more 
reasonable. I hope you will review this paper and contact me with any 
questions. I hope you will urge BPA to implement this approach.*
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    * The paper has been retained in committee files.
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    Finally, turning to the long-term, there are many potential 
solutions that have been covered by others here today. I would like to 
mention one additional solution that deserves more attention. The vast 
reserves of natural gas in Alaska, the Beaufort Sea, and northern 
Canada are a key to the long-term energy supply and continued economic 
prosperity of the United States and Canada alike. Left to their own 
devices, market forces will eventually be sufficient to get this gas to 
the Lower 48--but the gas will arrive here more slowly, in smaller 
volumes, and at higher prices than would be optimal for the North 
American economy.
    This is an instance where market forces could use some help in the 
form of active diplomacy and initiative by the U.S. and Canadian 
governments. The obstacles to an optimal timing, volume, and price of 
northern gas are primarily economic obstacles within Canada--
particularly the perceived interests of those who benefit from today's 
high gas prices and today's constrained limits on available pipeline 
capacity. Those interests are legitimate, but they can be reconciled 
with the broader interests of the economic health of both nations. If 
this happens and the two governments, working together, can bring it 
about then the northern gas should be able to get here quickly, in 
large volumes, and at prices low enough to spur decades of continued 
economic prosperity.
    Thank you for your time and consideration.

    The Chairman. Thank you very much.
    Mr. Mark Crisson, director and CEO of Tacoma Public 
Utilities, and again, none of you from the Pacific Northwest 
have mentioned the potential availability of power from British 
Columbia. Maybe somebody will, but I just wanted to remind you. 
I see we have a volunteer, Judi Johansen, who is next in line, 
so my question, while you think about it, is, can we not just 
go up to British Columbia and pay the price?
    Mr. Mark Crisson, please proceed.

    STATEMENT OF MARK CRISSON, DIRECTOR/CEO, TACOMA PUBLIC 
                     UTILITIES, TACOMA, WA

    Mr. Crisson. I am Mark Crisson, director of Tacoma Public 
Utilities in Tacoma, Washington. Our largest division is Tacoma 
Power, which serves 150,000 customers and operates 700 
megawatts of hydroelectric capacity.
    As you have heard from our earlier panelists, the Northwest 
is experiencing very dry weather conditions. Mr. Gale from 
Idaho said he has 60 percent snow pack. That sounds pretty good 
to me. We are looking at about 45 percent. Our inflows are the 
lowest of 80 years of historical record right now, and 
consequently our hydro facilities are greatly under-performing 
their planned levels, and we are having to turn to these West 
Coast power markets for about 25 percent of our power needs, 
and we have heard about the prices in the power markets.
    This is having a drastic effect our financial resources. I 
estimate that with continuation of current weather and market 
conditions we will exhaust our entire $130 million cash 
reserves by April, and that is with our rate surcharge in 
place. We put a 50-percent rate surcharge in place in December. 
In the meantime, other Northwest utilities have started to 
follow suit.
    Snohomish Public Utility District in Everett, Washington, 
did 35 percent. Seattle City Light has done 28 percent to date. 
Yesterday they reported that by October that may have to go up 
to a total of 75 percent in order to pass through the full 
effect of Bonneville's projected increase of 95 percent that 
was mentioned earlier in the panel discussion.
    Clearly, this is a regional problem, perhaps even a 
national problem, and the impacts of our power surcharge are 
already being felt in our community. While our rates have 
historically been low, our per capita usage is higher than 
average, resulting in bills that are equal or above the 
national average for our residential customers, so the increase 
in the bills from Tacoma Power will create significant hardship 
for many in our community.
    Moreover, many energy-intensive industries have located in 
the Northwest and in Tacoma in reliance on low power prices. 
The recent surcharge, together with steep increases in natural 
gas prices, have already forced several of our industries to 
curtail their operations or suspend production altogether. For 
example, Louisiana Pacific, Pioneer Chemical, who was our 
largest customer, Schnitzer Steel, and Atlas Foundry have all 
either curtailed or suspended operations. It should be noted 
this happened before the full impact of our surcharge is even 
reflected in their bills.
    We have taken a number of steps on the surcharge in trying 
to deal with this crisis. We brought in an additional new power 
supply by installing 50 megawatts of temporary diesel 
generation with the best available control technology to try to 
address our power shortage. These are not cheap, but at current 
power prices we are saving $300 to $400,000 a day in purchase 
power with these in operation.
    We are also promoting conservation in our service area 
through advertising, direct customer contact, and product 
promotion. Our city council has adopted a resolution that sets 
an aggressive conservation target of 20 percent in our 
community.
    I do believe there is a Federal role in this crisis. The 
Federal Energy Regulatory Commission is being called upon by my 
utility as well as by a host of others to temporarily 
reestablish cost-based rates and, if necessary, firm price caps 
in Western energy markets. Unfortunately, a current majority of 
the commission appears more concerned with not interfering in 
what is clearly a dysfunctional market than they are in 
fulfilling their prime directive under the Federal Power Act 
that wholesale rates be just and reasonable. In order to avoid 
further utility insolvency and to mitigate the rate impact on 
all consumers, it is time for FERC to impose cost-based pricing 
or caps on a temporary basis.
    I want to emphasize that insolvency is a continuing concern 
for Tacoma Power. Even with our 50-percent surcharge in place, 
we will need to borrow nearly $100 million between now and 
October to pay our purchase power bills. We just cannot raise 
the rates fast enough to keep up with what we are seeing in 
these markets.
    Many of the steps we have talked about today are fine, but 
they just do not address the short-term problem. In my opinion, 
we have a house that definitely needs to be put in order, but 
the house is on fire, and we need to put the fire out before we 
worry about remodeling.
    One panelist earlier was concerned that such steps might 
distort the market. In my view, we are ready for some changes. 
Distortion in this market might be an improvement.
    Mr. Chairman, many concerns along these lines can be 
addressed in how the pricing mechanism is structured and 
applied. That is why there needs to be a healthy discussion 
about the form of the pricing mechanism. The point is that the 
debate at the Federal level should be how best to reestablish 
the link between cost and price in these markets, not whether 
it should be done.
    Let me just conclude by saying that our problem in Tacoma 
and, I think, in the region can only be remedied in the short 
term by a return to cost-based power pricing or more 
precipitation in the Northwest, but not even Congress can make 
it rain, so Tacoma supports legislation to direct FERC or an 
appropriate party to fulfill the mandate of the Federal Power 
Act to assure just and reasonable wholesale rates in Western 
markets through temporary cost-based pricing, as described 
above.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Crisson follows:]
    Prepared Statement of Mark Crisson, Director/CEO, Tacoma Public 
                         Utilities, Tacoma, WA
    Mr. Chairman and members of the Committee, I am Mark Crisson, 
Director/CEO of Tacoma Public Utilities in Tacoma Washington. The 
Department provides power, water, and rail services to Tacoma and 
vicinity. Our largest division is Tacoma Power, which serves 150,000 
customers and has an annual budget of approximately $250 million. The 
utility owns and operates four hydroelectric projects comprising a 
total electrical capacity of over 700 megawatts.
    The Northwest is currently experiencing very dry weather, which is 
resulting in record low inflows to our power projects. Consequently, 
our hydroelectric facilities are significantly under-performing in 
relation to their planned levels, and we must purchase power in the 
western wholesale markets to replace this shortfall. Unfortunately, 
these markets are experiencing unprecedented price levels that are 
presently 10-15 times normal and at times have been as much as one 
hundred times last year's levels. This has had a drastic effect on our 
financial resources: we estimate that with a continuation of the 
current weather and market conditions, we will exhaust our $130 million 
cash reserve by the end of April.
    With the support of the Public Utility Board and City Council, 
Tacoma Power responded decisively by implementing a 50% electric rate 
surcharge on December 20. In the meantime other Northwest utilities 
have also imposed surcharges or announced rate increases, including 
Seattle City Light and Snohomish Public Utility District. Last week 
Bonneville Power Administration announced it will require a rate 
surcharge of 95% in October and estimates rates will average 63% above 
current levels over the next five years. As you can see, the power 
supply and price impacts of California's problems extend well beyond 
California: the Northwest has been adversely impacted as well. And as 
Chairman Greenspan testified last week, and as President Bush noted 
this week, this mess could undermine the country's economic expansion, 
making this not just a regional problem, but a national one.
    The impacts of our power surcharge are already affecting the Tacoma 
economy and our community. While our rates have historically been low, 
our per capita usage has been higher than average, resulting in bills 
that are equal to or above the national average for residential 
customers. The increase in these bills will create significant hardship 
for many in our community, particularly low-income residential 
customers using electric heat and water heat. Moreover, many energy-
intensive industries have located in the Northwest and in Tacoma in 
reliance on low power prices to enhance their costs of production. The 
recent surcharge, together with steep increases in natural gas prices, 
has forced several of our industries to curtail their operations or 
suspend production altogether, e.g. Louisiana Pacific, Pioneer 
Chemical, Schnitzer Steel, and Atlas Foundry. It should be noted that 
this has happened before the full impact of the surcharge is reflected 
in customer bills.
    In addition to the surcharge, Tacoma Power has taken a number of 
other steps in response to this crisis. First, we have tightened our 
belt considerably, reducing all unnecessary capital outlays and putting 
system expansion plans on hold. Second, we have secured additional new 
power supply by installing 50 megawatts of temporary diesel generation 
(with best available control technology) in our industrial area. These 
units began operation this week, and are saving us $300-400,000 per day 
in purchased power expense. Third, we are strongly promoting increased 
conservation in our service area through advertising, direct customer 
contact, and product promotion. Our City Council has also adopted a 
resolution that sets an aggressive conservation target of 20% for our 
community. And, finally, we are working with state and federal 
government regulators and legislators to address the energy problem.
    With regard to this last point, Governor Locke has tackled the 
energy problem by introducing a bipartisan package of legislation aimed 
at promoting new supply and increased conservation. He also declared a 
state-wide energy alert last week to facilitate operation of temporary 
additional generating sources and to require conservation on the part 
of public sector agencies. Tacoma, other Northwest utilities, and the 
State of Washington have all stepped up and taken meaningful, and often 
difficult, actions to address this dilemma--it's now time for the 
federal government to help.
    While the problems in California may be largely self-inflicted, 
their effects are regional and national in scope. Moreover, in creating 
the Independent System Operator, California essentially federalized the 
matter, since the ISO is under jurisdiction of the Federal Energy 
Regulatory Commission. FERC has been called upon by my utility, as well 
as by a host of others (the states of Washington, Oregon, California, 
Seattle City Light, and the California Municipal Utilities, to name a 
few) to temporarily re-establish cost-based rates and/or firm price 
caps in western energy markets. Unfortunately, a current majority of 
the Commission appears more concerned with not interfering in what is 
clearly a dysfunctional market than they are in fulfilling their prime 
directive under the Federal Power Act that wholesale rates be just and 
reasonable. California is taking steps to right its ship, but most of 
the steps are aimed at avoiding utility bankruptcy or facilitating the 
acquisition of new supply. It's not clear the state's actions will have 
any beneficial impact on the near-term price of wholesale power. In 
order to avoid further utility insolvency and to mitigate the rate 
impact on all consumers, it is time for FERC to impose cost based 
pricing and/or price caps on a temporary basis.
    FERC should move quickly to take three steps. First, it should 
define standards for what comprises a competitive market. Second, it 
should then require cost based rates and/or price caps for markets 
which do not meet this standard. Third, it then needs to establish some 
process for monitoring operation and compliance in the markets.
    Most concerns with price caps in this instance are not well 
founded, particularly since their implicit premise is a functional 
market. Many concerns can be addressed in how the pricing mechanism is 
structured and applied. That is why there should be a healthy 
discussion about the form of the pricing mechanisms, since this new 
territory. For example, one approach would be to use a multiple of the 
price of natural gas as the basis for a price cap, with exceptions 
allowed only when it can be demonstrated that actual unit-specific 
costs exceed that level. The point is that the debate at the federal 
level should be how to best re-establish the link between cost and 
price in these markets, not whether it should be done.
    Our residents, businesses, and industries are all suffering severe 
economic impacts due to higher power and energy prices. This situation 
can only be remedied in the short term by a return to cost based power 
prices or more precipitation in the Northwest. But not even Congress 
can make it rain, so Tacoma supports legislation to direct FERC or an 
appropriate party to fulfill the mandate of the Federal Power Act to 
assure just and reasonable wholesale rates in western markets through 
temporary cost based pricing as described above.
    That concludes my testimony. Thank you, Mr. Chairman.

    The Chairman. You realize, Mr. Crisson, you are challenging 
the ability of the lobbyists, who are often referred to as 
rain-makers.
    Mr. Crisson. We are definitely throwing down the gauntlet 
to that group, sir.
    [Laughter.]
    The Chairman. Well, the proof is in the pudding, and we 
have not had either one yet.
    Ms. Johansen of Pacific Corp is executive vice president 
for regulatory and external affairs.

     STATEMENT OF JUDI JOHANSEN, EXECUTIVE VICE PRESIDENT, 
   REGULATION AND EXTERNAL AFFAIRS, PACIFICORP, PORTLAND, OR

    Ms. Johansen. Thank you very much. The nice thing about 
batting clean-up is there is not much left to say.
    The Chairman. There is one more.
    Ms. Johansen. I was speaking on his behalf.
    PacifiCorp is the largest private utility outside the State 
of California. We have the pleasure of serving in six States in 
the Western region, and we serve over 1.5 million customers.
    As I sit here today, I think about the context of this 
debate. There has been a lot of discussion about price caps and 
economic theories. I sit here thinking there is a very high 
probability that the West Coast will face blackouts this summer 
due to the very events that people have discussed earlier, so 
our task is not simply what do we do for the long term, but 
what do we do for this summer and for the next few years.
    I would like to echo the call that several have made for 
the immediate imposition of some sort of cost-based price caps 
on wholesale sales. We, like other utilities, are seeking 
emergency rate relief today. We are before the Utah commission 
seeking emergency relief to keep our utility in good financial 
shape, so those price caps can only stem some of the bleeding 
that we are all feeling.
    There is an urgent need because of the situation for this 
summer for Federal and State political leaders to immediately 
appropriate funds and create emergency incentives for more 
conservation to compliment what is already being done.
    Third, the Federal Government must stop extending the DOE 
order compelling sales of power from Northwest utilities into 
uncredit-worthy parties in California.
    One point that has not been mentioned here today, the 
California Power Pool, the PX, has a very odd mechanism whereby 
if one party defaults the other parties pay their bill. With 
Southern Cal Edison defaulting on its payment to the PX, my 
company this week received a bill for their debt, and we are 
expecting an even larger bill for their debt in addition to the 
burden that we currently take on.
    That is an untenable position, and Senator Murkowski 
appropriately points out that it creates a takings liability 
for the Government to compel us to continue to participate in 
those markets.
    Access to capital is being hindered by the repercussions of 
the California situation. Our own utility is facing increasing 
cost and limitation on access to capital, and it comes at a 
very difficult time, because the very fix we need is 
investments in the infrastructure, so we need the Federal and 
State leadership to assure the financial markets that you will 
take actions to assure that our investments will be sound.
    Finally, I will comment on the Canadian situation. There 
are two thoughts that come to mind. First of all, while Canada 
has significant generation resources, they, too, are a hydro-
based utility, or have a hydro-based system. They, too, are 
suffering the same drought conditions, but that being said, 
they have been significant participants in this West Coast 
market and I would urge that, as we look at price cap 
solutions, we also assure that somehow the Canadian 
participants in the California markets and in the West Coast 
market somehow be caught under the net of that regulation as 
well.
    Thank you very much for your time.
    [The prepared statement of Ms. Johansen follows:]
    Prepared Statement of Judi Johansen, Executive Vice President, 
       Regulation and External Affairs, PacifiCorp, Portland, OR
    Mr. Chairman and members of the Committee, my name is Judi 
Johansen. I am Executive Vice President for Regulation and External 
Affairs at PacifiCorp. My company is an electric utility that provides 
retail service to nearly 1.5 million customers in six western states. 
We have about 8,000 megawatts of electric generating capacity in nine 
states, and approximately 15,000 miles of transmission lines across the 
west.
    PacifiCorp has not been a major player in California competitive 
markets since deregulation was implemented there in 1998. The 
California market presented few opportunities and increasing risk over 
time, so PacifiCorp has had small exposure in California. We do 
continue to provide service to about 45,000 retail customers in the far 
northern part of the state.
    Coupled with substantial growth in other parts of our own service 
territory, PacifiCorp has not had a substantial amount of electricity 
to sell to the California Independent System Operator since the forced-
sale emergency orders were issued, beginning more than a month ago.
    That is not to say, however, that our company and customers are 
immune to the problems in California. The western region is a highly 
interconnected grid that has spawned a region-wide wholesale power 
market. California represents at least 30 percent of the western 
market.
    PacifiCorp is in the wholesale market even though our generation 
portfolio roughly meets our load requirements. Generally, the company 
needs to purchase power to meet peak needs, both seasonally and daily. 
Peak power is generally the most volatile market; the cost of this 
power can be several multiples of off-peak prices.
    As a result, we have filed applications to account for 
extraordinary power costs and, in some cases, to begin recovering those 
costs from customers. We believe the volatility in peak markets has 
largely been driven by a combination of decreasing generation reserves 
plus flaws in the California structure that drove so much of that 
state's procurement into the spot market.
    The company and our customers are also exposed to the California 
utilities' defaults on obligations to the California Power Exchange 
(PX). This is due to a convoluted, inequitable provision in the PX 
system that assigns the obligations of defaulted PX participants to 
entities still involved in the PX. When Southern California Edison 
defaulted on its payment obligation to the PX two weeks ago, the PX 
sent other PX participants bills for shares of this obligation, based 
on their proportionate piece of the PX market. In PacifiCorp's case, 
this bill represented about $2 million or one percent of the defaulted 
obligation.
    The volatile, costly wholesale market and collapsing PX are two 
significant manifestations of the shock waves California has sent 
through the west. Now, California is in the midst of significantly 
changing its deregulation statute and policy makers here in Washington 
and in every western state capital are considering what needs to be 
done to bring demand and supply back into balance and otherwise 
stabilize the market.
    PacifiCorp is eager to engage in these discussions. In fact, the 
company gathered a series of regional stakeholders last October to 
discuss the problems that arose last summer and steps to alleviate 
future supply shortages. While nobody at that forum predicted the dire 
consequences that would befall the west less than two months later, I 
do believe we began an important dialogue.
    Whatever path federal and state leaders choose, the path must be 
one that works for electric consumers. Customers want prices to be 
stable and reasonable and they want service to be reliable. PacifiCorp 
aspires to remain a low-cost provider of electricity and to provide 
world-class customer service. Our new service standards and commitments 
will meet these aspirations.
    The fundamental requirement on all stakeholders is to take steps to 
balance supply and demand. In each case, it is vital to have a 
regulatory and investment climate conducive to meeting the following 
objectives:

  <bullet> tempering demand growth with price signals and other 
        opportunities to encourage energy efficiency;
  <bullet> facilitating the reliable, economic delivery of electricity 
        over the western transmission grid;
  <bullet> providing greater certainty over the terms and conditions 
        under which generating facilities already in operation may run 
        over the next 10-20 years;
  <bullet> creating an environment conducive to investments in new 
        generation resources.

    PacifiCorp has been working with state regulators and customers to 
enhance energy efficiency and load reduction both immediately and in 
the long term. We urge the Congress to give serious consideration to 
tax policies that encourage investments in energy efficiency such as 
those embodied in S. 2718 from the 106th Congress.
    With respect to enhancing transmission, PacifiCorp has been leading 
the effort to form RTO West in response to FERC Order 2000. We believe 
the current situation makes establishment of RTO West even more 
valuable than ever. Creation of RTO West will make grid operations more 
efficient and facilitate construction of new generation. While the 
company has not taken a position on proposals to provide the FERC with 
eminent domain authority to site new transmission facilities, it is 
worth noting in the west that significant existing and future 
transmission corridors are located on federal lands. Federal agencies 
should work constructively to locate facilities expeditiously and 
permit their construction and operation in a cost-effective manner.
    Maintaining existing generation capacity is vital to upholding the 
first rule for getting out of a hole--stop digging. Most of 
PacifiCorp's existing generation fleet is comprised of mine-mouth coal 
plants in the Intermountain West and hydro generation in Washington, 
Oregon and Idaho.
    With respect to hydro, we have been actively engaged in relicensing 
various projects and find the process frustrating as most agency 
participants have no obligation to balance environmental and economic 
objectives. This Committee heard testimony from PacifiCorp last year on 
Senator Craig's legislation to make modest changes in the Federal Power 
Act's licensing procedures. We thank Senator Craig, Senator Gordon 
Smith, and others actively engaged in this legislation for their work 
and urge the Committee and its members to review the bill now pending 
before the Committee, S. 71, in light of current and future electric 
resource needs.
    Our coal plants are already among the cleanest in the nation for 
SO<INF>2</INF> emissions. We recognize, however, that a new generation 
of air emission standards is possible in the next few years. PacifiCorp 
has been working at the regional level for nearly a decade to fashion 
an approach to regional haze that achieves environmental objectives 
through a flexible framework. Under the leadership of Utah Governor 
Mike Leavitt and the Western Governors' Association, great progress has 
been made on this front.
    It is this type of constructive, cooperative approach to air 
quality issues that PacifiCorp hopes will mark the wave of emission 
control agreements. The company is prepared to engage in a multi-state, 
multi-pollutant strategy that, going forward, will achieve significant 
emissions reductions. This is a far better approach than the 
adversarial, litigious tactics that have pervaded emissions debates in 
other parts of the country.
    To stimulate construction of new generation, it is important that 
policies and regulations at the state and federal levels properly align 
risk and reward. Investing in new generation--which by virtually all 
accounts is necessary to solve the west's problems--requires huge 
amounts of capital. Sending unclear regulatory signals about the 
potential return on investment (or sending clear, discouraging signals 
to investors) will thwart investment in new plants.
    Conversations with investors and investment analysts confirm not 
only the potential for this investment gridlock, but the reality of it 
as well. Wall Street equates regulatory uncertainty with a bad 
investment climate. This makes the cost of financing new projects 
higher. These costs are ultimately borne by consumers.
    While this concern is primarily a matter for state policy makers 
and regulators, it is relevant to how the Congress addresses supply 
policy and how the FERC fulfills its responsibilities.
    PacifiCorp has taken the step of proposing a realignment of its 
corporate structure in order to make it easier for regulators to 
address resource acquisition strategies most appropriate to their 
respective states and customers. This realignment will also have the 
effect of sending clearer signals to developers about the potential for 
fair returns on investment in new generation.
    Ultimately, our realignment will require approval from the FERC and 
Securities and Exchange Commission. But the consent of state regulators 
is essential to putting PacifiCorp in a position in which we may 
constructively contribute to solving the regional power supply problem.
    On a related matter, PacifiCorp believes one of the more promising 
technologies available to increase generation is new wind energy. The 
Congress can help facilitate development of new wind generation by 
expeditiously extending the renewable energy production tax credit. 
And, federal agencies can help by approaching constructively the siting 
decisions essential for generation and associated transmission 
facilities.
    Certainly, other inducements to new generation investment through 
the tax code and other instruments should be examined as well. 
PacifiCorp is eager to work with this and other relevant Committees of 
the Congress to this end.
    Mr. Chairman, this concludes my prepared remarks. Thank you for the 
opportunity to testify. I would be happy to respond to any questions 
you or other Committee members may have.

    The Chairman. Thank you very much, Ms. Johansen. I 
appreciate your statement.
    Our last witness will be Mr. Curt Hildebrand of Calpine, 
and we look forward to your statement, and then we will get 
into the questions shortly thereafter.
    Mr. Hildebrand comes as vice president, project 
development, of Calpine Corporation, Pleasanton, California.

  STATEMENT OF CURTIS A. HILDEBRAND, VICE PRESIDENT, PROJECT 
        DEVELOPMENT, CALPINE CORPORATION, PLEASANTON, CA

    Mr. Hildebrand. Thank you, Mr. Chairman, members of the 
committee. I am actually supposed to be seated down with my 
colleagues from California, but being a powerplant developer in 
California I am kind of use to this treatment, not in my 
backyard, so I am down at this end.
    The Chairman. There is more room at that end of the table 
than these folks have, so you are lucky.
    Mr. Hildebrand. We also believe at Calpine the principal 
problem behind the energy crisis in California is insufficient 
supply of generating capacity, and we believe that we need to 
build more new, efficient powerplants to remedy the problem. We 
also believe the Federal Government can play a key role in 
helping achieve this goal by streamlining the regulatory 
process.
    Today, I will describe my company, Calpine, and our plan to 
repower America. I will then share with you just two key 
examples of permitting problems we have had, specifically on 
California projects, and finally I will provide some specific 
recommendations on how to help solve these problems.
    Calpine Corporation is based in San Jose, California, and 
is a leading independent power producer in the United States. 
The company's ambitious, 5-year, $20 billion development 
program calls for Calpine to install and operate a 44,000 
megawatt portfolio of natural gas-fired environmentally 
responsible plants. This portfolio will be sufficient to supply 
the electrical needs of over 40 million Americans.
    The California energy crisis has numerous fundamental 
causes, but no simply solutions. Calpine is working at a 
furious pace to help address the situation in California. 
Calpine currently has 1,300 megawatts of generation capability 
in California that has been operating virtually around the 
clock during the crisis. Three of the first four new projects 
under construction in California are Calpine projects, 
including the only two plants coming online this summer.
    Mr. Chairman, I believe one of the key reasons the power 
supply is not adequate in California has been the slow and 
difficult permitting process for new plants. Calpine does not 
believe we must roll back environmental projections in order to 
increase electricity output. Instead, we want the Federal 
Government to take the lead and set an example by ensuring that 
new generation approval process proceeds as quickly as 
practical while still protecting the public interest.
    Let me share briefly with you two recent examples of less-
than-efficient permitting processes. In Sutter County, 
California, Calpine is constructing the 545 megawatt Sutter 
Power project that was designed to establish a new 
environmental benchmark as the cleanest gas powerplant ever 
licensed by the California Energy Commission. Over 3 years 
ago--in the interests of brevity I will summarize the 
testimony. It is in my written testimony.
    Three years ago, we filed an initial application for a 
prevention of significant deterioration permit at USEPA under 
title I of the clean Air Act. 17 months after that original 
application was filed, the EPA region 9 solicited comments on 
the permit. A person living 100 miles away was the only 
commenter, and the agency thoroughly investigated that claim 
and found it to be frivolous.
    Nevertheless, the same individual filed an appeal to the 
U.S. Environmental Appeals Board on the project. We were 
already in construction on the project. Even though the claim 
had no merits, the EPA's Environmental Appeals Board was forced 
to issue a stay of construction, effectively. They were not 
able to issue the final PSD.
    Finally, after nearly 4 months of our pleading of our case, 
the board denied the appeal on December 2, 1999, ruling that 
the claim lacked any merit whatsoever. This delay unfortunately 
caused Calpine, at great expense, to expedite construction 
activities, and it has severely impacted our ability to put 
that project online in time for next summer's peak demand.
    Let me share another brief example that has already been 
mentioned, the Metcalf Energy Center project in California. It 
is kind of the poster child, if you will, for projects, the 
current state of California.
    It is a 600 megawatt facility planned for San Jose. The 
Silicon Valley imports over 90 percent of our power from remote 
parts of the State. This project is intended to be a showcase 
project in our home town. It has been overwhelmingly supported 
by a majority of stakeholders, including local 
environmentalists, including the Sierra Club, consumer 
advocates, the NAACP, and over 26,000 local residents.
    However, this seemingly ideal project is being held up on a 
number of local, State, and Federal fronts, including local 
NIMBY opposition. I will concentrate on the Federal level. One 
failure affecting the project is the U.S. Fish & Wildlife 
Service and it is expected to issue a biological opinion in a 
timely manner. By law they have 135 days to do so. This opinion 
was originally due August 2000 on the Metcalf project. All 
issues have been settled. However, the opinion has still not 
been issued, and we have recently been told that it will not be 
issued for a matter of still weeks. This delay has in turn 
delayed the ability of EPA to proceed with their air permit 
process.
    The Chairman. Your time has expired. I would ask you wrap 
up, please.
    Mr. Hildebrand. Calpine is prepared to invest over $5 
billion over the next 5 years to expand power production in 
California. I do summarize four suggestions in my written 
testimony that I would suggest the Federal Government look at 
very strongly in terms of streamlining the overall approval 
process.
    Thank you.
    [The prepared statement of Mr. Hildebrand follows:]
  Prepared Statement of Curtis A. Hildebrand, Vice President, Project 
            Development, Calpine Corporation, Pleasanton, CA
    Mr. Chairman, and Members of the Committee, thank you for inviting 
me to testify today regarding the California energy crisis. My name is 
Curt Hildebrand. I am Vice President of Project Development for Calpine 
Corporation. We applaud the Chairman and the Committee for holding this 
hearing to better understand the California energy crisis and its 
implications for affecting the long-term electricity needs for our 
country.
    In my testimony, I will address the following issues. First, I will 
state briefly what I believe are some of the underlying causes of the 
California energy crisis and the ramifications for the future. Second, 
I will describe my company Calpine and our very active program to 
provide reliable, clean electrical power for our nation. Third, I would 
like to share with you today two particular examples of projects that 
offer much promise to helping us solve our nation's electricity needs, 
but have been significantly delayed as a result of the current 
regulatory system. Finally, I will attempt to provide some specific 
recommendations for helping to resolve the current electricity crisis 
and prevent future crises elsewhere in the country.
    I am here today because Calpine believes that the federal 
government has a role in helping to generate more electric power in a 
timely manner, which in turn will help to resolve the California energy 
crisis, reduce the costs to customers, protect the environment, and 
avoid other future energy problems. There is no question that Calpine 
and other companies possess the technology to produce significant 
quantities of electrical power efficiently, at a competitive price, and 
in an environmentally-responsible manner. However, while Calpine's 
plans show great promise for helping to solve our nation's energy 
needs, we are subject to an unnecessarily burdensome regulatory 
bureaucracy that hinders our ability to build modern, environmentally-
sound facilities.
    In essence, Calpine believes that the construction of badly-needed, 
state-of-the-art energy centers must be approved in an efficient 
manner. Calpine believes that the federal government review process--
which includes multi-agency action--should be coordinated and 
streamlined to allow all permits to be issued, after appropriate notice 
and comment, on a timely basis. We cannot afford to be subject to 
needless delays arising from the redundant review of the same claims 
that already have been thoroughly reviewed by the proper regulatory 
bodies. Federal and state agencies should adhere strictly to 
established deadlines in order to allow for the orderly construction of 
new power plants in a timely manner.
  our nation's energy infrastructure and the california energy crisis
    Electricity generation, transmission, and distribution is the third 
largest industry in the U.S. Only the health care and automotive 
industries are larger. There are 750,000 megawatts of generating 
capacity in the U.S., and demand for electricity is increasing annually 
by three percent. This growth in demand equates to 22,500 megawatts of 
new power generation capacity annually plus replacing nuclear, 
hydropower, and aging fossil-fuel plants that are retired from service.
    As the Committee knows, the electric industry has been restructured 
at the wholesale level nationwide, and retail restructuring is 
proceeding in many states. Healthy competition, if restructuring is 
done correctly, should lead to lower electricity prices, more reliable 
service and reduced pollution. Nevertheless, the country's current 
population growth, an expanding economy, and the increasing use of 
electricity have strained our nation's power infrastructure. In 
addition to experiencing power shortages in California and elsewhere, 
the nation's current electricity-producing infrastructure is aging: 45 
percent of the nation's power plants are over 25 years old. Aging coal-
fired plants also have been a major source of pollution. Obviously, 
older plants cannot adequately satisfy our nation's current energy 
demands, let alone meet anticipated future demands.
    The problems of inadequate supply can be prevented in the future 
only by the addition of new, efficient, clean energy centers. Modern 
gas-fired, combined-cycle plants are being built that will lower the 
cost of electricity and drastically reduce and even eliminate the 
impact of power generation on the environment. Calpine believes that 
building these new plants is important to the well-being of our 
country, and Congress should promote this transition from outdated, 
inefficient, and highly-polluting generation plants to the vastly 
cleaner and more efficient energy centers such as those that Calpine 
and others are building.
    Let me review quickly the recent history of electricity generation 
in the U.S. During the late 1980s and early 1990s, there was an 
abundant supply of relatively inexpensive electricity in this country. 
Due to this large supply of available power, electric prices dropped 
and utilities stopped constructing new power plants. At the same time, 
many utilities chose to implement load management techniques that 
helped reduce or manage their customers' electricity needs, thereby 
freeing up extra capacity for new users. Independent power producers 
sought to develop new projects, only to encounter a maze of regulatory 
requirements and uncertainties that raised construction costs and 
dissuaded private investment in new power plant projects.
    In recent years, the demand for electricity has, however, 
dramatically increased. The country's continued economic expansion 
during the 1990s, based in large part on growth in the electricity-
consuming high technology and Internet sectors, voraciously consumed 
much of the excess reserve capacity in electricity markets. 
Unfortunately, despite warnings of a looming electricity shortage 
during this time period, many federal, state, and local regulators 
continued to raise numerous obstacles to new power projects, and many 
promising new energy plants languished in an onerous regulatory review 
process. Only recently have many government officials begun to 
recognize that new, fuel-efficient electric power-generating 
facilities, such as those currently being constructed by Calpine and 
others, are desperately needed all across the U.S.
                     calpine corporation: overview
    Calpine Corporation, based in San Jose, California, is a leading 
independent power producer in the U.S. and is a recognized leader in 
our industry. Our goal is to become the largest U.S. power producer by 
being the low-cost base load generator and adding necessary low-cost 
peaking capacity. At the same time, the Company currently produces more 
renewable ``green power'' than any other company. We are the largest 
renewable power generator in the nation.
    Calpine has embarked on an ambitious program to help solve our 
country's energy needs. To date, the Company has approximately 28,000 
megawatts of total electric generation capacity in existing operation, 
under construction, and announced development in 27 states and Alberta, 
Canada. The Company has the most ambitious development program in the 
country with plans to install and operate a 44,000-megawatt portfolio 
of natural gas-fired, state-of-the-art, clean, and modern plants by 
2005. This development program, which will be sufficient to supply the 
electrical needs for 46 million American households, will require a 
private capital investment of upwards of $20 billion.
    Calpine is working at a furious pace to help address the situation 
in California. Calpine currently has plants with 1,300 megawatts of 
generation capability in California that have been operating at full 
capacity virtually around the clock during the current crisis. Our 
California fleet of generators had average plant availabilities in 
excess of 95 percent for each of the past two years--well above the 
industry average. Four hundred and twenty megawatts of generating 
capacity is supplied to utilities through long-term, qualified facility 
contracts; virtually the entire balance is sold through bilateral 
contract arrangements.
    Calpine is a recognized leader in developing new projects in the 
State of California. Three of the first four new projects under 
construction in California are Calpine projects. As we look forward in 
trying to meet the State's current needs, the only plants coming on 
line this year in California will be Calpine plants. We anticipate over 
1,000 megawatts of new generating capacity to come on line in time to 
help meet this summer's peak demand. Ultimately, Calpine plans to have 
10,000 megawatts of generating capacity in the State resulting from our 
estimated $5 billion private capital investment.
    Encouraging electricity generation based upon technology advances 
and utilizing cleaner resources, like natural gas, will enable the 
American consumer to be able to maintain their current standard of 
living at the same or reduced electricity cost, while meeting our clean 
air goals. One key to achieving these overall goals of increased 
electricity output, reduced cost, and a clean environment, is Congress' 
ability to establish an appropriate regulatory process that effectively 
and efficiently promotes new electric power plant permitting and 
construction.
  the federal government must coordinate and streamline the approval 
              process for constructing new energy centers
    Mr. Chairman, the California energy crisis is a national problem, 
or at least an indication of future national problems that must be 
addressed now. While some experts have pointed to numerous causes of 
this electricity crisis, including faster-than-expected increases over 
the past several years in consumer and business demand, Calpine 
believes that one of the most important causes has been the slow pace 
of development and construction of new sources of electric-generating 
capacity.
    In sum, Calpine asserts that federal regulatory reforms are 
necessary to help the nation address the projected electricity 
shortages currently facing many regions of the country. Congress must 
hold the government regulatory agencies, including EPA and the U.S. 
Fish and Wildlife Service, accountable to met specific timelines, 
particularly for permit reviews and related responses to stakeholders. 
The regulatory process must be streamlined so that the same issues are 
not raised repeatedly at numerous stages of the regulatory process.
    Mr. Chairman, I would like to state clearly for the record that 
Calpine cares about the environment; the Company designs efficient 
energy centers and prioritizes ``green'' energy resources. As a result, 
Calpine does not believe that the government must roll back 
environmental protections in order to increase electricity output. 
Instead, the federal government should take the lead and set an example 
by ensuring that the construction approval process proceeds in a timely 
and orderly manner. Currently, our bureaucratic process provides too 
many opportunities for individuals to halt or delay the approval 
process for reasons unrelated to local safety, health, and/or welfare, 
but rather to publicize and/or promote their other agendas relating to 
energy policy. The following are two good examples of projects held 
hostage by spurious claims and regulatory delays that have affected our 
ability to provide efficient electricity generation capacity that would 
help to prevent our current crisis.
                          sutter power project
    Calpine's Sutter Power Plant project is a good example of how the 
regulatory process has hindered the construction of new power plants. 
In 1997, Calpine committed to build a new, clean-burning natural gas-
fueled power plant in Sutter County, California. This new plant was a 
``milestone'' project for California. It became the first new energy 
facility licensed in the State's deregulated electricity marketplace. 
This plant was intended to serve the electrical needs for over 500,000 
households in the greater Sacramento Valley.
    The Sutter project was designed to establish a new environmental 
benchmark as the cleanest natural gas power plant ever licensed by the 
California Energy Commission. This plant also will conserve precious 
natural resources by utilizing 40 percent less fuel than the typical 
plant in operation today. As discussed below, this project was 
unfortunately delayed by one single individual living approximately 100 
miles from the plant who was able to abuse the permitting process and 
hinder the timely construction of this project.
    Early in January 1998, Calpine filed an application with EPA for a 
Prevention of Significant Deterioration (``PSD'') permit under Title I 
of the Clean Air Act to build the Sutter power plant. As evidence of 
its commitment to be a responsible corporate citizen in the communities 
where we operate new power plants, Calpine had proposed to partner with 
Sutter County to help its citizens enjoy the wide-ranging benefits of 
this new plant. For example, Calpine had committed to provide Sutter 
County with $2.5 million over ten years to assist the County with its 
ongoing efforts to improve levees and provide enhanced protection from 
flooding. Calpine also committed to providing funds for much-needed 
fire-fighting and emergency response equipment.
    Following our action, EPA Region IX eventually solicited comments 
in June 1999 on its decision to issue a permit granting approval to 
proceed with the construction of the new Sutter plant. During the 
comment period, EPA received only one negative comment on the proposed 
construction of the plant while hearing numerous comments 
overwhelmingly supporting the need for this plant. The Agency 
thoroughly investigated this one comment and fully responded in 
writing, even though EPA itself recognized that the comment was 
frivolous and questioned whether there was a need to respond to it at 
all. In fact, many of the concerns alleged by this commenter had no 
basis in law and had been thoroughly addressed during prior hearings on 
the project by the California Energy Commission and in the Final 
Environmental Impact Statement prepared by the Western Area Power 
Administration.
    EPA Region IX subsequently issued Calpine its final ``PSD Approval 
to Construct'' on July 21, 1999, with the Sutter project establishing a 
new more stringent benchmark for the ``Best Available Control 
Technology'' standard for emissions. In granting this permit, EPA 
determined that the emissions from the plant would be well below the 
maximum allowable standard as defined by the National Ambient Air 
Quality Standards.
    Remarkably, despite EPA's (as well as every other necessary local, 
state, and federal agency's) approval, construction was again halted 
and further threatened by another claim for appeal. Having failed in 
several previous attempts to block construction, the same individual 
commenter whose arguments had been rejected on several previous 
occasions appealed EPA's decision to issue the PSD permit to the U.S. 
Environmental Appeals Board. It is important to note that this appeal, 
which arrived on the last day of the appeal period, did not focus on 
federally-enforceable air permit issues; instead, the comment letter 
might be fairly characterized as a general letter of opposition to new 
power plants, not an appeal of the specific federal air permit for the 
Sutter plant. Nevertheless, under the Board's review procedures, this 
appeal, regardless of merit, forced EPA's Environmental Appeals Board 
to delay issuance of the final PSD permit, effectively creating a 
``stay'' of any construction of the new Sutter plant until the appeal 
was heard and reviewed.
    Mr. Chairman, in all due respect and despite the Appeals Board's 
policy to give priority to PSD petitions for review, working through 
the federal bureaucracy is a slow, arduous, and expensive process. The 
mere fact that no new claims were presented at all in this appeal and 
that EPA and other regulators already had fully considered this claim 
several times before should have resulted in an immediate denial of 
this appeal. But no such action was forthcoming. Instead, due to its 
considerable backlog of cases, it can take the Board many months to 
consider an appeal regardless of its merits, causing companies many 
millions of dollars and valuable lost time while awaiting a decision to 
construct. Further, the Appeals Board's appeal process does not 
currently allow for a motion for summary dismissal of frivolous claims.
    The inability to engage in construction activities coupled with the 
lack of a summary process meant that virtually all construction 
planning came to a grinding halt at the Sutter project. Due to this 
automatic ``stay'' on construction, Calpine lost millions of dollars 
tying up construction equipment and personnel, and a power plant 
critically needed in California was unreasonably delayed. Finally, 
after nearly another four months of pleading our case, the Board denied 
the appeal on December 2, 1999, ruling that the claims in the appeal 
lacked any merit whatsoever.
    EPA and its independent Appeals Board are not the only federal 
entities that can contribute to construction delays; other agencies 
also pose procedural obstacles. Calpine has read Senator Pete V. 
Domenici's (R-NM) recent letter to President Bush in which he astutely 
recognizes that EPA and the Departments of Energy and the Interior 
``approach each issue from the perspective defined by their own 
specific, narrow agency interests without considering the impact on 
energy supply.'' We wholeheartedly agree with your statement, Senator, 
and with your conclusion that ``That must change.'' Having shared an 
EPA war story relating to our Sutter power plant project, let me share 
another war story that helps to prove Senator Domenici's point.
                     metcalf energy center project
    Another prime example of the possible problems caused by the 
current regulatory process is the Metcalf Energy Center project in the 
Silicon Valley region of California. This project involves a new 600-
megawatt facility in San Jose that will provide enough electricity for 
a community of 600,000 people. If constructed, the Metcalf Energy 
Center would provide electricity sufficient to serve two-thirds of San 
Jose's average power demand and could be operational by early 2003.
    The Bay Area has not had a major power plant built since 1972, 
while the population has grown by more than 50 percent. In fact, San 
Jose currently consumes over 2,500 megawatts of power that is generated 
elsewhere while it is capable of producing only 165 megawatts itself, 
resulting in less reliable and lower quality electrical service, 
ironically for the nation's most high-tech region.
    This proposed new energy center is desperately needed. San Jose is 
considered the most generation-deficient area in California and, 
therefore, it is the most vulnerable area to blackouts. The California 
Independent System Operator (``CAL-ISO'') has deemed the Metcalf 
project to be one of the top two priority projects in the State. If the 
Metcalf project could have been on line last June 14, it would have 
prevented the blackouts that took place in the San Francisco area at 
that time.
    In essence, the Metcalf Energy Center was intended as a 
``showcase'' project in our hometown of San Jose to set a new standard 
of excellence for air quality and recycled water usage within the power 
generation industry and it would be cleaner than any plant its size 
ever licensed in California. Unlike many other power plants, this new 
plant has been designed so that there will not be a visible water vapor 
plume. Further, the Metcalf Energy Center would include more than $10 
million in visual enhancements; the main structure would resemble high 
tech office towers and over 800 new trees will surround the site. The 
site also is shielded from residential neighborhoods by a 350-foot high 
hill. The site currently is a junk yard and is undesirable for most 
development, and is in fact located directly across the street from the 
Pacific Gas and Electric Company's 40-acre Metcalf substation, the main 
hub for electricity in the South Bay. This large substation and 
associated transmission towers are equipped already with high capacity 
lines that have been located there for over 50 years.
    With all of these features, this new energy center plant has been 
overwhelmingly supported by a majority of stakeholders, including the 
local chapters of the American Lung Association and the Sierra Club as 
well as other health and environmental groups, the NAACP, major Silicon 
Valley corporations, local unions, consumer groups, local businessmen, 
and over 26,000 local residents and property owners. The staff of the 
California Energy Commission noted that ``the benefits resulting from 
the approval of the Metcalf Energy Center would be substantial'' and 
recommended approval of the project. This truly is an ideal site and 
situation for building a new power generating facility.
    To summarize briefly, the Metcalf Energy Center would not create a 
health risk to anyone, anywhere, at any time. It has enormous 
environmental benefits such as:

  <bullet> Emissions are so small and dispersed so high into the 
        atmosphere as to render them undetectable at ground level.
  <bullet> The Bay Area Air Quality Management District found that the 
        project does not pose any threat to public health and 
        determined that the project uses Best Available Control 
        Technology (``BACT'') and in many cases significantly improves 
        upon applicable air quality standards.
  <bullet> The project does not require new transmission towers, 
        routinely one of the most expensive and environmentally 
        detrimental aspects of new power projects.
  <bullet> The Metcalf Energy Center will use and evaporate an average 
        of three million gallons per day of recycled waste water and 
        will greatly assist the City of San Jose in meeting strict 
        discharge restrictions into the San Francisco Bay and improve 
        the South Bay salt water habitat for two endangered species.
  <bullet> The project will reduce local high tech companies' reliance 
        on diesel fuel to run back-up generators, few of which have any 
        pollution controls.
  <bullet> Calpine also helped to purchase 116 acres of adjacent land 
        that will remain as open space by collaborating with The Santa 
        Clara County Land Trust (and another 15 acres on Coyote Ridge 
        nearby).
  <bullet> Traffic and housing impacts from the project are minimal, 
        due to a small work force averaging 24 people per day.

    However, this seemingly ideal location and decision to build the 
Metcalf Energy Center is currently being held up on a number of local, 
state, and federal fronts--two of which involve federal regulatory 
approvals. The first is a ``Biological Opinion'' that must be issued by 
the U.S. Fish and Wildlife Service under the Department of the 
Interior. By statute, the Fish and Wildlife Service must provide a 
biological opinion granting or disapproving of the project within 135 
days of the date it receives the application. If the Fish and Wildlife 
Service adhered to this schedule, it would have rendered its opinion by 
August 2000. Even though all of the issues raised initially by the Fish 
and Wildlife Service have now been settled--at the latest by September 
2000, an opinion still has not been rendered over four months later. In 
fact, Calpine has been informed that no opinion will be provided for 
many weeks to come. Calpine understands that our submission is not 
atypical and that the Fish and Wildlife Service routinely exceeds its 
statutory deadline.
    Second, because of the Fish and Wildlife Service delays, the 
Metcalf project has also been seriously hurt by EPA's inability to move 
forward on the required PSD permit. We are unclear as to why the 
analyses required under these permitting procedures could not be 
managed simultaneously.
    Federal delays also tend to foster local delays by providing 
additional time for project opponents to mobilize and encourage other 
``Not In My Back Yard'' or NIMBY complaints. Calpine and our 
development partner, Bechtel Enterprises, have been embroiled in a 
well-publicized debate with one of the world's largest high-tech 
companies and a vocal neighborhood activist group, which played a role 
in the ultimate denial of the Metcalf Energy Center project by the 
local City Council. These intervenors have taken every opportunity to 
impede and derail our progress on the project. Since early 1999, 
Calpine has participated in over 50 public meetings or hearings 
addressing the Metcalf Energy Center project in order to respond to 
questions and reassure local communities; over one dozen additional 
hearings are still planned. The Company has responded to over 300 
written data requests to date.
    Due to the inordinate amount of obstruction in this case, the 
Metcalf project is not scheduled to receive a ruling until this summer, 
more than two years after the application was originally submitted to 
the State. Without the regulatory challenges and other complicating 
factors encountered to date, Calpine would likely have been actively 
constructing this vital power generating facility today. In its 
editorial last Friday, the Mercury News in San Jose characterized the 
initial failure to approve the Metcalf Energy Center as ``dumb'' and 
the continued failure to approve the project as ``dumber.'' Special 
interest opposition is further characterized as ``short sighted and 
parochial.''
             benefits of new generation of electrical power
    Calpine is prepared to invest in excess of $5 billion over the next 
five years to expand power production in California, adding over 10,000 
new megawatts of power for 10 million households. We are committed to 
spending our investors' money productively toward achieving beneficial 
goals that include reliable, low cost, and environmentally-responsible 
power. In essence, Calpine believes that the development of a modern 
fleet of power generation facilities will yield important benefits for 
our nation in four principle areas:
(1) Reduced Costs to Our Consumers
    Technological advances in the power generation industry now make it 
possible to generate power using 40 percent less fuel than the typical 
utility-style plants that were built in the 1960s and 1970s. Because 
fuel comprises over 85 percent of the variable operating cost of a 
plant, the reduced fuel use translates into lower overall costs. 
Calpine's plants also use highly efficient systems that require less 
heat than traditional plants to produce the same amount of electricity.
(2) Conservation of Resources
    By burning 40 percent less fuel while generating the same amount of 
electricity, modern power plants will significantly reduce our nation's 
consumption of fossil fuels. These important resources can then be 
conserved for future generations of Americans.
(3) Enhanced System Reliability
    The explosion of the digital economy has sparked an increase in 
growth for electric power as well as the need to ensure that our 
electrical system can provide reliable sources of power. Unfortunately, 
the nation's lagging development of new power generation and 
transmission facilities has put us in our current crisis and prevented 
the development of a highly-reliable and efficient electrical power 
service.
    According to past industry norms, a typical utility standard would 
provide electrical service with an average reliability rating of 99.9 
percent. This level of performance would translate into customers 
facing average outages of approximately eight hours each year. However, 
new, high-technology operations demand a much higher level of 
electrical service; typical internet and high-technology businesses now 
require service with a reliability rating of 99.9999 percent, the 
equivalent of having power outages for only a matter of seconds each 
year.
    Power shortages and blackouts have dramatic impacts on our economy. 
However, modern technology and power capabilities can allow us to 
greatly enhance the reliability of electrical service.
(4) Reduced Environmental Impacts
    Technological innovation has led to dramatic environmental 
improvements in electric power generation. Modern natural gas-fueled 
plants now typically emit air pollutants at a fraction of what were 
emitted into the environment by older plants. Our new modern projects 
can provide the following benefits compared to emissions from the 
typical fossil-fueled power plants built in the 1970s:


------------------------------------------------------------------------
                                               Reduction in emissions,
                 Pollutant                    pounds per megawatt-hour
------------------------------------------------------------------------
Nitrogen Oxides (NO<INF>X</INF>).....................  90+% reduction
Carbon Dioxide (CO<INF>2</INF>, greenhouse gas)......  40% reduction
Sulphur Dioxide (SO<INF>2</INF>).....................  99% reduction
------------------------------------------------------------------------

                       calpine's recommendations
    To help achieve our nation's overall energy goals, Calpine offers 
the following suggestions to the Committee. These suggestions are aimed 
specifically at improving the current burdensome regulatory procedures 
and not at the substantive environmental requirements themselves.
    First, Congress should take steps to ensure that the PSD program 
under Title I of the Clean Air Act is revised to eliminate the long 
delays--sometimes in the form of an ``automatic stay''--triggered by 
permit challenges by various allegedly ``interested'' parties where all 
of the key issues already have been thoroughly and extensively reviewed 
several times before by the appropriate governmental agencies. The PSD 
program is a detailed pre-construction regulatory review program under 
the federal Clean Air Act that applies to proposed new facilities such 
as electric-generating facilities that will be located in areas of the 
country that have good air quality (i.e., areas that ``attain'' 
applicable federal air quality standards). The PSD review process often 
can take more than a year, and in many instances, several years to 
complete. The public is allowed to comment at numerous points in the 
regulatory review process.
    For the past eight years, EPA has talked about streamlining the PSD 
and the related New Source Review (``NSR'') programs. The Agency has 
yet to finalize any revisions to its PSD rules, and the fate of the 
Agency's proposed reforms is uncertain. In fact, the directors of 12 
state environmental agencies (Alaska, Idaho, Illinois, Kansas, 
Louisiana, Michigan, Montana, New Mexico, North Dakota, Oklahoma, Ohio 
and West Virginia) recently notified EPA that they are dissatisfied 
with the Agency's recent PSD reform efforts, and have urged EPA to 
implement ``major reform'' so that a simplified PSD and NSR regulatory 
program can be established that provides affected parties with 
timeliness, certainty, and flexibility, while still protecting human 
health and the environment. We echo these states' concerns, 
particularly with respect to the need for increased timeliness and 
certainty in the PSD permitting process.
    Calpine believes that EPA's proposed reforms to the Title V air 
permit program may provide a useful example of the types of reforms 
that should be implemented in the Agency's PSD program. For example, 
over the past several years EPA has been working to provide facility 
owners with increased flexibility in complying with their Title V 
permit terms and conditions, defining set timeframes for agency review 
and completion of proposed permits, and eliminating unnecessary or 
extraneous permit conditions.
    Second, in general we must have clearly defined, standardized, and 
set deadlines for all federal and state agencies to complete their 
review of permit applications. We would recommend that all permit 
reviews be conducted concurrently whenever possible. In order to 
benefit from new power plants, Congress must help to establish a 
permitting process that fairly, yet efficiently, allows public input 
but does not delay or halt deserving projects. Calpine applauds the 
fact that the Fish and Wildlife Service is subject to a specific 135-
day review period, but this and other timelines need to be adhered to 
by the agencies. If these agencies fail to act within the prescribed 
timelines, they should then be precluded from further involvement. 
Calpine also recommends that specific deadlines be established for 
agency action denying or approving private party challenges to proposed 
permits. Once a decision is reached on any claim, Calpine believes that 
it should not be necessary to revisit the same issue again at another 
stage of the regulatory process.
    Finally, EPA should not automatically stay construction of new 
power plants merely because an appeal of a permit has been filed. EPA 
should consider issuing a stay only when a challenge presents clear and 
substantiated evidence that EPA may wrongly h