Letter to U.S. Senator Dianne Feinstein

February 26, 2001
 
The Honorable Dianne Feinstein
U.S. Senate
331 Senate Hart Office
Washington, DC 20510

 
Dear Senator Feinstein:
 
Thank you for providing Enron the opportunity to testify before the Senate Energy and Commerce Committee on January 31st. I will here elaborate on a couple of solutions I mentioned in my testimony and provide an update on the California crisis.
 
We are running out of time in California. This summer we are expecting a capacity shortage of 10% during on-peak hours. With normal weather and currently forecasted hydro conditions, California will face persistent, random blackouts.
 
California is not solving its problem. While there have been some welcome efforts to encourage conservation and expedite the movement of applications through the byzantine power plant approval process, most of the activity has now shifted to an effort to "nationalize" California's electricity industry. Legislation to put the state in the power generation business and establish state ownership of California's portion of the interstate transmission system is rapidly moving through the state legislature.
 
This legislation will only make matters worse. While giving the appearance of decisive action, a government takeover of the state's electricity system can only delay an honest reckoning with the very real problems that lay at the heart of the crisis. State ownership will not increase supply or reduce demand by a single megawatt. (Further, if previous experience with state-owned enterprises is any guide, it will likely reduce efficiency and reliability.) Worse, the measures in front of the California legislature will actually hinder or thwart entirely the ability to craft workable solutions to the supply-demand problem that undergirds the current difficulties.
 
At the most fundamental level, these efforts distract resources from actions that could actually help resolve the crisis. Beyond that, they present several significant problems. First, the reliability of supplies throughout the West depends on an open grid to move power from where it is to where it is needed. California's protectionist measures will only invite countermoves by other states, many of whom California needs to provide it with adequate supplies. Second, unless the state overpays substantially for the utilities' transmission assets, these steps will leave the utilities no better off than they are currently. Whether the utilities hold the assets themselves or their value in cash makes no difference at all to their overall financial position or to the willingness of creditors to continue dealing with them. Third, by funding the purchase of the assets with public monies the state proposes to divert its hard-won surplus away from schools, hospitals, law enforcement or other appropriate public uses, and toward a business it doesn't belong in. By proposing to buy the grid with money taken from its citizens in the form of taxes rather than higher electric rates, the state continues to mask the true cost of power to California's consumers while simultaneously driving out the private enterprises that could bring those costs down. The only discernible merit of these destructive proposals is their perceived political appeal to a constituency that views rate increases as anathema.
 
Let's put these legislative proposals in the context of hard realities in the state. California entities are not paying their bills for power purchased. Because their rates are frozen, California customers don't know the cost of the power they are using--so they don't conserve when prices increase. Meanwhile, they unwittingly pay the true cost through the depletion of the state budget surplus. Instead of reducing prices by lowering demand, the state calls for reregulation and price caps (while neighboring states must raise their own rates and make up California's supply shortfall). Legislation to give the state condemnation authority over private businesses and facilities is moving through the legislature. In short, California is building an "electric fence" around its borders, and telling private capital – which is desperately needed – to go elsewhere.
 
I suggest the following:
 
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    		•  The effort to carve off California's portion of the interstate grid from the rest of the West must be stopped.
     
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    		•  Instead, federal policy makers should focus on fully opening the power grid across the country to ensure the movement of power from where it is to where it is needed. California is not the first, and will not be the last, to attempt to interfere with interstate commerce in the power sector. Our nation's grid is more reliable and more efficient if it is open. As supplies tighten around the country, the problems we are seeing in California will be repeated.
     
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    		•  California must reform its environmental permitting process. The irony is that the current system actually reduces air quality by keeping new, more efficient plants off the grid while decades-old facilities that emit NOx at levels 40 times higher, continue to run.
     
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    		•  California must institute a program of demand "buy downs." There is not enough time to build new generation for this summer. But, the state could take bids for voluntary demand reductions. This will reduce prices more effectively than price caps and will reduce or avoid involuntary blackouts. California is tapping into an enormous amount of money from the General Fund to finance DWR's power purchases. California could likely reduce demand more economically by running an auction to determine the payments businesses would be willing to receive to reduce their demand for a sustained period (e.g., through the summer months). DWR could easily run an on-line auction to determine the price it could pay for these demand reductions. To participate, businesses would be required to have the metering equipment necessary to monitor and verify that they are actually achieving the reductions. To be successful, customers need access to the following key elements:
     
    >  An Internet-based, hour-ahead price posting system to track the market price for hour-ahead power in real time.
     
    >  Real-time metering systems for baseline demand and voluntarily curtailment verification.
     
    >  A Settlement process that allows for market clearing prices of energy to be paid for load reduction ("Negawatts").
     
    >  The potential benefits of an effective demand response program would include:
     
    -  "creation" of additional summer peaking capacity in California, particularly in the short term, without requiring construction of additional generation resources.
     
    -  reduction of peak or super-peak load on the over-stressed California electric system, thus potentially reducing the overall cost of electricity in the state.
     
    -  expansion of demand elasticity without subjecting customers to the full risk of hourly market price volatility by passing market price signals to customers and allowing them to voluntarily shed load and be compensated for responding.
     
    Just as important as getting these things done, is avoiding those measures that will make matters worse. In addition to the ill advised state takeover of the industry discussed above, price caps will compound problems in the West. "Soft" or cost- based caps have not worked in California--they left many sellers unwilling to sell, they reduced competition from marketers whose cost structure simply does not conform to traditional cost of service ratemaking, and they left California power purchasers scrambling at the last minute to buy power to avoid further blackouts. They only add to the uncertainty sellers face in deciding whether or not to invest or make sales. Cost of service ratemaking is at best a poor substitute for market pricing (which is why it is avoided for all services except monopoly services such as transmission and distribution). Rate proceedings are contentious, often political and extremely lengthy proceedings. They are particularly ill suited to situations like those we find in the West today (i.e. extremely volatile cost components such as fuel and emissions costs). At a time when investors need assurances that the power business will not be "reregulated", price caps will only exacerbate the already short power supply situation. There is a way to get prices down: increase supply or reduce demand. The solutions outlined above do exactly that. State takeovers and regulated rates do not. Instead, they leave policymakers with the worst possible task: deciding whose power to turn off. West-wide price caps will make this even worse: how will western states decide, for example, whether Idaho agriculture or California's high tech industry is more deserving of power during any given hour?
     
    Overall, California policy makers must adopt a laser-focus on measures that increase supply or decrease demand. Any measure that does not accomplish one or both of these objectives is a waste of time at best. At the same time, federal policy makers should focus on opening the interstate grid so that power can move from where it is to where it is needed.
     
    Again, I thank you for the opportunity to share Enron's observations with you and look forward to continuing to identify real solutions to this crisis.
     
    Sincerely,
    Steven J. Kean