Message-ID: <10403699.1075849641031.JavaMail.evans@thyme> Date: Tue, 13 Mar 2001 08:17:00 -0800 (PST) From: ken.skilling@enron.com To: all.worldwide@enron.com Subject: California Energy Crisis Mime-Version: 1.0 Content-Type: text/plain; charset=ANSI_X3.4-1968 Content-Transfer-Encoding: quoted-printable X-From: Ken Lay and Jeff Skilling X-To: All Enron Worldwide X-cc: X-bcc: X-Folder: \John_Griffith_Nov2001\Notes Folders\All documents X-Origin: GRIFFITH-J X-FileName: jgriffit.nsf California=01,s power crisis has generated heated debate over the last seve= ral=20 months. Unfortunately, this debate has generated more heat than light. We= =20 want you to know what the facts are and what we are doing about the crisis.= =20 Please spend a few minutes reading the following overview on the situation= =20 and our position on California energy issues. What happened in California The source of California=01,s current problem is as straightforward as supp= ly=20 and demand. California=01,s economy grew 29 percent since 1998. This incr= eased=20 the demand for electricity by 24 percent. At the same time, regulatory=20 restrictions prevented new generation from getting built in the state. So= =20 demand grew but regulations prevented supplies from being added. The resul= t,=20 predictably, is a shortage. This summer, peak capacity will be about 10=20 percent shy of peak demand, leading to further blackouts in the state. In addition to the supply and demand imbalance, there are two other related= =20 factors that led to the current crisis. First, the state=01,s regulations= =20 forced all sales and purchases into the spot market. The spot market for= =20 power is extraordinarily volatile. The way firms behave in a free market= =20 when faced with such volatility is to construct a portfolio of purchases lo= ng=20 term, medium term and short term, to reduce exposure to this volatility. I= n=20 California, state regulation prevented this strategy. This would be the=20 equivalent of putting the entire state on an adjustable rate mortgage in th= e=20 most volatile interest rate environment imaginable. Everything was fine=20 while the power surplus persisted, but when shortages ensued, every megawat= t=20 was purchased at the sky rocketing spot price. Second, retail markets were not deregulated. Regulated retail rates remain= ed=20 in effect, and stranded cost recovery charges were structured to keep=20 competition out. This meant that utilities were forced to pay high wholesa= le=20 prices in the spot market but were only able to recover costs at the=20 regulated retail rate. They are now nearly bankrupt. In short, California=01,s problems were caused by regulation, not deregulat= ion. =20 Regulations prevented competitors from entering the market, prevented new= =20 generation from being built, and prevented prudent hedging against volatile= =20 spot prices. At the time California was developing its restructuring plan, Enron warned= =20 the state=01,s policy makers about these risks and proposed alternatives, w= hich,=20 if adopted, would have averted the current crisis. Enron=01,s Role Many political leaders in the state have elected to fix blame rather than f= ix=20 the problem. Power sellers, including Enron, have been vilified by the=20 politicians and the media. Here are the facts: ? Other than a small amount of wind power, Enron is not a generator in the= =20 state of California. Every megawatt we sold in California we bought in the= =20 same market available to other California purchasers. Because we are a=20 market maker, not a generator, we are not biased toward high prices. We ar= e=20 interested only in having a market that works so that we can package produc= ts=20 for our customers. ? As a seller to end-use markets in the state, we provided protection from= =20 the problems the states=01, utilities, and their customers, now face. We= =20 protected, and still protect, our customers from price volatility. You may have read that EES recently elected to have the utilities supply=20 power directly to its customers in California instead of procuring power on= =20 the open market. Early reports mischaracterized this as a =01&turnback=018= of our=20 customers to the utilities. Here are the facts: ? As a result of a variety of factors existing in the current California=20 market, it made more sense for EES to source power for its customers direct= ly=20 from the utilities. This decision reduced EES=01,s market price risk by=20 allowing EES to access lower utility rates. ? EES did not terminate any customer contracts, and our customers continue = to=20 receive the financial benefits of their contract prices. ? EES is continuing to work with its California customers to provide them= =20 with other energy-related products and services, including assistance in=20 reducing the demand for power, particularly at peak times. Enron is currently proposing solutions to help California work out of its= =20 crisis; Enron continues to sign up customers in the state; and Enron=20 continues to actively manage its risks and capture opportunities in Western= =20 power markets. Enron=01,s primary business is managing risk for our custom= ers=20 with solutions customized to meet their needs. There has never been more= =20 demand for our products and services. The Solution The solution to California=01,s crisis is also straightforward. In summary= , the=20 state must increase supply, reduce demand, reduce reliance on the spot mark= et=20 and shore up the financial stability of the state=01,s utilities. Increasing Supply California=01,s process for siting and permitting new generation is nothing= =20 short of Byzantine. Enron has built plants elsewhere in the country in les= s=20 than a year. In California, it often takes 5 to 7 years. California simpl= y=20 must streamline this process. Ironically, while many of the regulations=20 generators must overcome are aimed at improving environmental quality, the= =20 regulations are preventing new clean technology from coming online and=20 displacing current plants, which emit 40 times as much NOx. California can= =20 have abundant power and cleaner air by expediting the permitting of new=20 facilities. Reducing Demand Customers in California today have no incentive to reduce or shift demand. = =20 They pay the same rate no matter what the market price is. An open retail= =20 market would trigger demand responses, which would balance supply and deman= d=20 at lower prices than today. California should fully open its retail market= . Reducing Reliance on the Spot Market In a truly deregulated market, customers would protect themselves from=20 volatile spot prices by purchasing some of their requirements on a longer= =20 term, fixed-price basis. The state has instead left procurement in the han= ds=20 of the utilities, which it has forced to buy exclusively in the spot market= . =20 Opening the market at the retail level will give customers control over the= ir=20 price risk. Restoring the Financial Integrity of the State=01,s Institutions The utilities in California are not paying their bills. This has led to=20 greater uncertainty in the market, higher costs, and reduced flexibility to= =20 arrive at lasting solutions. California must permit its utilities to recov= er=20 their costs so they can pay their bills and invest in the transmission and= =20 distribution assets necessary to get power from where it is to where it is= =20 needed. Just as important as doing these things, the state must avoid policies that= ,=20 while politically attractive, do not fix the problem or even make matters= =20 worse. Price caps have been proposed. They don=01,t work; have never work= ed;=20 and they will not work here. Price caps succeed only in creating shortages= ,=20 which then have to be allocated among competing users. Imagine how=20 ineffectively the government would be in determining, for example, whether = it=20 is better to make its limited power supplies available to the Imperial Vall= ey=20 or Silicon Valley. Price caps are a surefire way to make the current=20 shortage worse. The state has also proposed to take over generation and transmission in=20 California. There is no reason to believe, and every reason to doubt, that= =20 the state will be more effective than free markets at investing in,=20 constructing, operating and maintaining assets. This will also result in= =20 California tax revenues being spent on power transmission and power=20 generation -- which the private sector can do -- instead of education, road= s=20 and other public goods -- which the private sector cannot do. As you are approached by people outside the company or are learning about t= he=20 crisis from the media, it=01,s important for you to know this: We at Enron= will=20 continue to serve our customers and we will continue to propose real=20 solutions to the state.