Subject: Andersen releases reptort on CA crisis, lessons for regulation and market
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Date: Wed, 25 Apr 2001 03:18:00 -0700 (PDT)

All:  Attached for the reading pleasure of the CA team is the Andersen report 
- "Energy Crisis in the Western U.S." Reproduced below is a related article, 
and that is followed by the text of the Andersen press release on the 
report.  Ray

	NGI's Daily Gas Price Index 
published : April 25, 2001
	Andersen Warns Of Increased State/Federal Tensions 
	The likelihood of friction between state and federal regulators increasing 
over deregulation plans if states slow or walk away from retail competition 
is just one of several important implications resulting from the ongoing 
shockwave that has rolled through the Western energy markets, according to a 
new report issued Tuesday by Andersen. 
	The report, "Energy Crisis in the Western United States: Lessons for 
Navigating Regulatory and Market Minefields," was unveiled by Andersen's 
North American Energy Consulting Practice at a Washington, D.C., briefing. 
	David Jermain, principal with Andersen's North American Energy Consulting 
Practice, noted that the report identifies eight overriding implications 
emanating from the Western energy crisis. "These aspects of the California 
virus will shape the longer-term operations of the Western grid, the regional 
and national economy, domestic energy policy and the industry's evolution," 
he added. 
	The eight implications singled out in the Andersen report are: 
	Increased deregulation uncertainty and risk 
	Reduced investor confidence 
	Contributing factor in economic softening 
	Increased pressure on the Western grid 
	Unbundling failures that push companies back to portfolio strategies 
	Ineffectiveness in changing siting and development restrictions 
	Procurement management that alters user-utility negotiating leverage; and 
	Increased emphasis on distributed generation and new technologies 
	"Tensions and differences between state and federal regulators raise the 
specter of repeating the regulatory and political conundrum California's 
investor-owned utilities have been facing," Jermain said. If federal 
initiatives open wholesale markets while retail markets remain regulated, a 
crucial question emerges, namely whether state regulators will pass-through 
higher wholesale costs if they should occur. "Tensions between state and 
federal regulators over policies on deregulation will grow if states delay or 
abandon retail competition," Jermain stated. 
	As to the California situation creating increased pressure on the Western 
grid, Jermain noted that "Even as capacity increases and demand reductions 
work to resolve the California crisis, these solutions have long-term 
implications for the Western grid." Such implications include a realistic 
chance that California could become an "energy island" as a result of 
near-term reduction in available regional resources for export to California, 
according to the Andersen report. Also, there could be increased emphasis on 
security control to protect against overall Western grid failure as 
sub-regions have difficulties. 
	Along with yesterday's report, Andersen also issued the results of an 
Andersen survey of senior executives from 16 non-California utilities 
detailing their views of the implications of the California power crisis for 
their companies and the industry. The survey was conducted between February 
19, 2001, and March 2, 2001, by Knowledge Systems & Research Inc. of 
Syracuse. 
	On the deregulation front, nearly all the executives surveyed said they 
believe recent California events will slow the pace of deregulation over the 
next five years for states that have not begun or finished writing 
restructuring legislation. None believe that it will result in advanced 
states deciding to re-regulate markets, although many states will review 
their legislation to assess the risk of duplicating California's current 
situation and make any changes necessary to avoid it. 
	As to legislation at the federal level, the survey found that few executives 
suggest that the California situation will spark national energy 
policy/legislation. Other executives believe that it will be a continuing 
issue but, because of state-to-state variances, Congress will be unable to 
pass any comprehensive measures or force states to a restructuring timeline. 
	Turning to company strategies, most of the executives surveyed do not see any 
changes to their business models or strategies for generation, distribution 
or supply procurement as a response to the situation in California. However, 
many have, among other things, expanded their risk management programs, 
reduced spot market purchases and started emphasizing long-term supply 
contracts. Those executives facing price caps are rethinking their stance on 
them, according to the Andersen survey. 
	The full Andersen report on the Western energy crisis can be downloaded at 
www.andersen.com. 

ower companies and regulators must take steps to avoid spread of California 
Power virus: Andersen analysis

WASHINGTON, D.C., April 24, 2001 * A &new virus spawned in California8 poses 
formidable challenges requiring new strategies on the part of power 
companies, regulators and policymakers to contain and reverse its damage, 
according to Energy Crisis in the Western United States: Lessons for 
Navigating Regulatory and Market Minefields, a new Andersen report released 
today. 
&The implications for the development of competitive energy markets go far 
beyond the Western United States,8 Andersen,s national utility practice head 
Matthew D. Smith told a Washington briefing. &Unfortunately, California has 
taught the nation that regulatory and political barriers can create and 
sustain an energy crisis.8

&California has demonstrated that the risks in the electricity industry, if 
not properly acknowledged and managed, can simultaneously and profoundly 
impact all market participants. To be effectively managed, these risks need 
to be exposed, assumed or shared, measured and monitored. When they are 
hidden or ignored, all parties can potentially suffer. A shared, integrated 
view of these risks, and a strategy for their assumption and management, is 
critical to avoiding rapid value destruction within the energy market,8 Smith 
said.

An Andersen survey of senior utility executives outside California, also 
released at the briefing, indicates most utility companies believe they 
inoculated themselves against the California virus so that it is unlikely to 
affect their operations beyond slowing the pace of deregulation and 
increasing investor scrutiny. However, based on the potential implications it 
sees of the California situation, Andersen believes a series of booster shots 
are advisable for power companies and regulators. &To deliver reliable 
service at a predictable cost in today,s environment, companies must focus on 
market integration by developing new and innovative relationships between 
suppliers, customers, employees and investors ) while working with government 
officials and regulators to chart a smoother transition to a deregulated 
power market,8 according to Smith.

Eight Implications
The Andersen report identified eight overriding implications emanating from 
the Western energy crisis that are shaping the longer-term operations of the 
Western grid, the regional and national economy, domestic energy policy and 
the industry,s evolution:
1. Increased deregulation uncertainty and risk ) Tension and differences 
between state and federal regulators raise the specter of repeating the 
regulatory and political conundrum California,s investor-owned utilities have 
faced. If federal initiatives open wholesale markets while retail markets 
remain regulated, a crucial question is raised: Will state regulators 
pass-through higher wholesale costs if they should materialize? Tensions 
between state and federal regulators over policies on deregulation will grow 
if states delay or abandon retail competition. 
As wholesale markets are deregulated and RTOs begin operating, the prudence 
principles that state regulators have used for many years may have to be 
changed. For example, if FERC and RTO monitors determine that deregulated 
wholesale markets operate fairly, prices derived from those markets must be 
considered reasonable. If so, these costs should be allowed into 
state-regulated retail rates without regard to the prudence principles state 
regulators have used for years. Therefore, utilities, traditional burden of 
proving costs are or are not justifiable shifts to regulators.

2. Reduced investor confidence ) Prior to deregulation, stringent prudence 
review and disallowance of generation costs in the rate base made regulatory 
risk largely uncontrollable, killing IOU interests in most new investment. A 
major purpose of deregulation was to create an environment in which risk 
could be managed, but California,s political and regulatory environment 
provides only a limited ability to manage risks. The confidence and 
perceptions needed to support investment decision-making will be slow to 
return given the approach of the state to remedy the crisis.

3. Contributing factor in economic softening ) Uncertain energy reliability 
and higher costs can drive-out marginal businesses, cause healthy companies 
to constrain expansion, and lead new entrants to question whether to make new 
investments. As such, an extended energy crisis contributes to inflation 
pressures and may slow economic growth.

4. Increased pressure on the Western grid ) Even as capacity increases and 
demand reductions work to resolve the California crisis, these solutions have 
long-term implications for the Western Grid. These include a realistic 
possibility of California becoming an &energy island8 as a result of 
near-term reduction in available regional resources for export to California; 
increased emphasis on security control to protect against overall Western 
grid failure as sub-regions have problems; RTO requirements to strengthen 
locally available supplies to bolster overall system reliability; longer-term 
development of new plants using plentiful coal resources and clean coal 
technology will alter the pattern of imports into California; and the 
emergence of Mexico as a major supplier to southern California and Arizona, 
contributing to a bifurcation of the Western Grid into northern and southern 
markets

5. Unbundling failures that push companies back to portfolio strategies ) For 
California investor-owned utilities, unbundling has achieved neither the 
least-cost solution sought by regulators nor value maximization targeted by 
investors. This necessitates a reevaluation of portfolio management 
strategies potentially involving generation, transmission, power trading and 
marketing, and retail businesses in multiple geographies serving multiple 
markets.

6. Ineffectiveness in changing siting and development restrictions ) 
California,s retail price caps and multiple explanations for the crisis have 
left accelerated siting processes and environmental standards changes open to 
challenge by various interests. In addition, limiting application of new 
siting orders only to small generators contributes to uncertainty and 
investor hesitancy.

7. Procurement management that alters user-utility negotiating leverage ) 
Competitive markets compel participants ) suppliers, marketers, large 
industrial buyers, etc. ) to strategically manage procurement as a critical 
value-driver. Because risk is explicitly shared and always has the potential 
of shifting advantage to either seller or buyer, the sophistication of 
negotiations and contracts increases as competitive markets evolve.

8. Increased emphasis on distributed generation and new technologies ) 
California,s reliability and price challenges have triggered a re-emergence 
of energy crisis measures from the 1970s. End-users are investing in 
solutions they control, and the distributed generation market is being 
aggressively developed among large retailers, industrial users and 
residential customers. This makes possible the development of microgrids 
connecting consumers in local areas and related changes in traditional grid 
systems, from modifications in interconnection agreements to changing 
definitions of reserve margins and system reliability.
Industry Executives, Response
Senior executives from sixteen non-California utilities with a combined 
market capitalization over $120 billion and $145 billion in revenues 
responded to an Andersen survey with their views of the implications of the 
California power crisis for their companies and for the industry. The survey, 
conducted between February 19, 2001 and March 2, 2001 by Knowledge Systems & 
Research, Inc. of Syracuse, found that the companies are observing the 
California situation carefully, expect a slowing ) but not a turnaround -- of 
deregulation, and believe their internal plans and preparations are on-target 
for the changing environment:
Deregulation - Nearly all executives believe recent California events will 
slow the pace of deregulation over the next five years for states that have 
not begun or finished writing restructuring legislation. None believe that it 
will cause advanced states to re-regulate markets, although many states will 
review their legislation to assess their risk of duplicating California,s 
current situation and make any changes necessary to avoid it. 
National legislation - Few executives suggest the situation will initiate 
national energy policy/legislation; others believe it will be a continuing 
issue but, because of state-to-state variances, Congress will be unable to 
pass any comprehensive measures or force states to a restructuring timeline. 
Some expect additional state-level legislation. 
Company strategies - Most do not see any changes to their business models or 
strategies for generation, distribution or supply procurement as a response 
to the situation in California. However, many have expanded their risk 
management programs, reduced spot market purchases, begun emphasizing 
long-term supply contracts, planning new power generation capacity, and 
started hedging with futures trades. Those facing price caps are rethinking 
their stance on them 
Investor scrutiny ) Many executives indicate their shareholders are aware of 
the situation and investors -- particularly institutional investors -- are 
more heavily scrutinizing their actions. Many say news coverage has prompted 
retail, commercial and industrial customer skepticism of industry 
restructuring. 
Transmission deregulation - Many executives agree the California situation 
will increase interest in FERC,s regional transmission organizations (RTO) 
deregulation effort.
Utility Company Action Items
Both to guard against a sudden California cascade and as a potentially 
powerful competitive thrust, forward-thinking utilities should bolster their 
basic preparedness with a variety of tactics -- or inoculations -- 
specifically aimed to combat a potential California power virus, according to 
Andersen partner Mark Moskovitz:
Improve procurement management and risk management capabilities - To manage 
exposure to volatile supply and demand shifts, organizations must be sure 
that comprehensive and clear supply procedures, controls, decision points, 
risk limits and communications are in place. 
Plan and design innovative rate and pricing structures ) Companies and 
regulators must focus on communicating price signals that create value for 
both the customer and the provider. Innovative rate and pricing structures 
that more closely tie the customer,s price to the real cost of supply will 
better signal the value of the service as well as providing more accurate 
information upon which both end user and supplier can make decisions. 
Increase emphasis on demand side management (DSM) strategies ) In addition to 
new pricing strategies to help achieve and maintain supply-demand 
equilibrium, companies must now focus on employing more extensive and 
innovative demand side management programs. These programs may offer 
significant benefits with limited risk to both the customer and energy 
supplier. 
Assess the supply and generation dynamics in adjacent jurisdictions ) 
Companies must take a broader view ) beyond typical geographic market 
definitions -- of the economics of generation and related business decisions 
in an increasingly volatile market in which supply will follow the best 
prices. 
Develop contingency plans for the continued deferral of new generation 
capacity ) In the face of potential ongoing generation capacity shortages, 
companies and regulators must be prepared to move with a portfolio of 
strategies to meet demand, including for example DSM, flexible pricing and 
distributed generation. In addition, they should explore efficiency-improving 
upgrades to existing facilities and seize any opportunity to accelerate 
near-term construction plans. 
Proactively address potential organizational disruption ) As regulatory and 
economic changes continue to churn the industry waters and companies adjust 
and/or restructure, they must be highly cogniscent of, sensitive to, and 
directly address employees, concerns with information about the company,s 
future and theirs,.
Industry/Regulatory Lessons
There are also a number of broad primary lessons the electric power industry 
-- nationally and internationally -- should take away from its first major 
domestic test case in deregulation and restructuring, according to Andersen 
principal David O. Jermain:
Simplify market design. 
Build a continuing role for regulators. 
Maintain communications with multiple constituent interests. 
Prepare contingency plans for extreme stress conditions. 
Couple real-time retail pricing with transparently priced wholesale 
competition. 
Provide special incentives for RTO investment, formation and development. 
Break down regulatory and political barriers to market signals and responses.
Copies of the Energy Crisis in the Western United States: Lessons for 
Navigating Regulatory and Market Minefields report can be obtained at 
www.andersen.com/energyandutilities.