Subject: California Update 4/27/01
From: [email-masked]
To: [email-masked], [email-masked]
Cc: [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked], [email-masked]
Date: Fri, 27 Apr 2001 09:25:00 -0700 (PDT)

The following report contains confidential and sensitive information.  Please 
treat with discretion.

Executive Summary:
? FERC price cap decision reflects Bush political and economic objectives. 
Politically, Bush is determined to let the crisis blame fall on Davis; from 
an economic perspective, he is unwilling to create disincentives for new 
power generation
? Davis finds four major flaws with FERC plan, most notably its exclusion of 
out-of-state generators
? June 1st "kill clause" for FERC order could coincide with new Bush regional 
plan
? California facing growing fiscal risk following bond downgrade, expected 
$20 billion power bill this summer--economic crisis would force deeper 
Administration involvement
? QF bid for advance payments from PG&E likely to fail in bankruptcy court
? New generation delays probable because of State/QF squabbling
? Consumer groups are preparing a constitutional challenge to SoCal bailout 
deal

1. FERC Fallout
The FERC decision is a holding move by the Bush administration that looks 
like action, but is not.  Rather, it allows the situation in California to 
continue to develop virtually unabated.  The political strategy appears to 
allow the situation to deteriorate to the point where Davis cannot escape 
shouldering the blame.  Once they are politically inoculated,  the 
Administration can begin to look at regional solutions.  Moreover, the 
Administration has already made explicit (and will certainly restate in the 
forthcoming Cheney commission report) its opposition to stronger price caps 
on the grounds that they are unwilling to create disincentives to the 
construction of new generation.

It is interesting and ironic to note that electricity generators were 
generally happy with the FERC order and that the only FERC commissioner who 
favors price caps actually voted against this plan. 

2. Something Less than Effective Price Caps
 From Davis's point of view, the FERC plan has four major flaws:
? The order applies only to California, not to the rest of the west. 
Non-California generators are not required to sell at capped rates to 
California.
? As the order is written, it is more of a price floor for emergency power 
than a ceiling.
? State officials also believe that energy suppliers will continue to game 
the system, because the price mitigation scheme only kicks in after a Stage 2 
emergency and does not require any collusion.
? Even when the price caps kick in, they are based on the cost-plus for the 
highest cost producer supplying power to California and do not require 
wholesalers to abide by the cap.  The generators can also charge above the 
cap, provided they can subsequently justify the excess charge to FERC.

3. Proposal "Kill Clause" Adds to the Political Dilemma for Davis
The FERC proposal includes a "kill clause" that says the caps will be 
withdrawn unless California's ISO agrees by June 1st to become part of the 
regional grid now under FERC control.  If Davis doesn't sign on to the 
regional grid by June 1st, then he will have to live with June 2nd headlines 
blaming him for letting the "Bush price caps plan" collapse.

4. Growing Fiscal Risk in California
Sources speculate that California  could therefore pay as much as $20 billion 
on power this summer - this is more  than the combined enterprise value of 
PG&E and SCE.  These sources believe that, because of the severity of the 
situation, the FERC and/or the  federal government will be forced to take 
further action to control prices for  power.

The consensus is that the state of California will run out of money in about 
90 days. One of the first projects to be cancelled will be state plans to 
finance new power plant construction in exchange for long-term power deals.  
The bleak fiscal picture is also causing bank creditors to revisit the bridge 
loans they are providing to California.

The Bush Administration and the Fed are only now waking up to the seriousness 
of the fiscal picture.  The country's largest and most prosperous state will 
have gone from large surpluses to serious debt downgrades and devastating 
deficits in a matter of months.

5. QFs to Seek Advance Payment from PG&E
Meanwhile, on the bankruptcy front, the QFs reportedly  will ask the 
bankruptcy judge today to give them advance payment from PGE's  accounts, 
since their natural gas vendors have likewise demanded advance payment  for 
gas. It appears very unlikely that the QFs' request will be granted. If the  
QFs do not receive advance payment, it is likely that most of the 4,000 mw  
of gas-fired QF capacity will remain offline.
 
6 Delays Likely in New QF Generation
The QF deals made with the state for long-term contracts are  being 
continually renegotiated, which is likely to mean that the new plants  those 
contracts are supposed to finance will not be online as early as  anticipated.

7. Consumer Groups Ready to Challenge Constitutionality of SCE Bailout Plan
Harvey  Rosenfield and his colleagues reportedly have been reviewing an 
analysis  of the MOU for the SCE bailout  plan.  The analysis was done by a  
utilities analyst, rather than a lawyer, though it appears to raise a number 
of  good legal points. For example, one of the elements of the MOU is a 
"non-bypassable" charge  on ratepayers that would require  them to pay even 
if they disconnect from the grid. This is effectively a tax,  since there is 
no exchange of value  for money, which under the CA constitution cannot be 
used to directly  benefit a private entity.  This makes  the bonds that would 
be issued are general obligation bonds, rather than revenue  bonds. According 
to the constitution, the state cannot be put into debt to  benefit a private 
company.  For this and other reasons, even if the  Republicans would vote for 
the SCE bailout, which remains  unlikely, the bailout probably would not  
stand a likely constitutional challenge.  

8. Governor Hurt by Continued Failure to Disclose Long-Term Power Contracts
The issue of the Governor's failure to  disclose the details of the long-term 
power  contracts continues to  distress the other players in the  crisis.  
Even if he were to  disclose everything he and his staff have been 
negotiating, it is likely that their actions and negotiations will 
challenged, creating an even further delay.