Frontlines
Taken to the Cleaners
FERC's California plan needs pressing, to fix blatant gaffes on NOx, demand bids, and megawatt laundering.
You're a federal utility regulator. You want to place a ceiling on electricity prices paid to power producers in California, but you don't want to impose those evil price caps. No sir.
So you set a proxy price for a hypothetical competitive market, based on what you think are reasonable costs for operating a typical power plant, like thermal efficiency (plant heat rate) and buying natural gas for fuel. Then add $2 for miscellaneous operating and maintenance expense. That should do it.
But something goes wrong. After you've written your ratemaking order, have seen it hit the street, you discover that one of your cost categories--the cost of purchasing emissions allowances to meet environmental requirements--isn't even a cost any more. While you had your back turned, two or three months earlier, that darned governor out in California granted a reprieve to power plants designed to bring more supply to the market. He freed local generators from having to buy additional emissions credits for nitrogen oxides (NOx) for each hour of operations, but your fellow regulators somehow remained clueless.
So now the industry is calling for rehearing, and you're reduced to writing a letter to Barry Wallerstein, executive director of California's South Coast Air Quality Management District (SCAQMD), to ask how SCAQMD applies their NOx emission permit rules to electric generators. But the California Independent System Operator (ISO) filed tariffs ignoring your NOx cost and pricing emissions credits at zero, since the ISO already knew about the governor's order.
Didn't everyone?
That's just one of the seemingly obvious gaffes lurking in the order that the Federal Energy Regulatory Commission (FERC) issued on April 26 that imposed a price control scheme on electricity sold through the wholesale real-time market run by the California ISO. Now add in the other mistakes, including plans to (1) mandate demand-side bidding, (2) collect surcharges to build an escrow fund to cover debts owed to power producer robber barons, (3) link price mitigation to formation of regional transmission organizations, and (4) ignore megawatt laundering--the one single biggest problem facing state price control efforts. Pretty soon you're running a serious risk of reversal on an appeal that's sure to be filed.
THESE ERRORS HAVE GIVEN NEW LIFE TO CALIFORNIA IN ITS FIGHT WITH WASHINGTON OVER ENERGY POLICY. But let's first distinguish between the parochial complaints we always hear from the utilities and the power producers on issues that FERC probably got right:
- Gas Costs. Utilities and producers both say FERC's averaging of natural gas prices for all delivery points statewide will wreck the proxy price, giving a windfall to producers in northern California, who pay less (and also to those with long-term contracts or gas supply affiliates). That leaves costs unrecovered for southern generators, who pay more for gas, or for producers relying more on spot purchases. Everyone seems to want an index with multiple price zones. Why not?
- Must-Offer Rules. Public power utilities (Turlock, Modesto, SMUD) whine that FERC can't force municipal utilities to sell resources to the ISO. They'll lose their tax-free financing. Meanwhile, power producers say they should reap "scarcity rents" (prices above marginal cost) if forced to sell as well. Are you kidding? Neither side will win.
- Market Manipulation. Power producers rejoice that regulators have failed to cite evidence of precise episodes of market manipulation by individual sellers, while the ISO staff, and many famous economists, churn out empirical studies showing that about one-third of power producer revenues in California stem directly from market power. Guess what? They're both right.
- Protection Against Risk. Utilities want the ISO to keep its hands off their self-generation still dedicated to native load, to cover the risk of the duty to serve. Producers, meanwhile, are short on power (they're net sellers). They also face portfolio risk, and must adopt curious bidding strategies, like the "hockey-stick" bids banned by FERC, and to withhold some plants with run-time limits (such as environmental restrictions) from dispatch except in super-peak hours, as Reliant claims, to preserve their option value as a hedge against risk of loss of plants already bound by forward contracts, and having to buy replacement power at exorbitant prices. You say that producers can't feather their bids to cover the higher risk of running more hours, as Mirant wants? Chill out. You'll never cover every risk.
- Regulator Prejudice. Utilities complain that FERC won't grant refunds. Producers say the ISO is a virtual market player, disregarding some FERC rules, using its authority to coordinate outages to hold prices down artificially, and allowing the California Department of Water Resources to gain access to the ISO control room, as Duke Energy alleges, to pick up confidential market information to grab an edge against producers in buying power for California residents. Can they do that? Too bad. Politics is cruel.
"THE ISO'S REAL-TIME MARKET HAS DIMINISHED IN SIZE TO ALMOST INCONSEQUENTIAL LEVELS SINCE JANUARY," says Patrick McAuliffe, of the California Electricity Oversight Board, and that's where the problem lies.
McAuliffe puts the ISO's BEEP (Balancing and Ex-post Price) market--the market subject to FERC's price mitigation plan--at only 4.4 percent and 4.5 percent of California ISO load in January and February, and only 1.4 percent in March. When you consider that mitigation only occurs during a Stage One, Two, or Three alerts, when reserves fall below 7.5 percent, you find, as McAuliffe notes, that "the size of the BEEP market subject to potential price mitigation had the FERC order been in effect in March 2001 decreases to 0.3 percent." That's three parts in a thousand.
Where did the load go? It went to "megawatt laundering," whereby a California producer sells power forward to a daisy chain of power marketers, who then are allowed under the FERC rule to sell back into California on the strength of their own purchase price, without having to justify the price as against the FERC's proxy price, based on gas and other operating costs.
"This is a giant loophole," says Mark Patrizio, at Pacific Gas & Electric. "If marketers can justify their sales based on purchase price, then generators can sell to marketers for any price."
Yet the FERC defends its decision because of the inherent difficulty of tracking all the discrete plant heat rates and natural gas fuel costs bound up in the typical blended portfolio of a typical power marketer.
Meanwhile, the plan for demand-side bidding appears virtually indecipherable, as it calls for FERC to intervene in retail markets, where it has no jurisdiction. The rule forces California's investor-owned electric utilities to bid a price into the ISO for which they will be willing to blackout their ratepayers, even though the IOUs are no longer credit worthy, and now rely on the state's Department of Water Resources (DWR) to nominate schedules at the ISO. But the DWR is not a utility with an obligation to serve, so it also lacks authority to pledge a curtailment on behalf of retail electric customers. So that violates California state law, as Patrizio adds.
But the kicker is probably the FERC's suggestion for the ISO to impose a surcharge on ratepayers to fund an escrow account to recover money that the IOUs allegedly owe to power suppliers. The ISO is having none of it. It refuses to build the proposal into its compliance tariff. Sidney Jubien, chief counsel for the Electricity Oversight Board, thinks he knows why.
"A surcharge that might be considered 'reasonable' would take an absurd period of time to collect," he notes.
"If a $10-per-megawatt-hour surcharge were implemented, the collection period would last for 102 years."
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