For the utility, wresting its assets from PUC control is the real point.

Gas & Electric Co.'s 17-month-old proposal to divest its hydro assets via auction likely is dead, a casualty of California's ongoing energy market turmoil. Despite this reality, the utility's auction proposal remained active at the California Public Utilities Commission (PUC) as of press time in mid-January, even as the governor and state legislature held emergency meetings amid rolling blackouts.

In his Jan. 8 State of the State address, California Gov. Gray Davis proposed repeal of the state law permitting its three IOUs—PG&E, Southern California Edison Co. (Edison), and San Diego Gas & Electric Co. (SDG&E)—to sell their remaining generating facilities. "Instead," Davis said, "we must require them to hold on to those facilities and sell their power to California consumers."

Separately, within the state legislature, Assembly Speaker Pro Tem Fred Keeley (D-Santa Cruz/Monterey) has proposed legislation that floundered last year to buy generating assets and run them as part of a state authority. Gov. Davis and others also have floated the idea of a California public power authority to correct what he has described as the state's energy "mess."

"California's deregulation scheme is a colossal and dangerous failure," Davis said in his speech. "It has not lowered consumer prices. And it has not increased supply. In fact, it has resulted in skyrocketing prices, price gouging, and an unreliable supply of electricity—in short, an energy nightmare."

Sentiment for blocking the divestiture also is strong within the state commission.

PUC commissioner Carl Wood recently issued a statement bluntly expressing his feeling that divestiture must stop. "[D]ivestiture of utility-owned power plants is a core feature of this [deregulation] disaster," he says. "It is perhaps the single largest factor in bringing about the totally dysfunctional wholesale markets that we find ourselves in today. ... I am frankly in a state of disbelief that anyone would still be seriously considering authorizing the further divestiture of some of the very little remaining generation that is owned by the utilities in California."

Others at the PUC, and more broadly within the state, echo these sentiments.

"Several [speakers at recent PUC rate hearings] have said this is an insane situation," says Bruce Kaneshiro, PUC project manager for the environmental impact report on PG&E's auction proposal. "Why would you allow divestiture of even more plants to the very people who are gouging California-especially when these plants are infinitely more valuable because they're not dependent on gas?"

Adds Robert Kinosian, a senior analyst in the PUC's Office of Ratepayer Advocates, "I don't think there's any chance the commission is going to approve any more divestitures, so why are we having a proceeding talking about selling off the hydro plants? ... Our position ... is [the assets] should be retained by the regulated utility subject to regulation. They should not be sold at this time. They should not be transferred to the utility affiliate."

At Stake, Ownership and Oversight

PG&E's hydro facilities represent the largest private hydroelectric power system in the nation. Vast and diverse, they include 68 powerhouses, 99 reservoirs, 174 dams, and approximately 140,000 acres of land stretching 500 miles from Mount Shasta in the north to Bakersfield in the south along 16 different river basins . Together, they represent 3,896 megawatts of installed capacity, some of which is said to be as much as 100 years old, and provide approximately 5 percent of the state's electric energy.

The impetus for valuation and divestiture of these—and other—generation assets in California is Assembly Bill (AB) 1890, the state's deregulation legislation, passed in 1996 and signed into law by then-Gov. Pete Wilson in September of that year. Among its provisions, it deregulated wholesale electricity prices effective March 31, 1998, and required that PG&E, Edison, and SDG&E determine the market value of all of their non-nuclear power plants by Dec. 31 of this year. Retail electricity prices were capped and scheduled to be deregulated in March 2002, allowing a four-year transition period during which the IOUs could recoup costs of their "stranded assets."

PG&E auctioned—and thereby valued—6,934 MW of its fossil and geothermal facilities in two phases in 1997 and 1998 to companies including Duke Energy Corp., Southern Energy Inc., and Calpine Corp. That left it with 3,896 MW of hydro, 2,200 MW of nuclear, and a small amount of fossil scheduled for replacement or co-existing at a retired nuclear facility.

PG&E's position is that AB 1890 requires that it not only determine market value but also divest its hydro assets by the end of this year. PUC staffers counter that the legislation requires only that the assets be valued, not that they be divested. As with the proceeds from the sale of fossil and geothermal assets, any value over book is then to be dedicated to paying down costs for stranded assets. This difference in book vs. market value is not trivial. While the hydro facilities have yet to be appraised formally, PG&E estimates a book value of approximately $700 million and a market value as high as $4.2 billion.

Furthermore, PG&E feels it is bound by PUC stricture to continue pursuing the auctioning process-a position that others dispute. Moreover, it holds that once valued, the assets are freed from regulation by the PUC under provisions of AB 1890. This position is another point of contention, however.

"PG&E is pushing very hard to get those assets out of rate base," says PUC commissioner Wood. "They are very unhappy with commission treatment over the years and claim they haven't gotten sufficient return on their investment. And they would prefer to do that through their unregulated subsidiary. They [further] claim that after the valuation of assets is supposed to occur ... that [those assets] will be free of regulatory rate control. At the commission we disagree with that."

The Tortuous Road to Divestiture

PG&E first filed with the PUC to divest its hydropower system in May 1998. Subsequently, in December of that year, it applied to hire an appraiser to assign value to the system. PG&E feels it was blocked in this appraisal attempt, but PUC staff say the proceedings were only suspended and could be reopened. Be that as it may, PG&E changed tack in early January of 1999, proposing to value and then transfer the system to its unregulated affiliate, then U.S. Generating Co., now PG&E Generating Co.

When this proposed transfer met with stiff opposition at the PUC—causing a "huge uproar," according to one source—the company switched venues to the California legislature. But the legislature adjourned on Sept. 10, 1999 without taking action on the transfer, and so PG&E 20 days later filed back at the PUC for approval to sell off the assets through auction. In October of that year it filed its proponent's environmental assessment on the divestiture, and last April the PUC issued its notice of preparation of an environmental impact report (EIR) as required under the California Environmental Quality Act (CEQA).

The matter rested there until last August, when PG&E filed a proposed settlement agreement in conjunction with various consumer, agricultural, and water user groups. In this agreement, PG&E again proposed transferring the assets to its unregulated affiliate, but also included a revenue-sharing mechanism, environmental enhancement fund, land set-aside, market power mitigation agreement, and other elements to alleviate consumer and regulatory concerns. PG&E again valued the system at $2.8 billion.

As the state moved fully into the recent energy meltdown, however, changing market conditions and disagreements with some of its initial partners in the agreement led PG&E to withdraw the proposal in November. The company said that as one consideration of this move, it felt that the $2.8 billion valuation of the system "was no longer a true representation of the market value of the asset."

As Proposed, An Auction to One or Many Buyers

The PG&E proposal is to auction its hydropower system in 20 different groups, or "bundles," to the highest bidders. It would retain the related electric transmission and distribution facilities. These 20 bundles are distributed throughout five so-called "watershed regions" that align with how PG&E currently manages the assets.

One reason for this approach is that it keeps existing FERC licenses and water rights intact. PG&E also says the assets in each bundle belong together because of geography, hydrology, water rights, and system management requirements.

Individual bundles consist of one or more powerhouses along with the associated water systems, support facilities, equipment, watershed lands, licenses, permits, contracts, agreements, and obligations. These include environmental permits and agreements, such as regulatory requirements with federal, state, and local agencies, as well as local facility operation safety standards, and leasing and permitting agreements. Also included are historical and voluntary practices, such as informal agreements regarding summer recreational water levels, and compliance with water rights held by current water and irrigation districts.

Under the proposal, bidders may bid on any or all of the identified bundles (for example, a bidder may pursue one of the 20 bundles, or it may pursue an entire watershed region). Or a party may bid on any other grouping of the assets that the PUC determines is appropriate. As a result, at the end of the auction, one or several new purchasers could own each regional bundle.

If the auctioning process were allowed to continue, likely purchasers would not be utilities. As a result, the PUC most likely would cease to regulate these facilities. In addition, three of the facilities are not subject to oversight by the FERC, and would not be subject to regulatory oversight by either FERC or the PUC following an auction.

While PG&E's auction proposal is bucking strong headwinds in forums throughout the state, Edison is finding relatively smooth sailing at the PUC with a hydropower application of its own filed in December 1999. Edison's hydro assets are considerably smaller than PG&E's—about a third the size on a capacity basis—and the utility is not looking to divest. Instead, it is proposing to keep its hydro facilities in the rate base and under regulation, but with more favorable rate treatment. A settlement on this application is before the commission now, but no decision has been reached.

Others with hydroelectric operations in the state include the U.S. Bureau of Reclamation, the California Department of Water Resources, and the Sacramento Municipal Utility District.

For Environment, Status Quo Seen as Best Option

In November the PUC's draft EIR on PG&E's auction application hit the streets and new debate erupted. The draft, a 4,000-page, nine-volume document, estimates that the auction would produce 49 significant adverse effects on the environment in areas relating to land use, forestry, hydrology and water quality, fisheries and aquatic biology, terrestrial biology, recreation, air quality, aesthetics, geology, soils and minerals, and more.

Of these, it reports that two impacts could not be reduced, avoided, or mitigated: harm to fish as a result of anticipated changes in system operation, and adverse affect to air quality in local air basins attributable to anticipated development of watershed land.

Significantly, the draft also identifies 16 alternative dispositions to auctioning and ranks these based on how many environmental impacts each would avoid or mitigate. The "top-ranked alternative"—the one that would avoid all of the auction's significant negative environmental effects—is that PG&E retain the facilities under PUC regulation.

PG&E's response to this suggestion is that AB 1890 would need to be changed to accommodate it. That is consistent with the company's contention—challenged by others—that once the assets are market valued they are freed from regulation, and that AB 1890 requires that this valuation be completed by year end. PG&E also has identified what it views as a number of technical and analytical flaws in the water and power models used to come up with some of the report's other conclusions.

PG&E's Hydropower System At stake is ownership of the largest U.S. hydro system.

Gen Capacity. Total of 3,896 megawatts, consisting of 68 powerhouses with 110 electricity generating units. Reservoirs. Approximately 2.3 million acre-feet. Water Flow System. 99 reservoirs, 174 dams, and 76 diversions that alter rivers. Plus 184 miles of canals, 44 miles of flumes, 135 miles of tunnels, 19 miles of pipes, five miles of natural waterways. Land Rights. Interest in approximately 140,000 acres of lands (88,000 acres of which are outside the boundaries of the Federal Energy Regulatory Commission). Water Rights. The right to use water to generate power and the right to approximately 200,000 acre-feet of consumptive water for municipal, industrial, and agricultural uses. Operations. Remote control switching centers, central service centers, fleet vehicles, communication systems, instrumentation, and monitoring equipment. Plant Licenses. Transferable regulatory licenses for each facility, including 26 licenses from FERC (three unlicensed projects). Site Permits. Permits, agreements, and authorizations for each hydroelectric facility.

Other significant impacts noted in the report include the potential effect on the more than 200,000 acre-feet of consumptive water rights supporting municipal, industrial, and agricultural uses-a hugely important issue in water-tight California. A variety of economic and social issues also are discussed, including effects on customers and ratepayers, the appropriateness of the auction's design, the effects of the auction on the electricity market generally, and the effect on PG&E's rate structure and accounts.

Public hearings on the EIR began in January and end in March; written comments were due Feb. 5.

Johanna Thomas, regional managing director in California for Environmental Defense (formerly the Environmental Defense Fund), is among those with strong opinions about the draft EIR and proposed divestiture. "We have been concerned all along about the wisdom of deregulating these assets," she says, "because ... there are severe potential implications for the environment by running them, as we say, 'pedal to the metal' in a deregulated market."

Another is Stephen Wald, coordinator of the California Hydropower Reform Coalition-a group including over 100,000 Californians representing sporting, environmental, and other interests. "It's less important to us what color uniform the owners of the dams wear than how the dams are operated," Wald says. "Even regulated retention does not maintain the environmental status quo. That is because so much of the is tied to voluntary and informal arrangements. If the state is interested in continuing these often beneficial practices, it will have to do something affirmatively. Our position is that regardless of who owns the system, whether it's sold off as a unit or in pieces, it's time for the state to consider whether the broader public interest is really being met on these rivers. One critically important aspect of this is to begin systematic collection of data about the impacts of these dams and powerhouses on the environment, something that is not now being done and never has."

Both Wald and Thomas share the opinion that divestiture of these assets is likely a dead issue-unless the plants are to be sold to the state.

For Now, Assets in Limbo?

PG&E's auction proposal remains alive at the PUC, but recently was supplemented by a rate stabilization plan filed by the company in December. As part of this plan, PG&E says it "... recognizes, given the current dysfunctional state of the energy markets in California, that the divestiture of its remaining generation assets should be delayed until such time as the wholesale energy markets are functioning appropriately and competitively." The plan goes on to say that PG&E hopes the supply shortage will be addressed within the next two years.

Under the plan, PG&E would sell the output of its remaining generating assets directly to its retail customers on an "incentive ratemaking basis." As regards its hydroelectric facilities, the utility says "the commission should market value the assets (as it is required by AB 1890 to do), write-up the book value to their market value, and operate the hydro assets subject to a cost of service mechanism [that] provides certainty of recovery for capital improvements and expenses and provides for a reasonable rate of return."

According to PG&E spokesman Jon Tremayne, "If [we] were allowed to continue to operate them we think that would be the best outcome for Californians, because we've got the experience and relationships ... and we are good stewards of the land and water."

Bill Nesbit, a writer with 25 years of experience in the energy industry, is based in Davis, Calif.

Articles found on this page are available to Internet subscribers only. For more information about obtaining a username and password, please call our Customer Service Department at 1-800-368-5001.