"It could have been worse."

"It says to the market, `It won't be so bad.' It will take longer now, so that's better for the utilities."

"It creates a new bureaucratic entity that will make regulatory choices."

"It's regulated deregulation. It's alarming if that's the prototype for the nation."

That's the word, respectively, from Barry Abramson at Prudential Securities, Edward J. Tirello, Jr. of NatWest Securities, Steven Fetter at Fitch Investors Service, and Dan Scotto of Bear Stearns. I spent some time on the phone a few weeks ago with each one, asking for their thoughts on the latest proposal (two, actually) from the California Public Utilities Commission (CPUC) to restructure that state's electric utility industry.

It began in April 1994 with the "Blue Book." The CPUC announced what it called "A Vision for the Future of California's Electric Services Industry." Out with centralized government planning. In with consumer sovereignty. But the "vision" soon stalled at a crucial juncture: Where do we start? With the retail market, through direct customer access and one-on-one (bilateral) energy contracts? Or in the wholesale market, with a central pool ("PoolCo") that would manage the transmission systems and decide which plants would run and which would not?

Last winter, we put the vision to the test. In our issue of January 1, 1995, we invited a dozen or more experts to comment on that key issue, PoolCo vs. Bilateral Markets. Sadly, it didn't do any good. On May 24, the CPUC gave up. Led by president Daniel W. Fessler, the CPUC voted 3-1 to propose both a statewide PoolCo (abandoning retail wheeling for now) and direct customer access (an alternative view offered by dissenting commissioner Jessie J. Knight, Jr.). Two proposals. Twice the vision?

Who Won?

When you hear Abramson, Tirello, Fetter, and Scotto talk about PoolCo, understand one thing: They speak for utility investors (em who loath change or uncertainty. But there's more to it than stock prices.

Listen to Scotto from Bear Stearns. "The concept of a bidding process and pooling generation seems valid conceptually," but there's an oversight. The proposal talks about 'cooperative federalism' with the FERC [Federal Energy Regulatory Commission] regulating PoolCo rates. So PoolCo entails pricing constraints." Scotto adds, "It will restrict incentives for broad-based competition in generation. While they like to call it deregulation, it isn't (em it's a very select blending of generating resources. It doesn't make for a vibrant market."

Here's the rub: The PoolCo proposal cites competition in electric generation as a key driving force for opening up the wholesale market, but PoolCo, as envisioned by the CPUC, would not treat all generating plants equally. Fessler's PoolCo would attempt to mitigate stranded investment by placing all nuclear and hydroelectric in a special category that apparently will be dispatched first (presumably at the eventual pool price, but that's not clear). The majority proposal would also force the state's three major investor-owned electric utilities (Pacific Gas & Electric Co., Southern California Edison Co., and San Diego Gas & Electric Co.) to sell into and buy back from the Pool, subject to PoolCo's bureaucracy, while public power companies such as Sacramento Municipal Utility District or the Los Angeles Dept. of Water & Power (not to mention out-of-state competitors like Tucson Electric Power, Sierra Pacific, or PacifiCorp) retain the option of playing inside or outside PoolCo.

Mike Florio, senior attorney at the San Francisco office of TURN (Toward Utility Rate Normalization), California's most prominent ratepayer advocacy group, worries about IOUs controlling PoolCo: "We're already buying as much cheap power from out of state as we can. If there's cheap power to be had, the utilities should be buying it now. So the fact that out-of-state utilities can bid into the pool might not make much difference. Anyway, transmission capacity limits the amount of imports."

Adds Florio, "It's the worst of both worlds. It's unregulated monopoly pricing. But that's not to say that we love Knight's proposal."

Jessie Knight's proposal would admit retail customers into the game as direct players physical energy market, but power marketers, brokers, and aggregators would get to play too. That's a key difference between Knight and Fessler. The California PoolCo allows financial hedging (retail customers can sign purely financial "contracts for differences" with individual utilities), but the physical market for energy is closed to marketers and brokers. Customers must take energy only from the utility. So PoolCo, while staunchly defended as necessary to manage physical dispatch and transmission ("electricity is different than other commodities"), carries with it an important side effect: It shields distribution utilities from competition with marketers and brokers. For a while anyway. On the other hand, Knight's direct-access proposal gives entry to marketers and brokers to aggregate load or otherwise procure physical energy on behalf of retail customers.

All this may change, of course. Fetter thinks that timing is a key element: "Both proposals end up at the same place. The pool will take a couple of years to get running, followed later by bilateral contracts. Knight's proposal jumps right to direct access, probably a couple of years too soon. Both sides would be better served to target the year 2000 for true competition and spend the next five years getting the politics out of the way."

Tirello forsees a period of uncertainty. "Everything is still up in the air," explains Tirello. "The commission staff hasn't got cohesive marching orders. The out-of-state utilities are backing off to wait and see."

What About Rates?

The Blue Book complained about California's high rates. Will PoolCo help? Scotto asks, "If the CPUC's restructuring (with full cost recovery) is valid, what costs are going away?"

Prudential's Abramson points out a weakness: "A competitive pool might bring down the cost of power. But the CPUC also wants to fully recover any lost value through the transition cost, which will keep rates high. California may lose ground to other states. There has to be some pain."

He continues, "Utilities aren't necessarily any better off, because they still have customers. They may still have to fight a war of attrition with their large customers, who retain the flexibility that they've always had."

And while the California legislature may intervene, it might not help. The legislature, says Abramson, "Is more concerned about protecting special interests than looking at the big picture, which is trying to bring down rates." t

Editor

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