The California Refund Process Will Not Go Gracefully Into That Good Night

The timing cannot be a coincidence … in the wake of two different sets of audio tapes and transcripts from Enron that illustrate quite explicitly how venal their traders were, California’s Attorney General Bill Lockyer has chosen this week to express public outrage at a FERC order issued on May 12, over a month ago. This heavily-spun San Diego Union-Tribune article from Wednesday casts the issue as FERC ordering the state to pay $270 million in refunds to the very same “greedy, out of state, price-gouging generators” (those are Lockyer’s direct words from 2001) that manipulated energy prices in California’s poorly designed and managed so-called electricity “market”. This Sacramento Bee article does a better job of actually conveying some of the substance of the matter:

California’s latest war with FERC has to do with a little-noticed ruling May 12. FERC said the state Department of Water Resources owes $270 million to sellers such as Enron, Mirant Corp. and Williams Cos., the out-of-state companies that have been accused by California of manipulating the state’s beleaguered electricity market in 2000 and 2001.

The May 12 ruling is a complicated matter that stems from the state’s desperate efforts to keep the lights on in January 2001.

California’s big utilities, stripped of many of their power plants by the state’s deregulation plan, were falling into financial ruin because of skyrocketing wholesale electricity prices. They were so destitute, in fact, that the power sellers were refusing to sell to them. The state stepped in and began buying power on the utilities’ behalf at the Department of Water Resources.

According to California energy official Erik Saltmarsh, the refunds ordered by FERC have to do with purchases the water agency made in “real time” – those sometimes frantic deals made at the last minute when shortages popped up and various players bought and sold electricity back and forth.

At times, sellers had to compensate the state if a shortage developed because they couldn’t supply electricity they had committed to deliver, said Saltmarsh, executive director of the state Electricity Oversight Board. Those sellers were billed for the amount the state paid for the power.

When FERC ruled in 2003 that there was rampant market misconduct, it set a threshold for what electricity should have cost – and ordered sellers to make refunds for amounts over that threshold. While that ruling hasn’t been finalized, it should yield about $3 billion for California ratepayers.

Then, to the dismay of California officials, FERC went a step further. In its May 12 ruling, FERC said the fairness threshold also applies to electricity billed to the sellers during those “real time” deals. As a result, FERC said, the sellers paid the state too much – and the state owes them refunds.

The substance of the FERC notice from 12 May 2004 is arcane and challenging to understand (see pp. 25-28 for the discussion of the issue and the reference to the $270 million in question). Basically, my understanding of it is that in the period from 1 February 2001 to 20 June 2001, when the California Department of Water Resources/California Energy Resources Scheduling folks were purchasing power in wholesale markets on behalf of the financially strapped utilities, there were power transactions that were required to keep the network balanced in some hours. At these times the utilities had “net-short load” conditions, meaning that they had not made enough day-ahead purchases to cover their demand, so CERS had to buy real-time power on their behalf to keep voltage levels in check and avoid brownouts/blackouts. The California ISO, as the system operator, directed CERS to make these purchases to keep the network balanced. CERS made these purchase in bilateral transactions, meaning that they entered into contracts with generators.

The issue is who should pay for those purchases of real-time power to keep the network balanced. FERC’s position is that the parties responsible for the imbalance should pay for the cost of rectifying the imbalance. But it gets complicated because even though these transactions were bilateral contracts, the ISO had been treating them as sales to the ISO, but had been spreading the cost of them over all market participants, including utilities and generators. But by the law governing the operation of the ISO, and by FERC’s decisions regarding refunds from this period, these transactions are supposed to be subject to the refund calculations. That means (through all sorts of elaborate calculations and reasoning that I do not follow) that once the ISO fixes the accounting so it’s in line with the refund methodology and covering these transactions, a flow of $270 million back to non-utility market participants, which for all intents and purposes means generators.

This proceeding has been going on for years. This particular decision was made over a month ago. Yet Bill Lockyer chooses this week to fulminate about it, perfectly timed to ride the crest of outrage and disgust that I’m sure he expected (and has also helped to stir up, like it needed it) after people heard the Enron tapes. And, what a surprise, his office announced today that it has filed a commodities fraud lawsuit against Enron under new powers that the Attorney General was granted as of January 2004.

The shameless demagoguery of the timing boggles my mind. Every time Lockyer says or does some other populist thing that is economically idiotic using inflammatory rhetoric, like suggesting that the California PUC regulate refiners and retail gasoline prices because they “gouge”, I think he won’t be able to surpass it. Yet he does, over and over and over. I would not be surprised to hear that there is evidence to support his claim of commodity fraud against Enron. But sitting on the FERC order from last month and then steamrolling everything together with the release of the tapes and transcripts is utterly pathetic.

And the state’s two senators are piling on. FERC responds by saying that they will review the transcripts again to see if they bring up any evidence that would support changing the refund decisions currently in place.

3 thoughts on “The California Refund Process Will Not Go Gracefully Into That Good Night

  1. At this morning’s FERC open meeting, each of the four commissioners expressed their shock and outrage over the callous disregard of Enron employees for the suffering of the people in the West. Most of the Commissioners concluded by lamenting their current modest enforcement authority, and called upon Congress to give the Commission the ability to penalize this kind of “morally corrupt” behavior.

    I haven’t read the relevant press reports, but apparently the source of the shock and outrage are tapes recently made available which have Enron employees describing how they would calculate their ability to create congestion on the California grid when they could make money by doing so.

    Most of these congestion-based games made famous in the Enron memos would not be profitable in the LMP-based markets in PJM, New York or New England. Over two years ago the California ISO filed their “Market Re-Design ’02” (MD02) proposal, intended to move toward the LMP-style markets that have proved more successful. It is now ’04, and still the ISO drags along, more concerned about managing the problems of the current system than implementing the new approach it proposed two years ago.

    I wish Attorney General Lockyer would get upset about the delay of the MD02 reforms.

    (In related news, FERC staff reported concern about the electric supply conditions in California this summer. Low hydro year, transmission lines derated for repairs, transmission congestion problems for imports into the southern part of the state.)

  2. Mike,

    “It’s ‘deja vu’ all over again.” – Yogi Berra (famous American philosopher)

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