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The attached article appeared in today's San Diego Union. I now have the
official transcript from the Senate hearing of May 18 if you need that. If you are scheduling a conf call for tomorrow, can you do it after 12 your time as I am flying to San Francisco and will then be in the Brobeck offices. Thanks The information contained in this e-mail message and any accompanying documents is subject to the attorney-client privilege and/or the attorney work product rule and is confidential business information intended only for the use of the individual or entity named above. If the reader of this message is not the intended recipient or representative of the recipient, you are hereby notified that any dissemination of this communication is strictly prohibited. If you have received this communication in error, please notify the Systems Administrator at admin@pkns.com and immediately delete this message from your system. Content-Transfer-Encoding: quoted-printable Date: Wed, 06 Jun 2001 08:53:28 -0700 From: "Cindy Frederick" <cfred@pkns.com< To: "Michael Kirby" <mlk@pkns.com< Subject: IS TRADING AN INSIDER'S GAME? Mime-Version: 1.0 Content-Type: text/plain; charset="us-ascii" Content-Disposition: inline IS TRADING AN INSIDER'S GAME? Buying, selling of electricity is a growth business, but some say deck is stacked against consumers By Craig D. Rose STAFF WRITER June 6, 2001 While Californians decry deregulation's failure to deliver a competitive market, electricity wholesalers have quietly developed a vast and rapidly growing business of buying and selling power among themselves. The deals take place on high-tech trading floors in Houston and elsewhere around the country, as well as on Internet-based trading systems. Some experts say this electricity trading is a key mechanism for raising consumer power prices, yet it's largely unregulated. "Electricity trading is like buying stock -- when you have ability to change the stock price," said Frank Wolak, a Stanford University economics professor and member of the state grid operator's market surveillance group. Energy companies say the buying and selling of contracts to deliver power provides risk management, allowing plant owners to presell their electricity, lock in prices and avoid fluctuations. The rough and tumble of the free market, they add, is the most efficient means of allocating a resource like electricity. But industry critics say trading is far from a competitive market paradigm. In their view, it's a means of communication -- a way for energy insiders to collude and raise prices under the guise of competition. To be sure, the trading arms of major energy companies have emerged as stars in an industry where profit surges of 300 percent or 400 percent are not uncommon. The transactions, shrouded in secrecy, can leave ownership of a critical commodity in unknown hands. Consider the case of power generated by AES Corp.'s California plants. In 1998, AES made a bold move. Immediately after purchasing power plants that gave it control of 10 percent of the state's electric generating capacity, the company sold the output from its plants for the next 20 years to Williams Cos. Williams did not sit on this treasure trove of electrons. The Tulsa, Okla., company soon sold 80 percent of what it bought. It is difficult to say who owns that power now. Some might be owned by Sempra Trading, a sister company of SDG&E. Or some could be owned by Enron Corp., the nation's biggest electricity trader. A spokeswoman for Williams conceded that Williams itself may have repurchased some of the electricity it sold earlier. But trading companies closely guard their positions. This much can be said with certainty: Electricity that AES sold for less than 5 cents per kilowatt-hour to Williams changed hands perhaps 10 times in the wholesale market and emerged at times in recent months with a price tag for consumers that was 300 percent higher. Williams' trading profits increased by 523 percent in the first quarter this year. Advance sales All this buying and selling creates curious confluences. In their attempt to deflect criticism over high prices, generating companies such as Duke Energy -- operator of the South Bay Power Plant in Chula and others in the state -- frequently note that they sell most of their electricity far in advance. But they acknowledge less often that their trading units may also be buying power, which could boost the company's electricity inventory. Duke was the fourth biggest electricity trader last year and cited its trading activity as a prime contributor to its wholesale business profits, which soared 324 percent in the first quarter to $348 million. It is a company's power traders who frequently direct plant operators to increase or decrease the generation of power in response to market conditions. Energy companies have little option but to turn to trading for profits. One of the better kept secrets of electrical deregulation and its promise of competition is that there is remarkably little competition in the production side of the business. For one thing, electricity is a commodity; power from one company is indistinguishable from that generated by others. More important, nearly all modern plants generate power from turbines built by a handful of manufacturers. The result? Modern plants owned by different companies produce power at nearly identical cost. "The cost of power produced by modern plants is all within a mil (one-thousandth of a dollar)," said Michael Peevey, an adviser to Gov. Gray Davis and former president of Southern California Edison. So the extraction of profit in the electricity business relies much more on trading. Traders' profits rise when prices are volatile -- plunging, or even better, rising sharply. Little regulation But despite the obvious temptation to manipulate the market, the burgeoning electricity trading business has remained largely unregulated. The Federal Energy Regulatory Commission does require quarterly filings from energy traders, but these often provide incomplete information, or at least little that has been of concern to FERC. In fact, although the trading of electricity grew more than a hundredfold from 1996 to 2000, FERC has taken no major enforcement action against a trader. After the onset of the California crisis last year, FERC has acted once. That was against Williams, which agreed to pay $8 million without admitting guilt to resolve an allegation that it withheld supply to pump up prices. FERC's record of enforcement in the area of power trading stands in contrast to a long list of enforcement actions within other markets taken by the Securities Exchange Commission and the Commodity Futures Trading Commission. FERC has recently added staff to its market oversight operations. But William Massey, a FERC commissioner, says the agency's effort is still inadequate. "Electricity can be flipped, stripped and chopped up," Massey said. "It's an extraordinarily complicated market. "The sophisticated marketers and traders have simply moved past us. We're kind of horse and buggy in our approach and they're out there in rocket ships flying around ... The problem is that sophisticated traders don't necessarily produce reasonable prices. They produce profits." Before deregulation, electricity trading was a low-key affair. Regulated utilities dealt power back and forth on a reciprocal basis to fill electricity shortfalls in their control areas. There was little trading for profit until the mid-1990s, after federal legislation and FERC rulings opened the market. Major traders include large energy companies, sister companies of California's major utilities and Wall Street firms. Market volatility In many ways, the trading of power is similar to that of other commodities. But there are important differences. Because it cannot be stored and its use is so fundamental, the price of electricity is the most volatile of all. When supplies are tight, a single supplier can rapidly raise prices to budget-busting levels, as evidenced by Duke Energy's recent admission that it charged California nearly $4,000 for a megawatt-hour of power, a quantity that probably sold hours earlier for one-tenth of that sum or less. Wolak, the Stanford economist, and state Sen. Joseph Dunn, D-Garden Grove, who is investigating the state power market, say trading allows companies to collude under the guise of competition. Instead of wringing out lowest costs, the wholesale trading market serves to raise prices, they say. "As I trade to you and you trade to me, we communicate to each other what price we would like to get," said Wolak. "It's not collusive. It's just communicating price." Mark Palmer, a spokesman for Enron, the nation's biggest power trader, said California's problem is not the result of trading. "It's a result of shortages," Palmer said. Underscoring its emphasis on trading, Enron's new headquarters tower in downtown Houston rises from a six-story block of new trading floors, including expanded space for electricity trading. Enron also pioneered trading in cyberspace and its Enron Online site claims to be the most active computer-based trading market. The Houston company argues that consumers won't fully benefit from power trading and deregulation until they have greater choice in choosing their power supplier. And the company says FERC has not done enough to open access to transmission lines, which would allow traders to move power around the country. To that end, Enron has lobbied hard for President Bush's plan for a national electricity grid. Palmer says the notion that the price of electricity rises each time it is traded is mistaken. "The market is always looking for the real price of a commodity," Palmer said. Dunn, the California state senator, says his investigation found a different function for trading. At a time when supply barely meets or falls short of demand, he noted, companies with electricity to sell have to worry only about how high to set their price. "The trader is a pawn in the generator's game to drive up prices," said Dunn. "Trading develops a level of trust. You, my alleged competitor, will bid in the same patterns and I will respond not in a competitive pattern but in a complimentary pattern." The state senator said his investigation found evidence that on several days, energy companies appeared to test their ability to drive prices up, without being undercut by competitors. This ability to drive up prices without competitive consequence is a key test of market power, the technical term for manipulation or price fixing. But Dunn also conceded that antitrust violations can be hard to prove in court. He suggested that even if the trading behavior falls short of antitrust violations, it remains anti-competitive and devastating for the California economy. To Harry Trebing, a utility industry expert and professor emeritus at Michigan State University, wholesale electricity trading is reminiscent of what took place in the 1920s and early '30s. Back then, utility companies created complex networks of holding companies that traded stock among themselves, driving up prices in the process. Undoing that scheme was a focus of President Franklin Roosevelt's administration. Congress ended up barring national power companies and tightening regulation of utilities, in an effort to counteract their tendency to create markets that work only for insiders. "The broad goals of trading are the same," Trebing said. "The goal is to maximize profits through raising prices."
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