FERC's April 26th Order on California Wholesale Electric Markets

MEMORANDUM

TO: Regulatory Affairs Committee
Power Marketers Working Group

FROM: Jim Steffes, Regulatory Affairs Committee Chair
Bob Reilley, Power Marketers Working Group Chair
Julie Simon, Vice President of Policy
Erin Perrigo, Manager of Policy

DATE: May 1, 2001

RE: FERC's April 26th Order Establishing Prospective
Mitigation and Monitoring Plan for California Wholesale
Electric Markets

On April 26th, FERC issued an Order Establishing Prospective Mitigation and
Monitoring Plan for the California Wholesale Electric Markets. EPSA has
previously forwarded FERC's press release outlining the major features of the
Order, along with a brief e-mail explaining one confusing aspect of the
Order. This memo provides a more in-depth analysis of the Order. In
addition, we need to consider whether EPSA should seek rehearing or
clarification of any aspect of this Order. Filings would be due at FERC no
later than Tuesday, May 29th. Based on a review of the order, there are
issues on which EPSA might seek rehearing, which are outlined below. We will
discuss these issues on an upcoming weekly conference call. If you have
additional issues you want EPSA to raise, please forward them to Julie Simon
at 202-628-8200 or at jsimon@epsa.org.

APRIL 26th ORDER

In this Order, the Commission puts into place a market monitoring and
mitigation plan for real-time energy markets in California that is intended
to replace the $150/MWh "breakpoint" plan adopted in the December 15th
Order. The mitigation plan will go into effect May 29th, with the current
$150/MWh breakpoint and refund approach continued for an additional month.
Except for the demand-side bidding program, the plan will terminate not later
than one year from the date of the Order. However, the monitoring and
mitigation requirements are contingent on the three California utilities and
the CAISO making an RTO filing, consistent with the requirements of Order No.
2000, by June 1, 2001.

The Order also initiates a Section 206 investigation into the rates, terms
and conditions of public utility sales for resale of electric energy in the
WSCC, other than through the CAISO markets, for all sales in "real-time spot
markets" (defined as up to 24 hours in advance) and when contingency reserves
for any control area fall below 7 percent.

The Commission states that its goal was to address the need for mitigation
"in as market-oriented a manner as possible," so as not to discourage needed
infrastructure investment, while allowing price signals to create demand
response.

The Order includes the following requirements:

1. Coordination and Control of Outages

To ensure adequate capacity, the Order stresses the need for the CAISO and
generators to work cooperatively to schedule unit maintenance and outages.
The Commission stresses that the CAISO's requirements for outage coordination
need to "foster cooperation, rather than establish punitive provisions either
penalizing generators or the ISO." The Order requires the CAISO to make a
tariff filing within 15 days proposing a mechanism for the coordination and
control of outages, including periodic reports to the Commission. Comments
on the tariff filing will be due within 5 days.

2. Selling Obligations

In creating a must-offer obligation, the Commission's goal is to ensure that
all generating units that are able to run, but are not scheduled in
real-time, will in fact be made available to the CAISO in the real-time
markets. Therefore, the Order requires that:

all generators with Participating Generator Agreements (PGAs),
all sellers selling into the CAISO markets that own generation in California,
and
all sellers using the CAISO tariffs that own generation in California

offer the CAISO all of their capacity in real-time during all hours it is
available and not already scheduled to run through bilateral agreements. The
scope of this requirement includes non-jurisdictional, non-public utility
generators. Stressing that "all generators need to participate in helping to
solve the problems in California," the Commission concludes that a generator
that has capacity available in real-time would, under competitive conditions,
be willing to sell that energy "at a price that covers its marginal costs."
All generators are also subject to the price mitigation plan as well,
including the required filing of heat rate and emission data described below.

The Commission also clarifies certain issues. First, no generator will be
required to run in violation of its certificate or applicable law. However,
the Commission finds that environmental limitations are state-imposed and the
question of whether units can run outside proscribed environmental limits and
at what cost are within the control of the state. Generators will be
permitted to recover environmental mitigation costs, presumably by justifying
a bid above the proxy price. Second, because of its unique characteristics,
hydroelectric power is exempt from this requirement.

Finally, the Commission rejects the concerns of generators that they need to
withhold capacity to cover the risk of a generating unit tripping off line.
In that circumstance, the generator will pay no more than the real-time
market clearing price to replace that energy, which is what it is being paid
to make the energy available to the CAISO. Thus, it should be indifferent to
selling all available capacity into the CAISO real-time market.

3. Demand Response

Each public utility purchasing power in the CAISO's real-time market will be
required, by June 1, to submit demand-side bids indicating the price at which
load will be curtailed and identify that load. The bids are to include the
maximum price that the purchaser is willing to pay for specific amounts of
energy and the loads on its system that will be curtailed when the real-time
energy price exceeds that bid. This is the only aspect of the Commission's
plan that will not expire within one year.

4. Price Mitigation in the Real-time Auction During Reserve
Deficiencies

During all periods when Stage 1, 2 or 3 emergencies are in effect (i.e., when
reserves fall below 7.5 percent), certain price mitigation procedures will
apply to the market clearing auction for the real-time market. The following
explains those as we understand them. The language in the order is quite
confusing and may be open to more than one interpretation.

First, all gas-fired generators are required to submit to the Commission and
the CAISO, on a confidential basis, the heat rate and emission rate for each
generator. Second, each day by 8:00 a.m., the CAISO will publish a daily gas
price, using an average of the daily prices published in the prior day's Gas
Daily for all California delivery points. The CAISO will also publish an
emission cost using data from Cantor Fitzgerald Environmental Brokerage
Services, also for the prior day. In establishing the market clearing price
for its real-time market, the CAISO will calculate the fuel and emission
costs for the marginal unit, using the previously supplied confidential data
and the published gas and emission costs, plus a $2.00 add-on for operating
and maintenance expenses. That calculated cost or proxy price for the
marginal unit will be used to set the market clearing price for that hour.

Any generator that submits a bid higher than the proxy price calculated by
the CAISO will be paid what it bids, subject to refund and justification, but
that bid will not set the market clearing price. Any generator that submits
a bid lower than the proxy price will receive the market clearing price and
not be subject to any refund liability. Justification of higher prices must
be submitted to the Commission within 7 days of the end of the month and must
include a detailed breakdown of all of the component costs. Opportunity
costs may not be included because of the Commission's belief that no
opportunity costs exist in real-time markets.

Bids from resources outside California can elect the market-clearing price or
submit their own bids. Those bids will not be used to set the
market-clearing price. In addition, marketers can elect the market-clearing
price or submit their own bids. Bids above the market-clearing price must be
justified based on the prices paid for power.

5. Conditions on Market-based Rate Authority

The Order raises new concerns about certain bidding practices that may
suggest anticompetitive behavior. The Commission specifically identifies two
types of prohibited bidding practices that will be subject to increased
scrutiny, refunds and/or suspension of market based rate authority. The
first prohibited bidding practice occurs when bids vary with unit output in a
manner that is unrelated to the known performance characteristics of the
unit. Known as "hockey stick" bids, this involves bids where the last
megawatts are bid at excessively high prices relative to the other capacity
from the unit. The other identified prohibited practice involves bids that
vary over time in a manner that appears unrelated to changes in the unit's
performance or changes in the supply environment that would induce additional
risk. This type of bidding increases prices only in response to increased
demand or reduced reserve margins, and it timed to public announcements of
system conditions or outages in the bidder's portfolio.

6. Monitoring

The CAISO will be required to provide the Commission with weekly reports of
CAISO schedule, outage and bid data. The CAISO is to identify any concerns
it has about bidding practices in those weekly reports. The Commission is
maintaining the current six month time period for keeping bid information
confidential.

On September 14th, and quarterly thereafter, the CAISO is required to file a
report with the Commission analyzing how the mitigation plan is operating, as
well as the progress made in developing new generation and demand side
response. Comments on the CAISO reports will be due within 15 days.

7. CAISO Market Stabilization Plan

The Commission offered little comment on the CAISO's market stabilization
plan, but does note that the proposals for day-ahead and hour-ahead energy
markets go beyond the scope of this proceeding and should be filed under
Section 205 so that all parties can review the proposals. The CAISO is
specifically directed not to go forward with any plans, such as the purchase
of computer equipment or software, until the Commission has reviewed and
accepted the filing. In an unrelated section, the Commission notes that it
will "address allegations about the ISO's lack of independence and its
governance procedures in a later order."

8. Escrow for Past Unpaid Bills

The Commission invites comments, within 30 days, on whether the CAISO should
be required to institute, on a prospective basis, a surcharge on power sales
that would be maintained in an escrow account to cover the three IOUs' unpaid
bills to generators. The Commission specifically seeks comments on whether
increased production would be tied to an increased likelihood that generators
will be paid.

9. West-Wide 206 Investigation

As noted above, the Commission is instituting an investigation into the
rates, terms and conditions of public utility sales of electric energy in the
WSCC other than through the CAISO markets. The investigation is limited to
energy sold in what the Commission terms real-time spot markets, which is
defined as 24 hours in advance, and under conditions when contingency
reserves, as defined by the WSCC, for any control area fall below 7 percent.

The Commission also invites comments on whether the must-offer and price
mitigation rules contained in this Order for California should be applied to
the WSCC. Comments are due May 10th and EPSA is preparing draft comments for
members to review shortly.

POSSIBLE AREAS FOR REHEARING AND/OR CLARIFICATION

There are several areas where EPSA may want to seek rehearing and/or
clarification of the Commission's Order.

Given the current make-up of the CAISO Board, we have grave concerns about
releasing confidential heat rate and emission data to the CAISO. Since the
Board is clearly working at the behest of the Governor, that commercially
sensitive data could easily end up with DWR, which is actively negotiating
contracts to purchase power from these units. In addition, we have concerns
about the CAISO's ability to protect this data since similarly confidential
information from the CAISO's market monitoring unit has appeared in the Los
Angeles Times. The Commission should ensure that only an independent entity,
not the CAISO, have access to this data.

The actual operation of the price mitigation is confusing and amenable to
several interpretations. The Commission should clarify, possibly with
examples, how the market-clearing price will be calculated and the effect of
the market-clearing price on a variety of bids.

The discussion of second category of prohibited bids is unclear. The
Commission appears to be saying that bids that value scarcity are prohibited,
but this makes little economic or practical sense.

Do we agree with the Commission's conclusion that a generator is indifferent
(in real-time) to receiving the market clearing price for its as-available
energy, when it may need to energy to self-supply reserves if a unit trips
off? Are there operational concerns that make this economic trade-off
unworkable? We will need to educate the Commission if we want to raise this
issue.