On 26 March, the FERC staff released a study saying that the California Public Utilities Commission claim that certain generators withheld physical capacity on the critical blackout days, or bid their pricing higher than the marginal cost of generation, during the energy crisis was simply not proven. No such allegation could be substantiated. The now very politically sensitive FERC staff went to lengths, though, to ensure California that this is not to say that such activities might not have occurred on other days.

Elsewhere on the site, on the other hand, Reliant Energy signed a settlement agreement saying that its employees withheld physical capacity on two days in June 2000. That is, the capacity that would normally be available was withheld, and the employees admitted withholding it in hopes that prices would rise. Reliant will pay $13.5 million, which would be the worst case for damages caused to the California Power Exchange (note: not the real damages caused, because these evidently cannot be calculated).

In its press release on manipulation in the Western Power Markets, the FERC says: "The [FERC] staff reported that there was clear evidence of market manipulation in the western markets. But the manipulation was effective largely because of an underlying supply shortage, flawed market design and inconsistent rules...." Also of not in these releases is that the FERC's latest ruling takes its preliminary ruling (a judgment of $1.8 billion) and revises the calculation so that the amount is much higher, about $3.4 billion.

The problem with the original ruling was that California clearly owed $3.2 billion in unpaid bills from the crisis, meaning that even subtracting the $1.8 billion, the state's electrical and gas customers would need to cough up $1.4 billion. The new ruling, with the changed methodology, effectively nets the claims, with a little extra for Gray Davis. According to FERC's mandated remedial actions, much more will be required in terms of reporting from energy companies, raising their compliance costs, but also suggesting that part of the problem of "flawed market design and inconsistent rules" was the fault of FERC (so who pays?).

Investors and energy companies will now see the FERC as just another heavily politicized body. By netting the claims, accounts get adjusted across all participants in the chain, with no real money changing hands, or so it appears. Methodologies changed to facilitate this outcome.

Those who might lose actual money from the change in methodologies will sue (see the attached article below), because the FERC itself demonstrates that different methodologies can be used to different ends. The latest simply took an average basin price for gas, and an imputed transport tariff, to establish a fictitious price for gas "as if" there had been no market manipulation. By definition, therefore, any price charged above this amount must have been manipulation, and the manipulators can be pursued. So much for supply and demand in a supposedly free energy market. More interesting is the large number of such manipulators - 37 are under suspicion - which might mean that market participants were taking advantage of inefficiencies, flawed designs, and inconsistent rules, but not necessarily "manipulating" a market. Such a simplistic methodology does not take into account any of the normal behaviors of market players in an obviously supply-constrained market (which even the FERC acknowledges). Imagine wholesale pricing of shampoo or potato chips in the same way - cost of production plus transportation regardless of demand. Imagine a jury trying to figure out how much of the mess was due to any company's alleged manipulation as opposed to the State's or the FERC's inconsistent and unclear rules. This will be fun, and will take years.

However, settlements between the accused, the State, and FERC will proceed based on the calculation of manipulation as defined above vs. legal costs vs. the political scenarios vs. other possible future deals.

Investment in energy projects, particularly in the Western US, will now be hampered until energy companies absorb what all of this means. See the problems created by constrained supply above and brace for the future if the Pacific Northwest has another dry year.

Enron comes across as perhaps the prime target of FERC in this action. However, most commentators at the time, and indeed even the State of California at the time, concluded that Enron was not a very large player in California compared to others. They were nonetheless a convenient target in late 2000 (the Elections, stupid) and early 2001(the post-Elections) because of Ken Lay's personal connection to George W. Bush. Targeting Enron, thus, should be seen as easily done by FERC nowadays, since California will stand with the other unsecured creditors in the Enron bankruptcy proceeding, and neatly insulates Pres. Bush in the 2004 elections.

The FERC has so far refused to let California off the hook for the $40 billion in long-term power contracts the State signed in open bidding to reduce its exposure to short term rates. As anyone in the industry could have predicted, when it rained in the Pacific Northwest, spot power would get much cheaper. It did, and now California faces budget disaster, and Gov. Davis faces recall. If he is thrown out, no doubt he can chair some Department of Third World State-Run Economics at any of the State's fine institutions of higher learning.

Anonymous

Posted by Donald L. Luskin at 2:04 PM | link    

Wednesday, April 09, 2003

Posted by Donald L. Luskin at 1:09 PM | link    

Tuesday, April 08, 2003

Posted by Donald L. Luskin at 1:16 PM | link    

Posted by Donald L. Luskin at 1:00 PM | link    

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