UNITED STATES OF AMERICA

BEFORE THE

FEDERAL ENERGY REGULATORY COMMISSION

San Diego Gas & Electric Company          

v.                                  Docket No.       EL-00-95-000, et al.

Sellers Of Energy And Ancillary Services            

Into Markets Operated By The California            

Independent System Operator And The Power Exchange      

MOTION TO INTERVENE OF

THE ELECTRICITY CONSUMERS RESOURCE COUNCIL (ELCON),

THE AMERICAN IRON AND STEEL INSTITUTE (AISI), AND

AMERICAN CHEMISTRY COUNCIL (ACC)

The Electricity Consumers Resource Council (ELCON), the American Iron and Steel Institute (AISI), and the American Chemistry Council (ACC) hereby move to intervene in the above-captioned proceeding.  Industrial Consumers offer comments with respect to the pending proceeding relating to the “crisis” in the California power markets.

NOTICES AND COMMUNICATIONS

Notices and communications should be addressed to:

Dr. John Anderson

Executive Director

The Electricity Consumers Resource Council

1333 H Street, N.W.

The West Tower, 8th Floor

Washington, D.C.  20005

Tom Choman

American Chemistry Council

1300 Wilson Boulevard

Arlington, VA  22209

Sara D. Schotland, Esq.

Cleary, Gottlieb, Steen & Hamilton

2000 Pennsylvania Avenue, N.W.

Washington, D.C.  20006

DESCRIPTION OF INTERVENORS AND STANDING

The Electricity Consumers Resource Council (ELCON) is an association of industrial consumers of electricity organized to promote the development of coordinated and rational federal and state policies that will assure an adequate, reliable and efficient electricity supply for all users at competitive rates.  ELCON member companies produce a wide range of products, including:  steel, aluminum, chemicals, petroleum, motor vehicles, industrial gases, machinery, glass, agricultural and food products, rubber, computer chips, paper and electronics.  The member companies of ELCON consume approximately five percent of all electricity in the United States.

The American Iron and Steel Institute (AISI) is the principal trade association of the North American steel industry.  Its member companies account for about seventy-five  percent of the raw steel production in the United States.  The steel industry is one of the most energy-intensive sectors in the United States; the cost of electricity for AISI members may constitute as much as twenty percent of the manufacturing cost of a steel mill product.

The American Chemistry Council (ACC) is a nonprofit trade association whose member companies represent more than ninety percent of the productive capacity of basic industrial chemicals in the United States.  The manufacturing processes of many ACC member companies are highly energy-intensive.  In addition, the chemical industry usesdused a substantial amount of self-generated electricity.  Total electricity used by the industry, purchased plus self-generated, represented approximately eighteen percent of industrial electricity consumption in the U.S. and approximately six percent of national electricity consumption.

Industrial Consumers have standing to intervene because their membership includes industrial consumers which operate in California and will be directly affected by the outcome.

FERC’s NOVEMBER 1, 2000 DECISION

The FERC decision relies heavily on FERC Staff’s Report in its discussion of the causes of the California problem:

·                    Market responses to flawed market structure played an important role in the run-up of power prices.  In addition, high prices resulted from significantly increased power production costs combined with increased demand due to high temperatures and a scarcity of generation resources.  Flawed market rules played the dominanta dominant role including:  the: the requirement that the California IOUs buy and sell all energy into the PX; restrictions on the ability of the utilities to enter forward markets; powerful economic incentives to under schedule load and generation in the day-ahead and hour-ahead markets.

·                    There was some evidence of exercise of market power leading FERC to recommend elimination of “the single price auction rule” which pays all bidders the price paid to the last seller whose output is needed to clear the market.

The immediate remedies proposed in FERC’s November 1, 2000 Order include:

·                    The elimination of the requirement that the three IOUs—PG&E, SoCal Edison, and SDG&E—must sell into and buy from the PX;

·                    Requiring market participants to schedule 95% of their transactions in the day ahead market to reduce chronic underscheduling of load and generation and over reliance on the ISO's real time balancing market.  The Commission proposes a penalty charge for deviations in scheduling in excess of five percent of an entity's hourly load requirements and the disbursement of penalty revenues to the loads that scheduled accurately;

·                    The establishment of independent, non-stakeholder Governing Boards for the PX and the ISO; and

·                    The establishment of generation interconnection procedures.

FERC also identifies a number of structural reforms that must be addressed, including:

·                    the submission of a congestion management redesign proposal;

·                    possible changes to the auction mechanisms;

·                    improved market monitoring and market mitigation strategies;

·                    demand response programs by the ISO and Scheduling Coordinators;

·                    elimination of the requirement for balanced schedules; and

·                    new approach to reserve requirements.

The Order proposes temporary measures to mitigate prices, including modification of the “single price auction” rule.  Specifically, FERC imposes a temporary $150/MWh "soft cap" that prohibits supply bids in excess of $150 from setting the market-clearing price for all bidders.  FERC requires sellers bidding above $150/MWh to report their bids to FERC on a confidential, weekly basis and provide certain cost support.  The ISO and PX must report monthly information on such bids.  The Commission's price mitigation measures would remain in effect through December 31, 2002.

FERC states that several problems facing California consumers are outside of its jurisdiction.  . The California market will continue to experience serious problems unless the California PUC addresses the following issues:

·                    delays in siting additions of generation and transmission capacity;

·                    implementation of additional demand response programs at the retail level; and

·                    elimination of impediments on Load Serving Entities purchasing power supplies on a forward basis.

SUMMARY OF COMMENTS

·                    A serious problem is the lack of adequate generation capacity—a problem that California must remedy.

·                    Regionalization of western bulk power markets must occur.  Even California is not big enough to make workable a single-state RTO.  FERC should reject the State’s dangerous and counterproductive efforts to increase the authority of the California Oversight Board.

·                    It is far preferable to eliminate fundamental design flaws than to adopt price caps; price caps only treat the symptoms.  In addition, price caps are a barrier to price-elastic demand response.  Price caps have the downside of stifling investment, especially investment in peaking units.  Price caps also discourage energy supply companies and lenders from risking capital in California versus other states.  While consumers may need price caps as a last resort if the crisis continues, the goal should be to address the root causes such crisis conditions.

·                    Load response programs urgently need FERC attention.  While the Order pays lip service in the need for such programs, these should be required by FERC both in the context of California and in response to RTO compliance filings.  The California proceeding and the RTO compliance filings provide a “hook” for Industrial Consumers to advocate a model ancillary service dedicated to curtailable retail loads.FERC should consider a new ancillary service dedicated to curtailable loads.  As willth other ancillary services, the RTOs would facilitate the market for load decrements, on-site generation increments (INCs), or a combination of the two.the RTOs ___ facilitate the market a load decrements, om-site generation increments, or a combination of the two.[1]

·                    The single price auction feature should be eliminated.  The effect of this model is to allow low-cost suppliers to get the benefit of high prices.  Consumers will benefit if suppliers are forced to compete.

·                    California should adopt a flow-based physical rights model in tandem with the RTO West and Desert Star for congestion management and its balancing market.  The Commission should review the congestion management plan thoroughly and promptly, and that it should also include the option of expanding the existing transmission system.

·                    The PX’s restrictions on use of forward markets and hedging tools required utilities to resort to the spot market with disastrous results.

·                    The California market was modeled on the now discredited U.K. structure.  FERC should abandon its preference for power exchange-based market structures where prices can be more easily gamed.  FERC now recognizes that utilities under-scheduled in the day-ahead markets.

·                    One topic that the FERC decision does not cover is the impact of stranded costs.  ELCON’s paper on the California crisis discusses the skewed economic incentives created by the stranded cost recovery mechanism.[2]  As soon as supplies became short (due to weather, demand growth and failure to site new generation), the same economic incentive that allowed for a lucrative stranded costs (CTC charge) whenever the PX market clearing price was below the level of frozen rates created windfall profits for generators and marketers whenever the PX market-clearing price exceeded the level of frozen rates.

·                    We agree with FERC that independent boards, wherein the members do not have a financial interest in the operation of the transmission assets of the RTO, are more efficient and therefore ordinarily preferable to stakeholder boards.  This principle should apply to FERC’s evaluation of RTO filings.

COMMENTS OF INDUSTRIAL CONSUMERS

Industrial Consumers regret that the very problems that we predicted in the California market have unfortunately come true.  In comments filed on July 18, 1996 in Docket ER 96 -1663 we warned that “CPUC's mandatory buy sell requirement will significantly restrict the operation of the California market."”  As far back as July 25, 1994 we warned in Docket R 94 -04- 031 that the "“U.K. model is better left in the U.K."” and identified fundamental problems with the power exchange concept that unfortunately have been realized.  As recently as the RTO Docket, RM99-2, Industrial Consumers have advocated the need for large regional RTOs and independent boards of directors and pointed out the inherent insufficiency of single-state RTOs.  As discussed below these design flaws defects have had a serious impact on California restructuring.  Many of these flaws are discussed further in ELCON: Aa study of defects in the California market structure.[3]  

I.          WHAT WERE THE CRITICAL DESIGN FLAWS IN THE CALIFORNIA MARKET?

FERC has correctly identified several flaws defects in the California market, including mandatory buy-sell requirements into the PX, lack of a forward market, under scheduling of load and generation, the single price rule, and lack of price elastic load response.  These design flaws greatly exacerbated other causes of the price spikes such as peak demand growth, high NOX emission credit costs, high natural gas prices, forced outages of aging generators, and tight regional supply.

It is worth re-capping briefly each of these design flaws in order to assess whether FERC’s November 1, 2000 Order adequately assesses the problems.

A.            Forward Contracting

By restricting the ability to make forward purchases, the California rules limited the ability of Utility Distribution Companies (UDCs) and other Load Serving Entities (LSEs) to engage in forward contracting to cover their peak demand.  The Commission relieves this burden but fails to require LSEs to commit to a greater percentage of forward contracts.

Forward contracting would allow LSEs to hedge against high costs, thus providing buyers and sellers with a greater degree of price certainty.  Equally important, forward contracting would have mitigated the ability of potential suppliers to dictate the market clearingmarket-clearing price when demand is high by strategic bidding or withholding production.

As FERC states in the November 1, 2000 decision, moving more transactions into forward markets will (i) reduce reliance on price-volatile spot markets; (ii) eliminate the reliability problems faced by the ISO which, in lieu of performing a balancing function, has been forced to operate like a commodity exchange at the last minute; (iii) foster new generation which will not enter based on uncertain revenues from spot markets; and (iv) limit the ability of sellers to exercise market power in spot markets.

B.            Demand Response

There is a need to remove all barriers to retail demand response.  In California, there were several barriers to demand response. Retail customers were not provided accurate price signals due to the interplay between the retail price freeze and stranded cost recovery.  The CTC could not, in conjunction with PX prices, exceed frozen retail rate levels.  If PX prices were high, CTC recovery was lower.  If customers reduced demand, their rates did not fall, rather utilities simply recovered their CTC at a faster rate.  The rate freeze was lifted for SDG&E customers before those customers had the ability to respond to price caps.  For example, customers lacked time-of-use metering and there were no alternative suppliers.

Customers of all sizes have been deterred from participating in “demand response” programs or securing risk management products from other alternative electricity service providers.  In most markets, customers have the ability to respond to price increases by reducing consumption and prices reflect legitimate scarcity rents.  In California, where both demand responsiveness and new entry were severely limited, prices soared without restraint and suppliers were free to exercise market power.

C.            Underscheduling

Although the ISO’s real-time energy balancing market was designed to accommodate approximately 5% of the total anticipated load, there has been chronic underscheduling in the power exchange markets resulting in greater dependency on spot prices.  The rate freeze has encouraged UDCs to reduce demand in the PX, put downward pressure on the PX’s market-clearing prices and thereby maximize their stranded cost recovery.  The UDCs’ strategy, fostered by prior market design, backfired when the supply was short and price run up occurred in the Cal ISO spot and A/S markets. High real-time and replacement reserves purchase prices may have led suppliers to withhold production and bid high prices in the day ahead or hour ahead market.

D.            Elimination Of The Single Price Auction Rule

FERC has appropriately proposed elimination of the single price rule which has also been phased out in the U.K.  In California, the market-clearing price, which is based on the highest accepted bid, is paid to all sellers, including those who bid below the price.  FERC’s soft cap is intended to assure that above $150/MW, each seller is paid its bid rather than the market-clearing price.  In times of scarcity, the single price auction allowed sellers with small market shares to set the ceiling price, thereby exacerbating the effect of price shortages.  Strategic bidding a small amount of supply can raise the price of the entire market.  The single price auction rule was also a windfall for UDCs who bid their nuclear and hydropower capacity into the California PX at zero bid prices.

E.           Impact Of The CTC

FERC’s decision ignores a serious flaw in market design:  California’s decision to freeze retail rates without establishing a workable “shopping credit” has doomed the emergence of alternative energy service providers and thwarted development of retail competition.  California imposed a freeze on retail rates, while tying the back out rate for direct customers to wholesale Cal PX prices.  No retail suppliers were on the scene to serve SDG&E’s load when SDG&E completed recovery of stranded costs and terminated its rate freeze.  Retail customers were exposed to spot markets price and risk.

INDUSTRIAL CONSUMERS’ RECOMMENDATIONS

A.            Correcting Market Design Problems Is Far Preferable To Price Caps

It is far preferable to eliminate fundamental design flaws than to adopt price caps; price caps only treat the symptoms.  While consumers may need price caps as a last resort, if the crisis continues, the goal should be to amend such crisis conditions.

Primary flaws of price caps are that they inhibit new investment and discourage load response.  Developers and lenders who are faced with proposals for price caps will be discouraged from investing in California or other markets where they may be imposed.  This inhibition is especially great with respect to peaking units which only operate for limited periods and earn revenues for brief period.  It is obviously counter-productive to discourage urgently needed new investment in California. 

The short-term fix of price caps disguises the much-needed longer-term solutions.  Price caps inevitably have unintended consequences.

Price caps also prevent demand-response to rising prices or discourage suppliers and large customers from buying call options to protect themselves against prices above a certain figure by purchasing a call option contract to buy power anytime the price exceeds a certain threshold.

B.            Shortage Of Generation Capacity Is A Serious Problem In California

Electricity demand has increased 20% each year substantially since 1990.[4]   From 1990 to 1996, peak demand increased by 5,552 MW, while only 672 MW of new capacity was added.[5]  California, is of course, not unique in its need for new generation capacity, or for that matter, its need for new transmission capacity.  Unfortunately, new investment is deterred by (i) delays in the siting process; (ii) an uncertain regulatory climate which may chill investment decisions; and (iii) imposition of price caps in response to crisis conditions.  FERC is right that California urgently needs to address roadblocks to new generation.

            C.            Demand Response Programs Need Urgent Attention

While FERC’s November 1, 2000 Order pays lip service to the need for demand response programs, FERC must take the initiative to implement load response.  The issue arises not only in response to the California crisis, but in response to RTO compliance filings.  To the extent that some suppliers can exercise market power during periods of resource scarcity, competition for demand-responsive loads may be the only means for checking market power and restraining prices.

FERC should consider a new ancillary service that is dedicated to transactions that “source” at loads.  Traditionally, loads are considered “sinks.”  But loads that are curtailable or that include on-site generation (distributed generation or QFs) are capable of responding to real-time prices, solicitations for incremental or decremental bids for congestion management, and solicitations into day-ahead and hour-ahead markets.  This is often called “demand response.”  Industrial Consumers prefer the concept “curtailable load response” to distinguish this resource from utility DSM programs.  Like other ancillary services, RTOs would facilitate the market for load decrements (DECs), on-site generation increments (INCs), or a combination of the two.  In essence, the RTO would be acting as an aggregator of these load decrements (with or without on-site generation increments), and allocate the resource, at its discretion, to other markets (e.g., spinning reserves, regulation, reactive power, or balancing energy).  Accordingly, Industrial Consumers recommend that FERC consider a new OATT ancillary service dedicated to curtailable loads.  We urge Cal ISO to consider addition of this feature in its future filings.

D.                 FERC Should Forge A Single Western Interconnection RTO Or Its Functional Seamless Equivalent                                                           

Industrial Consumers welcome FERC’s recognition in the November 1, 2000 Order that the balkanization of the Western grid contributed to the California debacle:

… California is physically integrated into an extensive interstate transmission grid and has therefore been part of a western electricity market for a long time.  California’s markets will never realize optimal performance until the impediments to efficient utilization of the regional transmission grid are eliminated and the regional interstate transmission system is designed in such a way that it supports transparent, competitive Western bulk power markets ‑‑ markets that support all of the wholesale products that California requires, markets that remove impediments to efficient imports and exports, markets that eliminate rate pancaking and allow California to access more distant markets at a lower cost, markets that undertake regional transmission planning to ensure that the needs of California are considered when transmission expansions in other states are considered, and markets that allow regional market hubs like Palo Verde to develop where new generation can be located to serve multi-state markets. . . .  When fully implemented, RTOs will provide for operation and planning that will ensure consumer benefits for Californians and the citizens of other Western states.  The problems being confronted in California can, in many ways, be traced to the continued balkanization of the Western grid and the absence of a true RTO with regional scope. . . .  We expect that the matters addressed in this order will move the California market toward meeting the significant objectives of Order No. 2000 and that these long-term market reforms will facilitate California’s transformation into a properly sized and functioning RTO.

November 1, 2000 Order, slip op. at 31-32.

One of the primary goals of the Order 2000 initiative was to enhance economic efficiency, mitigate market power, and improve reliability through large RTOs. While it is welcome that FERC recognizes the need for regionalization, it must do more than passively review RTO compliance filings.  Now is the time for FERC to move ahead and insist either that RTOs achieve adequate size or that they eliminate seams with neighboring RTOs.  In theory, Order 2000 recognizes identifies regional configuration factors to assess the adequacy of RTO size and configuration:  making accurate and reliable ATC determinations over a large area; resolving loop flow issues; managing transmission congestion; creating the broadest possible energy trading area by eliminating pancaked transmission rates; improving operations through single OASIS operator and one-stop shopping; planning and coordinating transmission expansion.  The most important of these factors is the mitigation of market power.  FERC must stringently apply Characteristic 2 or else achieve the same goals through vigorous and detailed implementation of Function 8.

There is a tradeoff between Characteristic 2 and Function 8:  If the RTO isn’t big enough under Characteristic 2, greater stringency is required for Regional coordination Function 8.  FERC must enforce the guiding principle that the weaker the RTO is assessed under Characteristic 2, the stronger is the showing required under Function 8.

In comments on the RTO compliance filings, Industrial Consumers have observed that it is not surprising that RTOs are so vague about seams commitments given the lack of milestones in Order 2000.  We have suggested that FERC should convene a two-day FERC Technical Conference or mini-rulemaking to work out a compliance template for Function 8.

FERC should impose a reporting obligation on Cal ISO to report back its efforts to resolve seams issues with RTO West/TransConnect and Desert STAR.  Industrial Consumers recognized RTO West for as a proposed “best practice” in our comments with RTO filings with respect to RTO West’s interregional coordination with BC IGO—a paradigm for resolution of seams issues across international boundaries.  FERC should require Cal ISO to regulate a similar resolution with RTO West.

E.                  FERC Should Encourage Adoption Of A Flowgate/Physical Rights Approach To Congestion Management                                                                                

The November 1, 2000 Order invites the submission of a congestion management plan.  We urge a flowgate/physical rights approach both due to the inherent advantages of the flowgate approach and to assure a consistent approach within the Western Interconnection.  The holder of a flowgate right is granted a reservation or scheduling priority for using flowgates.  Flowgate capacity and thus the number of flowgate rights are knowable and relatively stable over time.  The holder may exercise transmission rights by using them to schedule transactions; if unused, the rights are worthless to the holder.  There is no incentive on the part of the holder to exercise market power or preclude others from utilizing transmission capacity that the holder does not need.  The flowgate system facilitates forward markets since the rights are tradable.  Holders have both a hedge against financial risk and a scheduling priority for physical movement of power.  Industrial Consumers believe that the flowgate physical transmission rights model is the ideal market structure for congestion management and for addressing other market functions. 

Industrial Consumers believe that both the objectives of efficient congestion management (Order 2000, Function 2) and interregional coordination (Function 8) are served by a coordinated use of the same approach to congestion management by Cal ISO/RTO West/TransConnect and Desert STAR.

F.            FERC Must Reject The State’s Request For A Greater Role Over Interstate Markets           

As FERC states in the November 1, 2000 Order:

The events of this summer provide dramatic evidence of the interstate nativeure of electric systems and markets in the Western Interconnection.  California is not an electrical island.  Operationally, the transmission facilities currently controlled by the ISO are part of the much larger Western Interconnection.  The reliability of California’s electric system depends on access to generating resources located throughout the Western Interconnection. . . . . . .  Over time, California utilities have increasingly relied on imports from generation located in neighboring states to meet their load requirements and have constructed significant transmission interties to import electricity for California consumers.  This summer exports from California to others increased.

November 1, 2000 Order, slip op. at 17.

Two conclusions follow from this factual predicate:  (1) FERC must oversee California’s market design as part of the statutory duty to assure that the California wholesale market results in just and reasonable rates for electricity wholesale transactions.  The markets operated by the PX and the ISO are interstate markets and the transmission system operated by the ISO is part of an interstate transmission grid.  (2)  FERC must take aggressive action to assure that seams are eliminated between RTO West and Cal ISO.

G.        FERC Must Encourage Independent Boards For All RTOs

There is a consensus that the ISO and PX governing boards are cumbersome, overly complex, and susceptible to political and interest group pressure.  The ISO governing board has been slow to address redesign of ancillary services markets:  reform of congestion management; and most recently, response to the summer crises and the issue of price caps.  . The boards have been subject to pressure from market participants jeopardizing their independence.  Accordingly, FERC has found it has “no choice” but to require modification of the Cal ISO and Cal PX Stakeholder boards.

Industrial Consumers agree with FERC that the ineffective stakeholder boards in California must be replaced by independent boards.  While Order 2000 allows both non-stakeholder and balanced stakeholder boards to meet Characteristic 1 – Independence requirements, over time Industrial Consumers recommend that FERC require a transition to nonstakeholder boards for all RTOs.  FERC has authority to do so under its authority “to assure "“that rates, terms and conditions of its jurisdictional services will be just, reasonable, and not unduly discriminatory or preferential.”  November 1, 2000 decisionOrder, slip op. at 3028.

Not all stakeholder boards are flawed and not all nonstakeholder boards are perfect , but nonstakeholder boards, because they are free from influence of market participants, are less likely to have improper conflicts of interest, because the are free from influence of market participants are less likely to have improper conflicts of interest.  Also nonstakeholder boards can be “lean and mean” in composition, in contrast, to be truly balanced, stakeholder boards are large and unwieldy.  FERC should not view the California governance issue as an isolated problem but apply “lessons learned” from California to evaluate the pending RTO proposals.

For the foregoing reasons, Industrial Consumers’ timely motion to intervene should be granted.

Respectfully submitted,

_________________________________

Sara D. Schotland

CLEARY, GOTTLIEB, STEEN &

   HAMILTON

2000 Pennsylvania Avenue, N.W.

Washington, D.C.  20006-1801

202-974-1500

Dated:  November 21, 2000

CERTIFICATE OF SERVICE

I hereby certify that a copy of the foregoing Motion to Intervene of the Industrial Consumers’ was today mailed to parties on the service list of this proceeding by U.S. mail, postage prepaid.

Dated at Washington, D.C., this 21st day of November, 2000.

                                                      __________________________________
                                                                        John Winter
                                                                        Law Clerk

                                                      Cleary, Gottlieb, Steen & Hamilton

                                                      2000 Pennsylvania Avenue, N.W.

                                                      Washington, D.C.  20006-1801

                                                      (202) 974-1500