Date: Wed, 28 Feb 2001 06:49:00 -0800 (PST) From: steven.kean@enron.com To: bernadette.hawkins@enron.com Subject: Ken Lay's email to Sen. Brulte Mime-Version: 1.0 Content-Type: text/plain; charset=ANSI_X3.4-1968 Content-Transfer-Encoding: quoted-printable X-From: Steven J Kean X-To: Bernadette Hawkins X-cc: X-bcc: X-Folder: \Steven_Kean_June2001_1\Notes Folders\All documents X-Origin: KEAN-S X-FileName: skean.nsf ----- Forwarded by Steven J Kean/NA/Enron on 02/28/2001 02:48 PM ----- Jeff Dasovich Sent by: Jeff Dasovich 02/16/2001 08:49 AM To: Sandra McCubbin/NA/Enron@Enron, Susan J Mara/NA/Enron@ENRON, MDay@GMSSR.com, Hedy Govenar <@mail.acom2.com> @ ENRON, Scott Govenar , Paul Kaufman/PDX/ECT@ECT, James D Steffes/NA/Enron@Enron, Harry Kingerski/NA/Enron@Enron, Richard Shapiro/NA/Enron@Enron, skean@enron.com, mpalmer@enron.com, Karen Denne/Corp/Enron@ENRON, BTC cc: Subject: Ken Lay's email to Sen. Brulte Greetings All: First, I am apologizing in advance for any typos in this email. Schedule i s very tight, but I wanted to make sure that everyone had it first thing this morning, with some back-up info that I've included below. Attached is the email that was sent to Ken Lay's office yesterday evening f or delivery to Sen. Brulte. It's of course confidential. Few points: I don't have Bev's email, so if you could please forward to her, that would be appreciated. As we discussed (Jim, Mike, Bev, Scott, Hedy) on our lengthy call on Wednesday, I'm assuming that the plan is still to "wallpaper" Sacramento wi th our proposed legislation. This email does not contain the legislation. Mike sent the "final" version s of our legislation out yesterday, except for the siting piece, which I believe Brian Cragg of Mike's office is finalizing today. You'll note that we promise Senator Brulte in the email that we'll deliver to his office today the proposed legislation. Again, based on our call on Wednesday, I'm assuming that we would simultaneously release the proposed legislation to the rest of the world at the same time. When we spoke on Wednesday, we decided that the Sacramento team would determine to whom we would circulate the proposed legislation at the same time that we deliver the Senator Brulte. I'm assuming that you folks will handle that end of things. Please let us know at your convenience to whom you've decided to circulate. This email does, however, include a "summary" of our proposed legislation. But I'm not certain that the summary included in this email is the appropriate language to distribute "to the world," or if we'll need instead to tailor some new language. I think we all agreed that we need a "one pager" to accompany the legislative package so that we can communicate the package effectively. We also discussed the need to quickly develop a coalition to support our proposals. We didn't finalize that plan. Perhaps the Sacramento team coul d propose a plan to do that. Perhaps we could start with our friends in the Direct Access coalition? We also talked about the need at this point to engage in PR and to get the PR machinery activated, also with the goal of effectively communicating our legislative package/message. We're in a meeting with folks today where we can discuss getting that side of things going and Karen Denne has contacted Marathon and they're pondering some things that we can do in the near term. You'll note that there's a considerable amount of information about the DWR credit issue. As I recollect, we discussed the issue in depth on the call. You note that attached to the email is a "legislative fix" to AB1X that cou ld solve the credit issue and an attached set of "taking points" related to a second alternative to solving the credit issue: a PUC order clarifying tha t DWR will get its money for power purchase costs. Note also that Steve Kean reminded me that we've got to continue to push to get the utilities out of the merchant function. Accordingly, I've put a brief paragraph on that issue in the note to Brulte in the last section (legislative solution) under the topic "create a real competitive retail market in California." To the best of my knowledge, we don't have legislative language on that piece yet, and it seems that we'll need to discuss it in considerably more depth before doing so. If you have any questions about any of the materials in the email, please don't hesitate to contact me or Jim or Sandi to discuss. I can be best reached to day by pager at 888.916.7184. Thanks to all for helping pull this together. Best, Jeff ----- Forwarded by Jeff Dasovich/NA/Enron on 02/16/2001 08:27 AM ----- Jeff Dasovich Sent by: Jeff Dasovich 02/15/2001 06:11 PM To: jdasovic@enron.com, skean@enron.com, Richard Shapiro/NA/Enron@En ron, James D Steffes/NA/Enron@Enron cc: Subject: Steve: Here's a substantially more cleaned-version, with attachments. There's a hard copy on your chair. Best, Jeff ----- Forwarded by Jeff Dasovich/NA/Enron on 02/15/2001 05:57 PM ----- Jeff Dasovich Sent by: Jeff Dasovich 02/15/2001 05:56 PM To: jdasovic@enron.com cc: Subject: Jim: It was a pleasure speaking with you yesterday. Based on our conversation, this email includes the following: An Enron contact to discuss developing small-scale generation on Tribal lan ds. Our views on the impediments to distributed generation and suggestions on h ow to remove those impediments. A description of the credit issues that continue to impede DWR,s ability to sign contracts with power suppliers, and options to resolve them. Two possible options for addressing the credit issue are 1) a California PUC order clarifying that DWR will recover its power purchase costs through rates, and 2) an amendment to AB1X designed to accomplish the same goal. I have attached talking points regarding the California PUC order and propose d amendments to AB1X. We believe that an amendment to AB1X is the preferable option. Our assessment of the supply/demand picture in California. Our suggestions for a legislative package designed to solve both the near- and long-term electricity crisis in California. We will deliver to your office tomorrow detailed legislative language. In those materials we will also identify existing bills that we believe can easily accommodate our proposed language. I hope that the information is useful. Please do not hesitate to contact m e if you would like to discuss these materials further, or if there is anythi ng else that I can do to assist you. Regards, Ken Contact Information to Discuss Interest Expressed by Native American Tribes in Installing Small-scale Generation on Tribal Lands David Parquet, Vice-President Enron North America 101 California Street, Suite 1950 San Francisco, CA 94111 Phone: 415.782.7820 Fax: 415.782.7851 2. Key Barriers to Distributed Generation Excessive and Unnecessary Utility Stand-by Charges Solution: The executive orders issued by the Governor on February 14th took a step in the right direction. Utility stand-by charges have always been designed by the utilities to protect their monopoly position, extract monopoly prices from customers, or both. But there is no reason to limit t he elimination of these charges to generation facilities that are less than 1MW. These limits will only lengthen unnecessarily the time it takes for California to close the significant gap between supply and demand and reduc e the risk of black outs this summer. We would propose lifting the cap by offering amendments to SB27X, which is designed to facilitate development o f distributed generation. Excessive delays and costs related to interconnecting facilities with investor-owned and municipal utilities Solution: The Governor,s executive order regarding interconnection is a step in the right direction*D-D-26-01 requires utilities to complete interconnection studies within 7 days. California should ensure that this requirement applies to all generation facilities, including distributed generation. In addition, the financial conflicts the utilities face when interconnecting generation facilities are simply too powerful to overcome through executive orders or other regulations. To the greatest extent possible, California should shift control over interconnection away from th e utility and place that control with the California ISO. This could be accomplished through amendments to SB 27X. Permitting and Air Quality Issues Developers of distributed (i.e., "on-site") generation that is 50 MWs or greater must receive certification from the California Energy Commission an d therefore face all of the impediments to development that large-scale generation faces. Solution: California should ensure that the executive orders (D-22-01 thru D-26-01) issued by the Governor to expedite plant siting and maximize plant output apply equally to smaller scale, "distributed generation" facil ities. In addition, distributed generation that is less than 50 MWs continues to face local opposition. The State should ensure that local, parochial interests cannot block otherwise beneficial distributed generation projects . These objectives could be accomplished through amendments to SB27X. 3. Credit Concerns Regarding Authority Granted to DWR in AB1X to Purchase Electricity on Behalf of the Utilities Enron responded to the RFP issued by DWR to enter into power contracts with suppliers. Enron is in active discussions with DWR to establish contract terms with th e goal of entering into a power purchase agreement as soon as possible. However, ambiguities contained in AB1X have created significant credit risk concerns that need to be resolved in order to finalize contract terms. We understand that the lion,s share of counterparties share Enron,s c redit risk concerns. Enron has proposed several options for resolving the credit risk issues and is working with DWR to arrive at a solution that is mutually agreeable to both sides and that might serve as a template for power purchase agreements going forward. Summary of the Source of the Credit Risk Issue Ambiguous Ratemaking Authority The language in AB1X is ambiguous as to whether DWR has any authority to charge California ratepayers for the costs of purchasing power. From our analysis of the bill, the language in AB1X appears to leave intact the California PUC,s exclusive jurisdiction over ratemaking in California. As such, suppliers have no assurance that the PUC will agree to include in rat es adequate charges to cover DWR,s costs of power purchases. Ambiguous Regulatory Authority Regarding Contract "Prudence" The language in AB1X leaves open the possibility that the California Public Utilities Commission could determine that power purchases made by DWR are "imprudent." On the basis of such a finding, the CPUC could then ref use to allow DWR to collect from ratepayers the costs associated with its power purchases. Consequently, suppliers have no assurance that the PUC will agr ee to include in rates the charges to cover the costs of power contracts that DWR has entered into with suppliers. Ambiguous Language Regarding the Ratemaking Mechanism that Will Be Used to Recover DWR,s Costs of Power Purchases In addition to the ambiguity regarding ratemaking and regulatory authority noted above, the language in the bill is equally ambiguous with respect to the specific ratemaking "mechanics" that AB1X directs the PUC to empl oy to permit DWR to recover its power purchase costs. Based on our analysis, it i s extremely difficult to determine how the PUC would design the rates to ensu re DWR recovers its power purchase costs. Moreover, as currently drafted, it is difficult to determine whether AB1X would even permit the PUC to include in rates all of the charges necessary to fully recover DWR,s power purchase costs. Again, this ambiguity raises significant credit risk concerns since suppliers have little assurance that DWR will have the ability to recover from ratepayers the costs of purchasing power. Options to Resolve Concerns Regarding Credit Risk We have been working diligently with DWR officials to resolve the credit ri sk issues. We have identified three options: Amend AB1X The amendments, which are attached to this email, would clarify that a) the PUC would accept as "prudent and reasonable" all purchase costs incur red by DWR, and b) the PUC is obligated to include in rates the charges necessary to ensure that DWR fully recovers its costs of power purchases. This is the preferred option, though we understand that the there may be some political challenges standing in the way of amending AB1X. (See attached file entitled, "AmendAB1X.doc".) Clarify the Ambiguities in AB1X through an Order Issued by the PUC, and through Contract Language This is the option that we are currently working with DWR officials to implement. However, it is more complicated and could take significantly mo re time to implement than the "legislative" fix. We have attached electronic copies of the talking points related to the order that the California PUC would need to issue under this option. (See attached file entitled, "cpuctalkingpoints.doc.") Make Use of Other Instruments Designed to Address Credit Risk As indicated in our letter responding to DWR's RFP, we are willing to ac cept other forms of credit from DWR. Those options include a letter of credit, cash prepayment, or an acceptable form of collateral. DWR officials have indicated to us that DWR prefers to pursue the second options. That is, DWR prefers to clarify the ambiguities in AB1X through a PUC order and through contract amendments. 4. California's Supply-demand Picture Heading into Summer 2001 Both the California Energy Commission and Cambridge Energy Research Associates (CERA), a private sector energy think tank, have issued reports showing that California faces a severe supply-demand imbalance. They diffe r only on how much and how soon additional supply will be made available. Al l credible sources agree that supply will be very tight throughout the Summer of 2001 and that unless a solution is found immediately, blackouts are likely. CEC and CERA both forecast that California will be short of supply this summer by approximately 5,000 MW. These numbers are in line with our estimates. California's supply base currently has a 6% capacity margin, well below the average 15-20%, which is recommended for reliable system operatio n in the West. Since the West relies more heavily upon hydroelectric power than other regions, reserves are particularly important, owing to the unpredictability of the weather and the dry year the West has experienced t o date. In the event of a low rain and snow period, the system must possess t he flexibility to respond to the reduced availability of power supply. California's very low reserve margin makes it especially susceptible to this requirement. Other reasons for reduced supply for the Summer of 2001 include the early draw-down of reservoirs in the continual effort to manage California's seve re supply-demand gap; emissions restrictions on existing plants; and a reduced number of customers who can be curtailed under their contracts with the utilities. Cambridge Energy Research Associates asserts that at the curren t pace of siting, permitting and construction, adequate supplies will not be added to correct the market imbalance until 2003 at the earliest. CERA predicts that California is likely to face approximately 20 hours of rolling black outs this summer. The CEC paints a considerably more optimistic scenario, betting that California will bring an additional 5,000 MWs on line to meet peaking summer demand. It is our view that California should view the CEC's "rosy scenario" with considerable skepticism. 5. Suggested Package of Legislative Proposals Designed to Solve California 's Electricity Crisis This email offers an overview of our proposed legislative solution. We wil l deliver to your office tomorrow specific legislative language and existing bills that we believe can accommodate our proposals. As we have suggested throughout the crisis, any solution to California's crisis must focus on four issues: Increase supply Decrease demand Establish a truly competitive retail electricity market Return California's Investor-owned utilities to solvency Increase supply--Legislative vehicle: SB28X (Sher) To site and construct a power plant in Texas takes approximately 2 years. Enron and others have completed the entire process in other states in less than a year. In California, it takes about six years, or longer. The Governor's executive orders and Senator Sher's siting reform legi slation are steps in the right direction. Our suggested amendments can improve tho se efforts by further addressing the difficulties that project developers face in securing air emission reduction credits to meet the air permit requirements included in the CEC's certification requirements. Enron's proposal seeks to streamline the process for 1) obtaining credits and 2) transfering credits between air districts. In addition, it creates an innovative emissions reduction bank to allow project sponsors to fund emissions in advance of obtaining certification, and permits the affected a ir districts to use those funds to finance projects that will produce the required reductions in pollution emissions. Decrease demand*Legislative Vehicle: AB31X (Wright) Because of the delay in getting a solution in place in California, closing the supply-demand gap through energy conservation and efficiency offers the best chance of avoiding blackouts this summer. This can be accomplished mo st effectively and quickly in two ways: Buy-down demand California is tapping into an enormous amount of money from the General Fun d to finance DWR's power purchases. California could likely reduce demand more economically by running an auction to determine the payments businesses wou ld be willing to receive to reduce their demand for a sustained period (e.g., through the summer months). DWR could easily run an on-line auction to determine the price it could pay for these demand reductions. To participate, businesses would be required to have the metering equipment necessary to monitor and verify that they are actually achieving the reductions. Enron has developed an on-line auction software package, "D eal Bench," that it would be willing to contribute to the effort. Use Price Signals to Incent Voluntary Curtailment To be successful, customers need access to the following key elements: An internet based hour-ahead price posting system to track the market price for hour-ahead power in real time. Real-time metering systems for baseline demand and voluntarily curtailment verification. Settlement process that allows for market clearing prices of energy to be paid for load reduction ("Negawatts"). The potential benefits of an effective demand response program would includ e: "creation" of additional summer peaking capacity in California, parti cularly in the short term, without requiring construction of additional generation resources. reduction of peak or super-peak load on the over-stressed California electric system, thus potentially reducing the overall cost of electricity in the state. fostering of demand elasticity without subjecting customers to the full ris k of hourly market price volatility by passing market price signals to customers and allowing them to voluntarily shed load and be compensated for responding. We estimate that we could generate a summer 2001 on-peak demand response in excess of 400 MW during certain high cost hours, and a demand response for summer 2002 on-peak hours that could exceed 1000 MW. We further estimate that the market response to this program from all ESPs could be 2 to 3 time s that amount. We recommend that the State of California provide rebates directly to customers to fund the installation of advanced metering and control systems that would support load curtailment implementation. Establish a truly competitive retail electricity market*Legislative vehi cle: SB27X The only customers who were protected from price volatility in San Diego we re customers who chose Direct Access and signed fixed price deals with energy service providers. Ironically, AB1X takes that important option away from customers and businesses. It is critical that AB1X be amended to remove th e prohibition against Direct Access. Enron's legislative proposal would give customers freedom to enter into a direct access transaction, while simultaneously addressing the Department o f Water Resources' concerns about stranded power costs that might result from customer migration. In addition, California will only achieve a competitive retail market when the utility is removed completely from the procurement function. Procureme nt is not a utility core competency, as evidenced by the dire financial condition in which the utilities now find themselves. California should therefore begin immediately to phase the utility out of the procurement function entirely, with the goal of having all customers served by a non-utility provider within 36 months. To execute the transition, California should hold a series of competitive solicitations over the 36-month period in which competing service providers would bid for the right to serve segments of utility load. Return California's Investor-owned utilities to solvency*Legislative vehicle: AB18X Utility bankruptcy will not increase supply and it will not decrease demand. In short, bankruptcy does nothing to solve California's supply-demand imbalance. In addition, bankruptcy increases the likelihood that consumers and businesses will bear the significant financial risks of having California State government assume the role of "electricity buyer" for an extended period of time. Finally, bankruptcy will undermine both investor confidence in California's energy markets and the private sector's willingness to participate in that market. California can return the utilities to financial solvency by implementing a series of staged rate increases. California should design those rate increases with the dual goal of returning the utilities to solvency without "shocking" the economy or household budgets For example, California could amortize the recovery of the utilities, past debt over a 5-10 year period. In addition, the magnitude of the rate increase can be reduced in two ways: First, the utilities could absorb some portion of their existing debt in recognition of the risk they accepted when they agreed to the structure of AB 1890. Second, California can "net" the revenues the utilities have r eceived from selling electricity into the Power Exchange against the debts they hav e accrued due to the retail price cap.