Long-Term Power Contracts Present Dilemma for Utilities

California electricity users just can’t seem to buy a break.

After a summer of sky-high wholesale prices that briefly socked the bill to consumers in San Diego, various power marketers have come forward with a deal for the state’s big utilities: Sign long-term contracts for electricity, at one-third to one-half current prices, and everybody goes home happy.

But utilities and independent power generators have yet to sign such bilateral contracts despite industry assurances that the deals could offer a way out of the state’s continuing electricity crisis.

The aversion of utilities to the contracts’ risks, regulatory uncertainty and the unsettled energy market overall are cited as causing the stalemate. In any case, the standoff is yet another sign that the deregulated California electricity market isn’t working as expected, with residents, small businesses and utility shareholders the ultimate losers.

Power merchants, which complain that they have been cast as heavies and as market manipulators during the summer-long electricity crunch, say the contracts they have offered to utilities illustrate how they are putting “solutions on the table,” as one executive put it, that so far have not been picked up.

Southern California Edison, a unit of Edison International, and PG&E; Corp.’s Pacific Gas & Electric received permission from regulators last month to sign long-term contracts to buy energy directly from generators and bypass the California Power Exchange, where wholesale prices soared this summer on higher-than-expected demand and generation shortages throughout the West.

San Diego Gas & Electric, a unit of Sempra Energy, got a green light to sign such bilateral “forward” contracts last week. The utility’s 1.2 million customers suffered through a summer of doubled and tripled bills before price caps were enacted last month; retail prices in Edison and PG&E; territory remain frozen under terms of the state’s landmark 1996 regulation bill.

Those limits on rates have saddled the utilities with $5 billion in uncollectable costs--the difference between the skyrocketing wholesale rates and the prices they can pass along to consumers. Doubts surrounding whether the utilities will recoup any of that growing deficit is causing increased nervousness on Wall Street.

On Wednesday, Edison International shares plunged $3.19, or 14%, to $19.88 on the New York Stock Exchange in heavy trading, as investors focused on the risks the company faces in borrowing to cover power costs. The stock now has slumped 24% from its recent high.

PG&E; Corp. slid $1.92 to $25.39 on Wednesday, extending its loss to 20% from its recent high, also on concerns about its borrowing needs.

After the state’s Public Utilities Commission authorized bilateral contracts, power merchants including Duke Energy Corp., Reliant Energy Inc. and Dynegy Inc. came forward, offering to supply power to the utilities at fractions of the going wholesale rate.

The power merchants have been touting energy as cheap as $50 per megawatt-hour in contracts spread over one to five years. That would seem to offer big savings over the average Power Exchange electricity price so far this month of $122 per megawatt-hour and the $166 average for August--dramatic spikes upward from the $40 average of August 1999.

Why, then, have no deals been cut?

Edison and SDG&E; say that the Public Utilities Commission’s right of review would create huge potential liabilities for their shareholders if wholesale electricity prices were to fall.

The risk is that prices on the Power Exchange could drop significantly 18 to 24 months from now, when added generation capacity coming online in California should ease shortages. That could leave utilities paying more under contracts than on the open market.

“The PUC could look at the transactions, find them to be imprudent, say the difference between the contract price and Power Exchange price was the cost of our actions, and then try to recover the difference from shareholders,” said Kevin Cini, Southern California Edison’s manager of energy supply and marketing.

The PUC could possibly take such action any time the contract price turns out to be more than a 5% “safe harbor band” above the average Power Exchange wholesale price over the life of the contract. “We think the safe harbor should be 20%,” Cini said.

A source at the PUC--some of whose members have been against bilateral contracts on grounds they distort the workings of the Power Exchange--said the utilities want a “blank check” to make deals and bypass the commission’s mandated oversight role in setting retail electricity rates.

“The utilities don’t want any constraints on what they can do,” said a PUC administrative source who asked not to be identified. “They don’t want the PUC to take a retroactive review and say this was unreasonable and disallow some costs, nor do they want pre-approval and be subjected to review.”

Industry observers say that the PUC’s right to review all contracts longer than two years hamstrings the utilities’ ability to hedge their risks in the volatile state energy market.

“The utilities can judge the risks. What we need is the PUC to allow the utilities to enter into these deals without the second chance of looking at them,” said Greg Blue, senior director of Dynegy, a Houston-based power merchant that owns several power plants in Southern California.

Regulators and consumer advocates, meanwhile, are concerned that allowing the utilities to sign contracts for supply represents a merchant role they relinquished under deregulation.

Mike Florio of the Utility Reform Network, a San Francisco-based consumer watchdog, said the utilities could someday lose some of their retail customer base, “leaving the remaining customers to pay contracts costing more than what was available on the spot market.”

Stanford professor Blake Johnson believes the California wholesale market will one day “settle out” as a mixture of short-term contracts on the Power Exchange and long-term bilateral deals. Until then, he said, he can see the risks on both sides of the issue.

“When the house is on fire,” he said, “it’s not the right time to buy the insurance policy.”