No Easy Out on Energy Contracts

In one of the last battles remaining from the energy crisis, California and other big power buyers face daunting hurdles in their bid to overturn more than $17 billion in electricity contracts signed during the market meltdown of 2000 and 2001.

California contends the contracts should be tossed aside because they were negotiated in a market perverted by energy firm shenanigans. Fearful that electricity prices would keep skyrocketing during that time, California and power buyers in other Western states locked into long-term deals at rates that in some cases were double what they would pay now.

But legal precedent, politics and federal policy are stacking up as major obstacles for those who seek to overturn the contracts. And although the dollar stakes are high, the conflict also highlights broader questions on the permanence of contracts and underscores the still-unhealed wounds from the energy debacle.

Two out of three members of the Federal Energy Regulatory Commission have signaled their reluctance to toss aside dozens of energy deals in California and other Western states, some of which guarantee power more than a decade into the future.

FERC member Nora Mead Brownell has argued for preserving the “sanctity” of contracts, and suggests that the already troubled energy industry could lose even more investors if disgruntled buyers are allowed to break contracts.

That view is challenged by Sen. Dianne Feinstein (D-Calif.).

“When you say that a contract negotiated under bogus conditions is sacrosanct, that’s just dreadful,” Feinstein said.

Feinstein and others argue that the reality of a wildly gyrating energy market -- now linked at least in part to misconduct by suppliers and traders -- should overcome the fine print of contracts that public officials signed in a desperate bid to ensure stable power supplies.

This side is quick to cite a provision of the Federal Power Act of 1935 declaring that prices should be “just and reasonable.” In addition, FERC staff recently concluded there was a “statistically significant” correlation between high spot market prices and high-priced long-term contracts in 2000-01.

Nonetheless, companies that signed such contracts say they have delivered what officials asked for, often after investing millions of dollars in new facilities, and that there is no proof their prices are out of line.

“We feel it’s inappropriate for them to request this,” said Michael R. Niggli, president of Sempra Energy Resources, which holds a 10-year, $6.6-billion contract to provide electricity to California. A “long, long” legal history and tradition backs up the notion that contracts should be honored, he said.

Niggli and others say those who wish to escape contracts should meet a separate, stiffer legal test arising from disputes over long-term contracts for natural gas and electricity in the 1950s.

In a decision that became known as the Mobile-Sierra Doctrine, the U.S. Supreme Court in 1956 set an extremely high “public interest” standard for tossing out such contracts. Under this standard, for example, a utility would have to show, among other things, that abiding by the deal could put it out of business.

Defenders of the contracts also maintain that discarding them would create a new sense of risk for investors and discourage much-needed energy projects. They warn that if contracts are seen as less than binding, a reluctance to invest ultimately could reverberate negatively through the broader economy.

“If you stop enforcing contracts, lenders say, ‘I really don’t want to invest in that particular business,’ ” said Phillip Lookadoo, an attorney in Washington with Thelen Reid & Priest who represents power companies that have long-term contracts with California. “That’s the cost to the overall economy.”

At the peak of the energy crisis, California entered into about $42 billion in long-term contracts as a way to avoid the out-of-whack short-term market and ensure that electricity would continue to flow.

Since then, some deals have expired or been voluntarily renegotiated, and some of the costs have been paid, with the result that California’s portfolio is valued at about $35 billion, according to the state Department of Water Resources.

Of that amount, about $15.7 billion remains in dispute, including deals the water resources agency cut with Sempra, Allegheny Energy Supply, Dynegy Inc., Coral Power and others. Other jurisdictions are contesting more than $1 billion in remaining contracts. Initially, the contracts in dispute totaled about $45 billion.

The agency bought power for the state’s investor-owned utilities at the height of the energy crisis, when the utilities no longer could afford to buy electricity. Some of those contracts have since been assigned to the utilities.

Efforts to renegotiate the remaining deals have proved elusive. California and Sempra, for example, have come close to agreement on reworking a major contract three times. The San Diego-based company, which has invested more than $1 billion to produce the power, says that it has made “good faith” efforts to consider changes the state has asked for but also that its prices are reasonable.

“There will be times when the price you could pay on the market is lower than our contract, and there will be times when the price you could pay is higher than our contract,” Niggli said, adding that the firm previously has offered contract changes that would save the state $1.5 billion over the long term.

Allegheny, which also is at odds with the state, says its contract is cheaper than the average for the long-term deals but that it nonetheless is willing to talk.

“Despite the fact that we have a fair and binding contract, we’ve been willing to renegotiate -- and continue to be willing to renegotiate -- a mutually beneficial settlement with California,” said Janice Lantz, communications manager for Allegheny in Monroeville, Pa., which has an 11-year contract with California valued at more than $4.3 billion.

What may pain California politicians who pushed for the deals is that Allegheny’s comparatively low-cost contract at $61 per megawatt-hour may have seemed like a bargain when spot prices exceeded $300 per megawatt-hour. Although Allegheny says its price remains several dollars per hour lower than the average, it now contrasts with shorter-term prices in the $30 range.

A final obstacle to overturning the contracts could be political. Two of the three members of FERC are Republicans, and the GOP generally opposes meddling with contracts after they have been signed.

In fact, the House Energy and Commerce Committee recently included a strong protection of future contracts in the House energy bill. The provision endorses the Mobile-Sierra Doctrine. Some saw the House bill as a signal to FERC. In any case, there was nothing secret about it.

“This is not language that was slipped into the bill in the dead of night,” said Ken Johnson, spokesman for the House Energy and Commerce Committee. “This is a provision that was thoroughly, exhaustively and passionately debated before being approved.”

Federal regulators recently told California that it would have a last chance to argue for contract abrogation in May. But a preview may have come last week.

At a hearing before FERC, parties varying from Southern California Water Co. and a utility district in Snohomish County, Wash., argued that the contracts were unfair and should not stand. The only verbal support they gained was from the commission’s lone Democrat, William L. Massey.

Paul Pantano, counsel for Morgan Stanley Capital Group Inc., which holds a contested long-term contract with Snohomish County, sought to shred the arguments of those who want the contracts renegotiated.

“Once you cut through all the hyperbole, this is really a case of buyer’s remorse,” Pantano said.