SECTION: CAPITOL HILL HEARING TESTIMONY

LENGTH: 1512 words

COMMITTEE: SENATE ENERGY AND NATURAL RESOURCES

HEADLINE: ELECTRICITY PRICE CAPS, NATIONAL ENERGY PLANS

TESTIMONY-BY: STEVEN M. FETTER, MANAGING DIRECTOR

AFFILIATION: GLOBAL POWER GROUP FITCH, INC.

BODY:
June 19, 2001

STATEMENT OF

STEVEN M. FETTER MANAGING DIRECTOR GLOBAL POWER GROUP FITCH, INC. NEW YORK, NEW YORK

UNITED STATES SENATE COMMITTEE ON ENERGY AND NATURAL RESOURCES

I appreciate the opportunity to testify before the Committee on Energy and Natural Resources to offer the views of Fitch on S. 764, a bill to direct the Federal Energy Regulatory Commission to impose just and reasonable load-differentiated demand rates or cost-of-service based rates on sales by public utilities of electric energy at wholesale in the western energy market, and sections 508-510 of S. 597, the Comprehensive and Balanced Energy Policy Act of 2001, relating to wholesale electricity rates in the western energy market, natural gas rates in California, and the sale price of bundled natural gas transactions. I will speak from the perspective of a member of the financial community as well as former Chairman of the Michigan Public Service Commission. By now we are all familiar with the factors that have led to the energy catastrophe in the Western U.S. electricity market. California's restructuring plan encouraged utility divestiture of generation and called for a high proportion of customer demand to be met by spot market supply from day-ahead or hourly transactions. This exposed the state's three investor-owned utilities, which were operating under retail price caps, to extreme financial pressures due to wholesale market volatility. By contrast, in more rational market structures for electricity and other energy commodities, approximately 85-90% of demand is normally provided through long-term contracts, with at most only 15% subject to spot market fluctuations. The extreme volatility of price at the wholesale level has given rise to urgent calls for a "fix" in the form of lower and lower price caps.

Three months ago, before this committee, I offered Fitch's views as to whether price caps could provide a solution to the problems facing California and the West. While I continue to believe that price caps would negatively influence the evolution to a competitive electricity market, I am willing to admit that federal enactment of a uniform price cap at a high level - such as $1000 per mwh - might serve a useful purpose. It could operate as a circuit breaker to cap wholesale prices during the brief periods when extremely volatile circumstances result in a market that cannot be contained by any manner of competitive forces. It also probably would not interfere with any strategic decision making by industry participants since builders of new generation or transmission would not employ prices at that level (or higher) in their financing models.

However, to go lower than such a safety valve type level would undoubtedly slow the nation's movement toward an efficient competitive wholesale market. We have already seen that imposition of a low price cap, such as $250 per mwh or even $150 per mwh, can have the negative effect of encouraging suppliers to seek alternative market outlets or even to slow production, or could create anomalous pricing patterns during off-peak periods. Continued tinkering with market rules, especially if at the macro federal level, is sure to create uncertainty among energy investors and delay implementation of their business plans - this is even more the case in light of recent ambiguous economic signs.

A further concern for market participants is that major investments have been made in California and other states based on the particular competitive frameworks mandated by state legislatures. Price levels for generation asset auctions were driven by the new market orientation. A retrenchment on these policies back to a form of cost-of-service regulation would likely curb investors' enthusiasm for additional investment pending clearer signs as to future policy direction. This is especially true where the change in direction comes from the Congress, which is considering proposals for price controls that could apply to just California, or potentially all eleven states within the western energy market, or conceivably the entire U.S.

What concerns me most about Congressional involvement in regulation of the wholesale electricity market is the uncertainty it engenders among investors. Industry participants, including federal and state regulators and elected officeholders, have called for substantial amounts of investment if the nation's utility restructuring movement is to progress. New generation must be added across the country and upgrades to the existing transmission grid are needed to transform the former integrated utility structure into a complement of regional competitive markets operating in a coordinated manner.

I believe the policies encompassed in the legislation under consideration today would add to the uncertainty currently in the minds of investors in light of the serious financial difficulties facing Pacific Gas & Electric and Southern California Edison. I draw an analogy to the well-intentioned, but flawed, federal policy enacted within the Public Utility Regulatory Policies Act, known as PURPA. Passed in 1978, PURPA sought to encourage both cogeneration and small power production in order to diversify electricity supply away from traditional large utility-owned power plants. In that regard, the law failed miserably. It did succeed, however, in touching off two decades of regulatory and judicial disputes and creating billions of dollars in stranded costs - as I saw firsthand as a state utility regulator.

In 1987, I was appointed to the Michigan Public Service Commission (MPSC). At the time, I had no idea what PURPA was, but I soon learned of the positive objectives Congress sought in enacting the legislation. Unfortunately, those aims only became evident to me from a reading of PURPA, because its goals were never achieved in its implementation within the State of Michigan or anywhere else in the U.S.

Soon after the announcement of my appointment, I began to receive calls - both pro and con -- about the largest cogeneration facility in the world, a 50% utility-owned facility, that was to be considered by the MPSC under PURPA. I was confronted with PURPA issues every day of the six years I served as a state regulator. Finally, in May 1993, the MPSC resolved the final major cogeneration matter before the Commission. I left soon after, never having seen the congressional intent - and good intentions -- underlying PURPA being manifested.

I offer this example because I firmly believe that utility regulation is not an area where the Congress can step in every few years and attempt to deal with a pressing issue of the moment. As we saw with PURPA, such a step can have long-term negative economic consequences. If illegal behavior is occurring within the California market, laws already exist to remedy those wrongs. But if this body seeks to preempt state regulatory prerogatives and act as a guardian against market movement in an upward direction, you will generate growing concern in the minds of investors and lead them to question whether they really do want to be part of the changing energy landscape.

Already in California there is talk that the state may try to back out of some of the agreements it recently negotiated because wholesale electricity prices have collapsed from the highs of a few months ago. And what of the contracts that remain in place for the next ten to twenty years? In view of the proposed about- face on competition under consideration today, what investor would not fear that five to seven years hence - when the rates flowing from California's long-term supply contracts far exceed market levels (just as happened under PURPA) - that today's proponents of price caps would fight to relieve their constituents from having to pay the "outrageous" above-market rates being forced upon them. And the situation is not necessarily confined to the West. The Midwest electricity spike of June 1998 and its aftermath led Fitch to state that "the electricity market involves unusual risks that will affect the credit of all market participant" .Indeed, there have been other instances of rate aberrations in both the electric and natural gas sectors in various regions of the country over the recent past. Some industry observers have speculated that the New York City region might experience price or supply problems this summer.

Does this Congress intend to maintain an ongoing oversight role so that price controls may be extended beyond the western market whenever prices in other regions fluctuate upward? If so, the efficiency gains envisioned coming from a truly competitive energy environment will likely never be achieved.

Already in the wake of California's serious difficulties, restructuring activities have come to a dead halt across the country. You may believe you are playing the role of the cavalry coming over the hill to save the day, but from where investors sit, it appears more like the waving of a white flag on electric industry competition.



LOAD-DATE: June 21, 2001