Deal Breaker

California Governor Gray Davis attempts an election-year power play.

In December 2000, California's chief energy regulator, Loretta Lynch, was asked why the state was preventing utilities from locking in predictable prices for power. "You can't just allow any contract," she explained. Spot prices for power might drop, the California Public Utility Commission reasoned, and then fixed-price contracts would mean higher prices for consumers. One company, PG&E, ended up filing for bankruptcy after spot power prices increased for months on end.

With PG&E bankrupt and other utilities too broke to buy power last winter, the state stepped in to become the main purchaser of electricity for consumers. Suddenly everything changed.

Governor Gray Davis took a break from berating "out of state profiteers" to declare that contracts with these folks "are the bedrock of a long-term energy solution." To keep the lights on, state bureaucrats negotiated an estimated $43 billion worth of contracts of varying lengths and conditions with more than 20 power generators. The generators lived up to their end of the bargain by delivering the juice to keep California's air-conditioners humming all summer.

But as Lynch earlier feared, spot prices eventually dropped. Now, with the state spending billions on power, the deals look dumb. Davis and Lynch want out, and have gone crying to the Federal Energy Regulatory Commission (FERC) to get them declared "unjust" and "unreasonable" and to secure a $21 billion price break.

The state must leap a few hurdles if it is to succeed in breaking its word and backing out of its many power deals.

First of all, there's an obvious contradiction. Last Thursday, the Public Utility Commission declared the contracts just and reasonable for the purposes of setting rates. The very next day, it told FERC these same contracts were unjust and unreasonable. "They are talking out of both sides of their mouths," says Gary Ackerman, executive director of the Western Power Trading Forum, which represents power generators. "Same agreements, same costs."

Furthermore, the state has only the slimmest claims of wrongdoing. Some economists point to high prices as sign of market manipulation. But other economists say the market is too complex to game and point out that there's never been any smoking-gun evidence of withholdings. No one can deny that it was the state that the created the structure that produced the high prices. As Robert Levin of the New York Mercantile Exchange puts it, "They invented a doomsday machine and they want to blame the people who used it."

Nor does the state have any serious evidence of price-fixing among the many sellers that negotiated individually with the state and its consultants. The state may be an incompetent commercial agent, but this was a known problem when it chose to give itself incredible buying responsibilities rather than freeing up the market. "These were consenting adults negotiating with each other in a situation that is very hard to characterize as duress," says Cal State-Fullerton economist Robert Michaels, who's moonlighting as a consultant to power producers.

In some cases, the state is the unjust and unreasonable party. Sempra Energy Resources wanted to contract with the state to deliver peak power starting in 2003, because it needed to build plants to produce the electricity. "The state said no," says Sempra spokesman Doug Kline. According to Kline, the state had made this offer: "We are going to be in a power crunch in summer of 2001 and 2002, and if you want to do business with us you need to go out into the market, get power, and sell it to us at discounted rates. You can recoup the costs in the latter years when your plants come online." The company agreed, and went into the market and purchased the power and resold it at a loss, even as it made major investments in plants to meet its agreement. Now that the crisis has passed, the state wants to renegotiate the deal.

Such bad-faith dealing is not unexpected from Davis, a lifelong politician. Fear of Davis' duplicity is exactly why the contracts contain stringent conditions protecting the generators from the state, provisions the state now cites as reasons for why it ought to be allowed to back out of the deals. It's a gutsy move, but one that FERC is likely to reject.