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July - Duke Energy Employee Advocate

Deregulation - Page 17 - 2002

“As long as wholesale power markets have rules, energy companies will try to exploit them.” – Dow Jones

'Low-Rolling' Energy Traders

Dow Jones – by Andrew Dowell – June 14, 2002

(6/11/02) - NEW YORK - The current structure of the U.S. electricity trading business is fundamentally flawed, and its illiquid and uncertain markets are unlikely to improve in the near term, a senior trading executive said Tuesday.

In an assessment that was unusually bleak even by the current dire standards of the energy sector, Dan Gordon, president of Allegheny Energy unit Allegheny Energy Global Markets, said creditworthy counterparties are too scarce, balance sheets and management are too weak for the risks involved, and an already fragmented regulatory approach is introducing political risks that are difficult to control.

"I don't see why these markets would have a reason to rebound in the very, very near future, absent some sort of dramatic change," Gordon said at a conference in New York.

Merchant energy companies Mirant Corp., Reliant Resources, Williams Cos., Dynegy Inc. and El Paso Corp. have seen their stock and debt prices battered since last year's collapse of Enron Corp.

Pressured by a bear market for electricity, disclosures of questionable trading activities, investigations by securities and energy regulators, California-related litigation, and credit downgrades, a number of companies have cut back their trading activities or had them cut back for them by skeptical counterparties. At the same time, the Federal Energy Regulatory Commission is considering petitions to undo long-term energy contracts signed by utilities in Nevada and the state of California at the height of the 2000-2001 power crisis in the West.

As a result, Gordon said, electricity markets lack the characteristics of functioning markets: liquidity, creditworthy counterparties and a degree of certainty about risks.

"None of that exists today," Gordon said. "Unless those three things develop, these markets will continue to flounder."

Electricity trading continues on a short-term basis, but the list of acceptable counterparties is dwindling and longer-term deals are drying up, Gordon said.

"You have a number of markets where liquidity has evaporated on a long-term basis," he said.

Even if the market itself recovers, meaning liquidity reaches healthy levels, overcapacity will likely keep commodity prices depressed for the next five years, he said - indicating a number of energy merchants will continue to face tough times.

Kevin Howell, president of Dominion Resources trading unit Dominion Energy Clearinghouse, agreed that the electricity markets have been hobbled by counterparty credit concerns, poor liquidity and regulatory risks, but was more optimistic the problems could be sorted out.

"I'm counting on the fact that this is going to be a fairly short-term phenomenon," Howell said. "I'm hoping it's going to be 12 to 18 months, maximum."

Electricity traders will eventually shape up their balance sheets, as weaker credits disappear and as new money enters the market via acquisitions and consolidation. European power companies, Wall Street banks and perhaps big oil companies are all looking at prospects, Howell said.

"I think there's a lot of strong balance sheets that are looking hard at this market," he said.

Gordon, who came to Allegheny from Merrill Lynch last April, when the utility bought the bank's electricity trading operation, disagreed, at least as far as Wall Street is concerned.

“I don't think Wall Street firms are going to want to involve themselves in the markets as they exist today," he said. "Nor do they want to run the front-page risk."

Mirant, Calpine Corp. and Williams have all said they are seeking creditworthy joint-venture partners to help shore up their trading operations.

UBS AG unit UBS Warburg got into the electricity trading business early this year when it bought Enron's trading operation.

An 'F' For Triple-B

Electricity traders have been rocked by scandals on essentially a weekly basis since Enron's collapse.

Disclosures include Enron's use of questionable trading tactics to profit in the western markets during the region's power crisis and some traders' use of "round-trip" trading to inflate volumes and revenue.

The Federal Energy Regulatory Commission is looking into the practices, which energy companies have denied for the most part. Companies like Duke Energy and Aquila Inc. have defended occasional trades with round-trip characteristics as having legitimate business purposes.

Neither Gordon nor Howell, however, saw any legitimate reason for doing round-trip deals.

"A lot of it is indicative of the level of immaturity associated with energy trading markets, particularly electricity," Gordon said. "It's part of an ongoing epidemic, where we really have a crisis of confidence as to the entities out there, their leadership," and their long-term strategies, he said.

In a widely anticipated report last month, Moody's Investors Service questioned whether electricity trading as a business - typically characterized by high leverage and insufficiently sophisticated risk management - had investment-grade characteristics.

Inverting that judgment, Gordon said credit ratings that are barely investment grade are inappropriate for trading operations. Triple-B-level ratings wouldn't be considered adequate in other markets and expose end-use customers to too much credit risk.

"Long term, no, the triple-B rating will not be sufficient to sustain a large trading business," he said.

Most electricity traders are rated by Standard & Poor's somewhere in triple-B territory, the equivalent of Baa at Moody's. That includes Allegheny Energy Supply, which is rated triple-B-plus.

The structures of the electricity trading industry aren't adequate to support the sustainable activity of managing risks, Gordon said.

"They exist today to support manipulation of rules or moving power from one region to another," he said.

Deregulated Energy Not ‘Too Cheap to Meter’

Knight-Ridder – June 12, 2002

(6/10/02) - Almost half a year after its much-ballyhooed launch, electric deregulation in Texas remains an unfulfilled promise.

Rates, which dropped Jan. 1 when deregulation took effect, are rising again. Most consumers have been slow to switch from their longtime monopoly utility to a new electricity provider, while thousands of others have encountered billing problems. Electricity trading has been tarred by disclosures of "sham trades," adding to the dark cloud cast over the industry by Enron's collapse.

Barely 4 percent of Texas' 5.5 million eligible meters have been switched from an investor-owned utility to one of several new electricity marketers. In North Texas, just 3 percent of TXU's customers have switched, according to a Wall Street report released last week.

Despite those small numbers, the task of accounting for customer switches has proved to be too much for the computer systems of the utilities, the providers and the Electric Reliability Council of Texas (ERCOT). ERCOT chief executive Tom Noel says as many as 300,000 bills and accounts out of nearly 1.2 million switches attempted since trials started in August have been lost or delivered late, due largely to computer errors. Most of these switches are for people who have moved, not from changing their electric providers.

TXU acknowledges that it has lost track of about 90,000 of its 2.8 million customer accounts.

"There's been a lot of finger-pointing," says Noel, who has been on the hot seat in front of legislators for paperwork problems that have plagued deregulation since Jan. 1. Last week, ERCOT's chairman, Jack K. Hawks, resigned under fire.

Noel notes that ERCOT has been working to tie together the computer systems of the various utilities and energy marketers, but says "in reality, we all are responsible."

The missteps have caused second-guessing even among the leading advocates of deregulation, including Erle Nye, chairman of Dallas-based TXU Corp., and state Rep. Steve Wolens of Dallas, one of the authors of the 1999 Texas law that opened up the power market.

"In hindsight, we should have given deregulation a longer trial period before we plunged in," says Nye, referring to a pilot program run by ERCOT in late 2001.

Says Wolens: "We underestimated the magnitude of the task involved in the switching process."

Meanwhile, the big consumer savings touted by government and industry leaders, including then-Gov. George Bush and former Enron Chairman Kenneth Lay, have yet to be realized.

A 6 percent reduction in TXU's rates mandated by deregulation on Jan. 1 is likely to disappear later this month when the Public Utility Commission acts on TXU's request to raise rates 6 percent because of rising natural gas costs. TXU's new rate, when monthly charges are included, will be near 9 cents per kilowatt hour.

Rival providers, who opened the market in January with rates at least a penny below TXU's regulated "price-to-beat," have recently hiked their rates in anticipation of TXU's increase. As of last week, just one of the eight competitors in the Fort Worth-Dallas market -- Reliant Resources of Houston -- was offering a price below 8 cents per kilowatt hour.

The skimpy margin between the price to beat and the competitive prices has prompted a round of 'I-told-you-so' from deregulation critics.

"Deregulation is a clear case of overpromising," said Reggie Harris, director of the Southwest office of Consumers Union. "This is reminiscent of what we were told years ago about nuclear power, that it would be 'too cheap to meter."'

Competition was weakened in Texas this spring when one of the new market entrants, New Power Holdings, stopped taking new customers amid financial difficulties. After booking 86,000 accounts during the pilot program, and about a third of all switches under deregulation, New Power is facing possible bankruptcy. The company, 44-percent owned by Enron, was squeezed by that company's collapse.

The loss of New Power was significant because it was the most aggressive marketer -- offering an opening price of more than 1 cent per kilowatt hour below TXU's price.

The price comparisons have left many consumers unimpressed. Darwin Hushhour of Keller, a customer of the Tri-County Electric Cooperative, said he was surprised to learn that his mother-in-law would have to pay a monthly price higher than his for electricity from TXU when she moved from Bryan to an area of Keller not served by Tri-County.

"I was feeling left out because Tri-County said it wouldn't be a part of deregulation," Hushhour said. "Now I feel better. At least I can check around for another rate for my mother-in-law, but so far it doesn't look all that attractive. As for me, I plan to stay with the cooperative."

Meanwhile Enron, like an unwanted relative that won't leave, continues to haunt deregulation. Last week, PUC recommended that Enron be fined $7 million for using phony "wash trades" during peak electricity demand periods last August to drive up prices and revenues.

The proposed fine was an indication that, contrary to promises made by deregulation boosters in Texas, the state's vaunted wholesale market can indeed be gamed by clever wholesale electricity traders, and that California-style wholesale price spikes can happen here.

Some worry that Texas may be vulnerable to another round of wholesale price rises this summer as the state's electric grid moves the peak loads needed to power air conditioners.

Although the state expects to generate up to 25 percent more electricity than the 60,000 megawatts needed on its hottest days, Texas' transmission system is vulnerable to congestion. And Fort Worth-Dallas is a prime worry. On a peak hot day, the Metroplex will consume about 9,000 megawatts of electricity while nearby generators can create about 5,000 megawatts.

The deficit has to be drawn over transmission wires, usually from generating plants in central and south Texas.

"I'm worried about congestion on the transmission system this summer," said Wolens. "We could have a problem."

Noel is more sanguine, describing Texas' transmission system as healthy. Still, he added, "there is no question that more transmission is needed, particularly for the D/FW area."

In 2001, TXU opened a 345-kilovolt transmission line from a Limestone County generator to hook up with the Fort Worth-Dallas grid. But three other major transmission projects -- two approaching Fort Worth-Dallas from the southwest in Comanche County and another northwest from Graham -- won't be ready for another year.

The experiences of California and even Texas last August show that any constraints in the electricity delivery system can prove expensive since electricity can't be stored. The wholesale trading market for electricity is unregulated, and system operators usually can't follow trades that are made mostly on Internet platforms.

So on days when electricity is in short supply, wholesale prices can run from the normal $20-$35 per megawatt hour to $1,000 or more.

Noel says that ERCOT has learned from the hiccup last August and has adopted a transmission rate structure for wholesalers that penalizes, rather than rewards, traders such as those at Enron who deliberately overloaded the grid system.

"This summer, if you cause the congestion, you'll pay for it rather than benefit by it," Noel said.

State and federal regulators are working on various rules that would control the wholesale markets. Politicians are taking notice.

Democratic gubernatorial candidate Tony Sanchez has already run television spots highlighting "skyrocketing" electric rates.

Anti-deregulation forces see a possible opportunity in this political cycle. "I hope that deregulation becomes a major political issue in this campaign," said Tom Smith, director of Texas Public Citizen and a longtime critic of deregulation. "Tony [Sanchez] is setting up the issue beautifully."

The glitches in Texas, coming soon after the California disaster, have given other states cold feet.

Arkansas, Montana, Nevada, New Mexico, Oregon and West Virginia, which had been set to open their electricity markets this year, have delayed deregulation. Florida and North Carolina, two larger states whose legislatures have considered deregulation bills, have decided to pass for the time being.

TXU's Nye points to Enron, which he called "the poster boy for deregulation," as a prime cause of renewed skepticism. Enron and its now-discredited management for years preached the virtues of opening both the regional transmission grids and the monopoly utility systems to free market competition.

Enron aside, the old-line investor-owned utilities have proved to be tough competitors even when the laws allow them to be undercut in price. Virginia, like Texas, began deregulation on Jan. 1. But after five months, the competitive market has all but evaporated as none of the new providers were able to compete with the dominant Dominion Power. Similarly, Illinois has failed to generate a competitive retail market after deregulation.

Wall Street, at least, had assumed greater switching. "TXU has lost only about 3 percent of its customers, fewer than I anticipated. We figured on a 20 percent turnover by the end of the year," said Daniel Ford, an analyst with Lehman Brothers.

TXU's Nye looks for residential electricity marketing to heat up this summer.

"People become price-sensitive when their costs are highest," says Nye. "If we're going to see significant movement of customers, the summer will be the time."

FERC Grows Tired of Energy Games

Dow Jones – by Arden Dale – June 12, 2002

(6/10/02) - NEW YORK (Dow Jones) -- The electricity business has been a frontier since deregulation reshaped it in the 1990s, but its wild and woolly days may be numbered. The sheriff has a gun, and it looks to be loaded.

Then again, those could be blanks.

The U.S. Federal Energy Regulatory Commission created the troubled $600 billion wholesale power market, and now appears poised to oust several companies from it using an extreme measure for the first time. Last week, FERC told El Paso Electric Co., Williams Cos., Avista Corp. and Enron Corp. unit Portland General Electric Co. it will take away their so-called market-based rate authority if they don't comply more completely with its investigation into California's energy crisis of 2000 and 2001. It gave them until June 14 to do so. The move could end up hobbling the companies significantly, or even putting them out of business, by forcing them to sell power at rates determined by their costs while competitors charge market rates.

"It is the ultimate weapon, which signals that they're serious, that if a company is abusing the market, they'll take away their license," said Robert Burns, senior electricity research specialist at the National Regulatory Research Institute, at Ohio State University. "It's kind of like they're saying 'Make my day', but they don't really want to pull the trigger."

Whether FERC will follow through is an open question for energy companies, Wall Street firms and other regulators. A flood of negative news about the power industry has put the agency under intense pressure of late, and its action may have been an attempt at damage control more than anything else, according to some observers.

Threat Seems More Real Now

FERC has used the prospect of stripping market-based rate authority to frighten companies before, but never come this close to doing it. This time, it issued so-called "show-cause" orders, directing the companies to prove why it shouldn't revoke authority. The agency has never done so before, according to FERC spokesperson Celeste Miller.

"A show-cause order carries a certain magnitude; they're trying to let companies know they want full cooperation," said Donna DiDonato, an analyst at Fitch Ratings. "FERC has said that this isn't necessarily a complete list of companies, so it puts others on alert that they may be asked to provide further information." The California Independent System Operator, which operates the state's power grid, asked FERC last year to revoke the market-based rate authority of six companies, but the agency still hasn't acted on the request. "The commission has made these types of threats on numerous occasions and hasn't acted on them; our motions filed last year are still pending and may never get acted on," said Anthony Ivancovich, senior regulatory counsel for the ISO. "But I do think FERC is getting the message across that it means business and it wants some answers."

Mirant Corp., Duke Energy, Dynegy Inc., and Reliant Resources Inc. are among other electricity trading companies that have been in turmoil in recent months as the result of sagging electricity prices, fallout from the collapse of Enron and California's energy crisis of 2000 and 2001, and recent revelations about possible widespread fraudulent electricity trading practices.

FERC agitated the industry and investors last month when it released internal Enron memos that detail trading schemes the company used in California during the crisis. It then ordered 150 companies to provide documents revealing their practices, and subsequently issued a series of requests for information about different kinds of trading activities. Adding more fuel to the fire, a number of companies confirmed that the U.S. Securities and Exchange Commission is investigating aspects of their energy trading.

As a result, energy companies and Wall Street firms have been working furiously to reinvent the power trading business to keep it viable as FERC prepares new rules of the road it plans to issue in the fall. Stunned Silence

FERC's action last week seem to stun companies into silence. Across the board, they were unusually reluctant to comment publicly on the development because of the sensitivity of the issue. Privately, some took a bluff approach, saying that companies that break the rules should be punished, and adding that deregulated electricity markets will survive even if FERC does revoke market-based rate authority for these and other companies.

"In light of the fact that Wall Street is reacting so quickly to everything that's being said about competitive suppliers, I wish FERC had chosen a different penalty," said a prominent industry official. "It served a purpose of getting people's attention that FERC is going to be a strong cop on the beat, but it's creating an overreaction."

One longtime FERC critic called the action "the first get-tough approach attacking the cause of the energy crisis. "California State Senator Joseph Dunn, D-Garden Grove, has been investigating causes of the crisis for more than a year.

"I've always said market-based rates are the goose that laid the golden egg, and the companies will protect their market-based rate authority until their death, in my view," Dunn said.

Was Manipulation Sold Like Cash Balance Plans?

The Dallas Morning News – by Crayton Harrison – June 12, 2002

Jun. 11 -- A California Senate committee asked on Monday that Perot Systems Corp. chairman Ross Perot testify in Sacramento about allegations that the firm helped energy companies learn how to manipulate prices.

Committee staff investigating the matter also believe that Perot Systems may have been making sales pitches to California market participants long after it resolved a conflict of interest dispute with one of the energy exchanges.

California state Sen. Joseph Dunn accused Perot Systems last week of masterminding ways to raise prices artificially, using the knowledge it gained from doing technology work for the state's energy exchanges, the California Independent System Operator and the now-defunct California Public Exchange.

Last week, Mr. Perot emphatically denied Mr. Dunn's accusation, and promised the senator via telephone that if needed, he would testify before the committee investigating energy price manipulation.

Mr. Dunn took him up on the offer. "While investigations by both Perot Systems and our committee continue, it is vital that Californians hear directly from you as chairman of the board concerning the role that Perot Systems may have played in the failure of the deregulatory energy market in this state," said his letter, faxed to Mr. Perot.

Perot Systems spokeswoman Mindy Brown Malooly confirmed that Mr. Perot received the committee's letter and is working to arrange a date.

Both Perot Systems and the committee have been digging through old files and contacting former employees of the company to find information on Perot Systems' contacts with energy companies. In particular, they're trying to determine the origin of a document the committee obtained from Reliant Energy Inc.

The computer presentation document, with Perot Systems logos on each page, contains examples of how a company could congest a power line to alter prices.

Reliant paid Perot Systems $11,000 in June 1998 to make a presentation on California's energy markets. But the document in question was not part of that presentation, both companies have said.

Mr. Perot said last week that the document contains information that was publicly available at the time.

The California committee now says the document was created in August 1998 or later, based on research and interviews with former Perot Systems employees, said Larry Drivon, special counsel to the committee.

Perot Systems had been doing sales pitches to energy companies since at least 1997, when it started technology projects for the two exchanges. It eventually stopped the presentations because of a lack of interest.

Last week, Perot Systems submitted a series of letters exchanged in 1997 between the company and the California Independent System Operator discussing conflict of interest concerns. The letters indicate that the concerns were resolved.

Perot Systems no longer does much work in the energy industry, so many of the employees involved in the sector are no longer with the company.

The company is doing the best it can to investigate the matter, Ms. Malooly said.

"We're still digging," she said.

New Federal Energy Investigation Under Way

Dow Jones – by Bryan Lee – June 7, 2002

(6/5/02) - WASHINGTON (Dow Jones)--A House panel investigating the financial collapse of Enron Corp. has moved to widen its probe to consider alleged market manipulation by Enron and other energy companies.

As House Democrats Wednesday demanded that the Republican leadership end its "silence" in the face of mounting revelations about possible energy market manipulation, a House Energy and Commerce Committee aide acknowledged that a "preliminary investigation" is already under way.

"We're trying to gather as much information as possible in order to determine how to proceed," said Ken Johnson, a spokesman for Rep. Billy Tauzin, the Energy and Commerce Committee's chairman.

Johnson was responding to a June 5 letter from 70 House Democrats demanding hearings and an investigation into allegations that Enron and other power providers manipulated electricity markets to reap windfall profits in California and other Western states during an energy crisis in 2000 and 2001.

"The House has ignored reports that Enron and other energy companies gamed the energy market, charging astronomical prices," said the letter signed by the 70 Democrats.

"We urge you to initiate a full investigation of the business conduct and pricing practices of the Enron Corporation and other energy suppliers," said the letter to Tauzin and House Speaker Dennis Hastert.

The letter demanding an investigation comes after Democrats for three months have asked for hearings into alleged market manipulation by Enron. The letter and a related press conference Wednesday marked a bid to ratchet up the pressure on House Republicans.

The effort, led by Democrats from California and other Western states hit hard by the power crisis in late 2000 and early 2001, has taken on momentum in the wake of revelations about trading practices by Enron and other energy companies that California officials claim was behind skyrocketing prices.

Enron documents made public a month ago detailed alleged market-manipulation schemes with headline-grabbing names like "Get Shorty," "Fat Boy," "Death Star" and "Ricochet." The Enron memos indicated that other companies besides Enron also employed the questionable trading tactics.

The U.S. Federal Energy Regulatory Commission, which had launched a staff-level investigation into alleged market manipulation in February, immediately demanded that companies involved in Western markets during the 2000-2001 crisis attest to whether or not they used similar tactics.

House Democrats complained Wednesday that while the Senate has held a hearing on the trading schemes outlined in the Enron documents, Tauzin's committee to date has not.

And in the weeks since the Enron documents made headlines, other energy companies disclosed that the U.S. Securities and Exchange Commission and the Justice Department were investigating so-called "round trip" or "wash" trades, in which energy is simultaneously sold and then bought back at the same price.

The round-trip trading, first associated with Dynegy Inc., CMS Energy and Reliant Energy Inc., helped companies boost revenues and trading volumes, factors that Wall Street analysts weighed in assessing the merits of investing in energy companies.

The FERC rapidly expanded its probe, demanding that companies attest to whether or not they engaged in similar round-trip trades for electricity and natural gas.

Persons familiar with FERC's investigation said the commission wants to know whether the round-trip trading was part of an effort to manipulate published energy market price indexes that affected other transactions with prices pegged to the published indexes.

Since Enron's trading tactics came to light, "a steady stream of revelations about the shady deals of other energy companies that figured in the Western energy crisis have appeared in the press," the Democrats said in their letter to Hastert and Tauzin.

"With members of the House about to enter into conference with the Senate on comprehensive energy legislation, we need to learn about the flaws in our energy markets," the letter said.

Tauzin has spearheaded the most comprehensive congressional probe to date into the alleged insider deals and misleading accounting that contributed to Enron's stunning collapse into bankruptcy last December.

But Tauzin has consistently rebuffed the demands of Democrats for hearings on Enron's alleged contributions to the Western power crisis, and he called off a subcommittee vote on electricity reform legislation because of the political impact of Enron's financial implosion.

"We have dealt with the aspects of Enron's business that harmed investors. It is now time to examine how Enron and others hurt consumers," the Democrats said in their letter to Tauzin and Hastert demanding an investigation.

"The fact of the matter is we have an ongoing investigation. We have had one for several weeks now," said Johnson, Tauzin's spokesman.

"While there's a very good possibility we'll hold a hearing, we won't until we evaluate all the information in our investigation," Johnson said.

The acknowledgment of a committee investigation marked a turnabout of sorts. Last month, as Democrats first ratcheted up their demands for hearings in the wake of the Enron trading-scheme documents, Johnson rejected the demands as an election-year ploy.

"Enron for all practical purposes is dead. Unfortunately, for political reasons, some people want to drag the bodies through the streets," Johnson said.

As part of the House investigation begun since then, the committee has asked FERC to provide details about its market-manipulation probe to date and is preparing to interview "people who have intimate knowledge of some of these suspicious deals," Johnson told Dow Jones Newswires Wednesday.

He declined to elaborate as to who the committee's investigators are preparing to interview. But he did say that FERC officials, including chairman Pat Wood III, were expected to brief Tauzin and other key committee members on the investigation.

"We will be consulting closely with FERC," Johnson said of the committee's probe.

Any details regarding FERC's cooperation with the House probe will be released by the committee, not the commission, said FERC spokesman Kevin Cadden.

Paying More After Deregulation

Knight-Ridder – June 7, 2002

(6/5/02) - AUSTIN, Texas--Despite promises of cheaper electricity, Dallas/Fort Worth residents could soon pay more under electric deregulation than they paid 18 months ago under the old regulated system, according to an analysis by Fort Worth and other cities.

The higher rates would result from a proposed TXU rate increase that, if approved, could take effect by next month. The increase also would erase any benefit from a 6 percent rate reduction included in the Texas deregulation law, the analysis shows.

People outside Dallas/Fort Worth also would pay more under electric deregulation if the Public Utility Commission approves hikes for other utilities, according to similar reviews.

"This is not what the Legislature intended," said Kristen Doyle, an attorney for Fort Worth, Dallas and other cities served by TXU, Central Power and Light and other utilities. "If that (TXU) increase gets approved, it will cost more for electricity under competition than it would before deregulation."

Although not disputing the underlying figures, a TXU spokesman called the cities' analysis unfair. He also said that deregulation allows customers to shop around for cheaper electricity if they don't like what TXU is charging.

The dispute raises questions about a central promise of deregulation: Will it indeed result in cheaper electricity for Texans? It also addresses what has become an increasingly hot topic as the gubernatorial race enters into the summer months.

In television advertising, Democrat Tony Sanchez has linked Republican Gov. Rick Perry with "skyrocketing" electric rates. The Perry camp calls the advertisements inaccurate, and cites PUC figures showing that major utility rates dropped when the law took effect.

Neither side disputes that rates dropped Jan. 1, the first day of deregulation, when compared with utility rates immediately preceding that day. But a precipitous drop in the cost of natural gas -- not a 6 percent rate drop mandated by the law -- explains most of that decline.

The state's major utilities can charge no more than those Jan. 1 rates for the next three years, although they can request adjustments to reflect increases in fuel costs. To figure for such changes in fuel costs, the cities analyzed the proposed rate hike to pre-deregulation rates during a period with similar prices in natural gas. Under the company's proposed hike, TXU figures natural gas at a $3.63 per million British thermal units. In January 2001, TXU claimed natural gas prices at a slightly more expensive $3.83.

After deregulation -- under the proposed rate hike and with gas prices slightly cheaper -- TXU customers would pay 8.7 cents per kilowatt hour, the analysis shows. Before deregulation -- and during that period with slightly more expensive natural gas prices -- TXU customers paid about 8.5 cents per kilowatt hour, according to the analysis.

That's about an $87 electric bill for the average Metroplex homeowner under the proposed rate hike. About 18 months ago the average homeowner paid about $85 per electric bill. The post-deregulation bill would be higher, despite a 6 percent rate reduction that went into effect Jan. 1, according to the analysis.

An administrative law judge recently approved the proposed rate hike, which now goes to the full PUC for consideration. If approved, Metroplex customers could be paying the higher rates next month, said a company spokesman.

TXU's Chris Schein also questioned the fairness of the cities' analysis, saying the commission now uses different methods when calculating fuel charges. "We're absolutely comparing apples to oranges here," Schein said. "And from those comparisons, the cities are using misleading information designed to confuse everyone."

For instance, the commission no longer allows TXU or other major utilities to recoup any of their past losses associated with fuel costs. Schein said TXU has been undercharging for fuel for several months, and that the company will never recoup those past losses.

"That is a million dollars statewide that customers will not have to pay," he said.

TXU also uses more natural gas than during that previous period, and the company's proposed increase fairly approximates its current fuel expenditures, he said.

The cities agree that the commission uses new methods to determine fuel costs -- but they argue in a challenge of TXU's proposed rate hike that those methods are unfair.

Although TXU no longer charges customers for past fuel losses, for instance, neither must it lower rates if its fuel costs drop and it overcharges customers. Under the old system, the utilities could recover only their exact fuel costs -- no more, no less.

Likewise, the commission previously considered a broad variety of fuel-related components -- including expenditures for natural gas, lignite, coal and nuclear generation -- when setting rates. Under deregulation, the commission focuses on a single component: natural gas futures.

Doyle, the attorney representing Fort Worth and other municipal governments, said the new method hurts consumers and undermines electric deregulation. As a result, homeowners could pay more under deregulation.

"Natural gas prices are the most volatile component of fuel factors," Doyle said. "And if you just tie in natural gas prices, you are passing 100 percent of the risk to the customer. It's like buying 100 percent of your energy on the (volatile) spot market, every single day."

A PUC spokeswoman said the commission closely followed the 1999 deregulation law when it adopted rules on judging utility requests for fuel-related rate adjustments. She said the commission must now follow those rules, and that those rules do not leave much room for interpretation.

"There is a good deal of math to it ... to determine the calculation was done correctly," said PUC spokeswoman Carrie Collier.

Doyle also argued that although Metroplex residents would have paid less under the previous, regulated rates, even those rates were too high.

That's because the PUC allowed higher rates for several years before deregulation so utilities could recoup the cost of various big-ticket investments, officials say. Ratepayers paid TXU at least $887 million extra from 1998 to 2001, according to documents on file at the PUC.

TXU spokesman Schein said the PUC would have authorized utilities to charge for those investments anyway -- with or without deregulation -- and that consumers may have saved in interest payments by paying for them earlier.

But given the previously higher rates to cover investments and the new method of calculating fuel costs, Doyle said consumers could end up paying more under deregulation.

"Rates are already overinflated," Doyle said. "The commission let (utilities) overearn to pay down those (investment) costs -- that was acknowledged. Then the commission gave ratepayers a 6 percent reduction as a safe harbor as they went into a deregulated market. I don't know when the goal changed, but now they're flooding that safe harbor."

Latest Energy Executive Suicide

Wall Street Journal – by C. Cummins, T. Herrick – June 5, 2002

A senior vice president and treasurer at El Paso Corp., a large Houston energy producer and trader, was found dead in an apparent suicide, further rattling an industry facing growing scrutiny from investors and regulators.

C. Dana Rice, 47 years old, was found dead at his home in a Houston neighborhood Sunday afternoon, according to the Houston police department. Results of a full autopsy won't be available for weeks, but a police spokesman said the apparent cause of death was a self-inflicted gunshot wound.

Mr. Rice, who had been with El Paso for 25 years, struggled with serious medical problems for the past year, according to a person familiar with Mr. Rice's condition. He underwent a major heart-related operation last year and had been on dialysis for a time, this person said.

Mr. Rice was out of the office for several months last year for medical reasons and had been planning to retire in three weeks.

But the timing of the death, and Mr. Rice's seniority and position at the company, couldn't have come at a worse time for El Paso. The company last week said it would restructure for the second time in six months amid increasing questions from investors, analysts and regulators about the energy-trading sector in the wake of Enron Corp.'s spectacular collapse. And Mr. Rice's death immediately recalled the suicide earlier this year -- also in Houston -- of J. Clifford Baxter, a former vice chairman at Enron. Though Mr. Baxter's death hasn't been specifically linked to his former employer's woes, he killed himself in January at the height of Enron's troubles.

News of Mr. Rice's death shook El Paso investors, who already had beaten down the company's stock price and market value sharply last week. As of 4 p.m. in New York Stock Exchange composite trading, El Paso fell $3.70, or 14%, to $21.95.

"This is a tragic event for our company," said El Paso Chairman and Chief Executive William A. Wise in a statement, adding that Mr. Rice was a personal friend. "However," Mr. Wise said, "the market reaction is unwarranted." El Paso also said there wasn't any information regarding the company's financial performance or credit that wasn't disclosed last week as part of its restructuring announcement.

In an effort to shore up its creditworthiness, El Paso said last week that it plans to issue equity, sell assets and cut operating expenses. It also disclosed a major retrenchment from energy trading, cutting about 50% of its 600-person trading staff. Mr. Rice's job wasn't affected by those cuts, a spokeswoman said.

Mr. Rice joined El Paso in 1977, became director of the company's planning department in 1992, director of the accounting department in 1996 and vice president and treasurer in 1998. He was appointed senior vice president in 1999.

Following the collapse of Enron last year, the entire sector has been under a cloud. More recently, a handful of El Paso peers have disclosed large-scale sham trades that artificially boosted trading volumes and revenues.

Last week, El Paso said it had identified 125 electricity trades out of more than 40,000 transactions that fit federal regulators' definition of round-trip trading, essentially mirror-image trades of the same amounts at the same price. El Paso said two of those deals were conducted to generate fees for a charity fund, and the rest accounted for less than 1% if its revenue for the past two years…

It’s Hard to Lose When You Make the Rules

New York Times – by Floyd Norris – May 31, 2002

Would you get fired for an extra $33 million?

(5/30/02) - The chairman and chief executive of the struggling energy company Dynegy, whose departure was announced on Tuesday, is entitled under his contract to a huge severance check -- one that is about $33 million more than he would have made had the company allowed him to serve out the eight months remaining on the contract.

Charles L. Watson guided Dynegy from a tiny company into a member of the Fortune 500 and just six months ago appeared to have vaulted it into the top ranks of American business by agreeing to acquire Enron.

But that deal, which soon fell apart as Enron collapsed, ended up putting Dynegy under a microscope, and Mr. Watson's position weakened this year with continued disclosures of questionable accounting practices and trading techniques in the energy industry. Dynegy faces an accounting investigation by the Securities and Exchange Commission, although the company said that had nothing to do with Mr. Watson's departure.

Dynegy declined to discuss Mr. Watson's severance package, but his employment contract was made public more than two years ago, and it provided for substantial payments if he was forced out. The term in the contract is ''constructive termination,'' and it requires that he be paid what amounts to three years' compensation even though his contract had less than a year to run.

Moreover, the cash the contract calls for him to get now includes the ''projected value'' of stock options he would have received had he stayed at Dynegy for three more years and the stock had risen for years to come. He will receive that money without having to wait to see whether the stock really does rise.

Including the expected value of his options, he has been making more than $11 million a year.

In addition, he is to receive compensation for what he would have earned the next eight months, before his contract expired on Feb. 1, 2003. While the board has some discretion in fixing that amount, it could be about $7 million, for a total value of $40 million.

For Mr. Watson, 52, the money means that he may wind up doing better financially than he would have had he been able to keep his job for the next several years. And he certainly does better than he would have had he left next February.

Just why Dynegy's board decided to take that financial hit is not clear. But it appears that the board felt that with investor confidence ebbing, it could not afford to have Mr. Watson in charge the rest of this year.

A Dynegy spokesman, Steve Stengel, declined to comment on Mr. Watkin's severance. ''That issue is between Chuck and the board, and we are not going to comment on it,'' he said. Nonetheless, S.E.C. rules will force Dynegy to disclose the figure at a later date.

Many chief executives have contracts that provide for generous payments if they are forced out before their contracts expire. But Mr. Watson's contract is unusual in that it provided for such large payments in addition to what he would have received if he had kept his job. It is also unusual to cash out the expected value of options that had not been granted.

The contract's severance benefits would not have applied if Mr. Watson had resigned on his own, but that does not appear to be the case. In announcing Mr. Watson's departure on Tuesday, Otis Winter, the company's newly named lead director, said ''the board and Chuck concluded'' that Mr. Watson should leave. He added that ''it was the independent directors of Dynegy who made these decisions.''

Mr. Watson, who began running Dynegy's predecessor in 1989, signed his current contract in early 2000, just before Dynegy's merger with Illinova, the parent of Illinois Power, took effect on Feb. 1 of that year. The board could have allowed Mr. Watson to stay until his contract expired on Feb. 1 and thus avoided having to pay the additional $33 million in severance, plus three years of health insurance benefits, as called for in the contract.

But the board could not have simply kept Mr. Watson on the payroll while someone else performed his duties and guided the company in a new direction. The contract stated that there would be a constructive termination if ''a significant diminution in your responsibilities, authority or scope of duties is effected by the board of directors,'' even if his title did not change.

The board could have avoided paying the severance had it fired Mr. Watson for cause, but it appears not to have done that. Mr. Winter was careful to say that the departure had nothing to do with pending investigations of the company's accounting practices. Instead, he said, there was ''a conclusion that a new management focus was needed.''

The year 2000, when Mr. Watson signed his contract, will remain as the time Dynegy shined the brightest and he did the best financially. In transactions related to the closing of the Illinova merger, Mr. Watson sold part of his stake in Dynegy for $227.8 million. A few months later, in April and May of 2000, he took in another $19.2 million, selling shares at an average price of $29.74 a share, adjusted for a subsequent split. But he did not sell more shares as Dynegy's stock took off later that year, buoyed by the California energy crisis and the perspective that energy traders were in a good position. Dynegy's stock peaked in September 2000 at $59.47 a share.

The shares climbed as high as $47.20 last November after Mr. Watson agreed that Dynegy would acquire its larger rival, Enron, at a price that Mr. Watson was confident was a bargain. But as Enron continued to unravel, investor confidence in Dynegy also faded, and it called off the deal later that month. This year, as investigations intensified, the shares have fallen further. Yesterday, shares of Dynegy fell $1.19, to $8.50.

Mr. Watson's contract provides that in the event of his constructive termination he is to receive 2.99 times the average annual compensation he received in his best three years. That compensation includes his salary, which ranged from $1 million in 1999 to $1.5 million in each of the last two years, and his bonus, which rose from $4.3 million in 1999 to $5 million last year.

But it also includes the value of the options he received in those years. And it appears that value is to be calculated based not on what actually happened to the options but on their projected value, a figure calculated by assuming that Dynegy stock would go up 15 percent a year. That projected value was to be 3.75 times his base salary.

There was a time an assumption of 15 percent gains seemed conservative. Dynegy stock rose 122 percent in 1999 and 361 percent in 2000. But in 2001 it fell 55 percent, and it is down 67 percent so far this year. The shares now trade just about where they did exactly three years ago.

As a result, the 1.7 million options that Mr. Watson received under his contract through last December had exercise prices ranging from $23.85 to $47.19, figures well above the current market price. Those options will not expire until 2011, however, so he could still make money from them if the stock recovers under new management. As part of his severance agreement, all the options can be exercised at any time he wishes.

Deregulation - Page 16 - 2002