Assembly Considers Energy Reform Measure: SoCal Edison's Bob Foster Explains Why

There are bills currently in the Legislature to encourage investment in the state's energy markets. Why don't you describe AB 2006, and why a bill is even needed?

The issue is being revisited because there is a problem in California. We're going to be capacity shortened in the state in the range of 2006-2009. That means we need more machines-more physical equipment-in the state to produce electricity. And perhaps as importantly, we need those generators to be in locations where they can meet load. Electricity is a unique commodity in that you have to have generation sources close to load centers. It's an instantaneous commodity and it's a network to which we're all connected. We have to anticipate capacity needs well ahead of need because these generators don't just spring up out of the ground. So, we need to start now.

If you look around the state, there are very few new power facilities being built. Why? Utilities are unable to sign long-term contracts right now, making it difficult to invest in a long-term capital program. There are a couple of reasons for this. One, there is no stability around who is going to be able to shop at retail. That will change when the California Department of Water Resources sells its last electron (2013). So, if we sign a 10 or 15-year contract right now, in year eight we could have a mass exodus of retail customers going to some other provider while we still have this contractual obligation. So, there need to be some boundaries around retail customer direct access-who can go, when they can go, and what the rules are. Or, potentially, offering no direct access is another option.

Two, because of the recent electricity crisis, the compact with investor-run utilities was ruptured. Part of that compact stated that we would be able to pass through legitimate and prudent cost to customers. During the crisis, we were going out and buying electricity. To give you an example, in the month of December we bought electricity for customers on the wholesale market at 23¢ per kilowatt-hour. We were only able to charge customers 6.2¢ per kilowatt-hour. During that period, we had to borrow $5.5 billion to serve our customers. Clearly, that is not sustainable. The financial community wants to know that the state is going to honor its end of the market arrangement.

So, there are two fundamental things we need to do: (1) put some stability around the customer base for the long run, and (2) make sure that a deal made today is going to be honored tomorrow by a future commission. I would also add that we want to see that anybody selling at retail is responsible for the physical resources to serve those customers, including a 15% reserve on top their customers' needs. That's an expensive business, but that's important.

AB 2006 by Speaker Nunez does exactly those things. It attempts to create the framework in California inside which you can have robust investment to get the power generating facilities that this state is going to desperately need up and running. The bill would allow customers who use 500 kilowatts or more to choose their own power suppliers, while all other customers would take service from their local utilities. The bill also directs state regulators to set power reserve levels that utilities and power suppliers must maintain to ensure extra electricity is on hand to cover supply disruptions or demand spikes.

The energy crisis in California appears to have been addressed, although we have news flashes when the weather is hot that a crisis remains. Put in perspective what have we been through- and the lessons learned.

We went through a period of almost runaway hubris and avarice on the part of market participants. And, we've been through a period of government's lack of response, particularly at the federal level, to a real crisis situation in California.

The premise on which every deregulated market is based is that you will be able to produce adequate supplies-in electricity, we would call it reliability-through markets. That premise was sorely tested during the crisis, and we haven't fully learned that lesson. But, can you provide reliability through markets? Can you make sure that there are adequate supplies? The answer is yes, but you have to tolerate passing directly to customers the physical and economic consequences of a shortage.

Electricity is the most capital intense commodity in the world. It is also the most volatile commodity. It can go, in the space of two hours, from five cents a unit to five dollars a unit, and you have to pass that directly along to customers. So, a fully competitive market can work. But, the public would have to tolerate those kinds of fluctuations. I keep reminding people that Adam Smith didn't write about economics, he wrote about political economy. The economic system is tied to the polity. My view is that customers, or constituents, will not tolerate the physical or economic consequences of shortages. If I'm right, that means that policymakers are going to want assurances that adequate supply will be available ten or twenty years out. The minute you make that judgment, you are now talking about some form of regulated market.

In California, the policymakers have made that latter judgment: we want some entity, be it the state or an investor-run utility, to be responsible for assuring that there's adequate supply for present and future customers.

I don't know if we fully learned the lesson of the crisis of reliability through markets. We are spending a lot of money in California and across the country to wire up competitive markets, particularly on the retail side. However, I don't know what those markets will produce. I have yet to have someone tell me what the benefits of retail competition in electricity are. There are clear benefits on the wholesale side. But on the retail side, the only comment I've ever gotten was that it leads to "innovation." Electricity is not like telephony. This is a basic commodity that has unique characteristics. There's no substitute, it can't be stored, it's instantaneous and it has almost no short-run elasticity.

As a state, we need to make a judgment. Either we're going to go to a competitive market and withstand the kind of impact that a competitive market produces, or we're going to have a regulated market in which we really do provide adequate supply for present and future customers. AB 2006 tries to define that regulated market.

What troubles me about what I see in the market today is the argument that competition necessarily is best without fully taking account of what this commodity does, how unique it is, and how important it is to modern society. People favor the option of getting out of the regulated system because of a perception that the regulator imposes unwarranted and excessive costs as a way to subsidize residential customers. I might add, there may be more than a grain of truth to that; 64% of our residential customers, despite everyone's perception, have seen no rate increase since 1995. In fact, many have seen a rate decrease.

What is the California Energy Commission's position re AB 2006? What is it's position?

The Energy Commission does a lot of forecasting and planning. A recent report indicates that there is not likely to be a serious problem under normal conditions until 2009. But, if you look closely, even if you have a mild summer, you'll have problems in 2006. They look at demand and supply balances and appear to be very interested in transmission. But, transmission alone isn't going to solve this problem. They do a lot of work in efficiency and renewables, and we agree with all of that. The loading order that they have suggested-the first priority in terms of what you add to the system-in their new plan, we actually agree with. You really should start with efficiency and work down into physical plant. But, even with the best efforts on efficiency and demand reduction, we are going to need physical equipment in the state.

They have not, to my knowledge, taken a position on this bill yet. But, it is consistent with a lot of the things they're saying.

In a term-limited Legislature, are institutional lessons re energy policy and governance ever really learned?

That's very difficult. Some of the members that went through this in 2000 and 2001 are still here, but many are gone. At the time of the crisis, we had probably the most competitive market you can imagine; it was the equivalent of an electricity eBay. It wound up being manipulated, it wound up not producing good prices for consumers, and it would up being rigged to the benefit of those very generators who extracted substantial wealth out of the state.

Today, the push to confine utilities only to purchase from members of their Independent Energy Producers Association is surfacing again. Regrettably, the arguments are over how to distribute market share instead of what the proper market structure should be. Term limits are a disadvantage in that few of the legislators who were involved in this debate during the energy crisis are still serving and able to contribute their historical purview to the debate.

We started this debate because we're trying to be responsible. We think it's an important debate to have while we are not in a crisis period. Once you get in a crisis, very poor legislation gets enacted, generally, and you get actions out of desperation. You need only look at the $43 billion in contracts the state signed during the crisis, which all of us in California are will be paying for well into the future.

We want to get the structure right, and we want investment on that structure to be robust. We have no desire to own everything. We don't have the economic capacity to own everything. We think you need not only a diverse set of resources, in terms of having renewables and fossil fuels and nuclear and hydro, but you also need a diverse group of ownership. But as long as a company like ours has an obligation to serve, we need the tools to be able to exercise that obligation. And, during the crisis we were handcuffed, only being able to buy through one entity, the power exchange. That's exactly what many in the industry want to do again. They want to go out and get a market that they again can manipulate.

Edison was in financial distress. PG&E went into bankruptcy. Time has passed, Edison appears to have righted its' ship, and PG&E has come out of bankruptcy. What were the opportunites both for the customer and your investors , re Edison going forward?

When we were at the edge of bankruptcy we were not an investment grade company; we actually didn't even have the credit to get leases for vehicles. When you don't have access to capital, you cannot serve customers. We tried to use as much of our existing capital and our secured capital as we could to continue to serve customers, and we did that. But, that was not a tenable situation. We've come out of it; we are now an investment grade company again. More importantly for our customers, we now have access to capital markets to be able to have the quantity and the price of capital that's necessary to serve them.

PG&E chose to go into bankruptcy. My own view is they did so to gain the protection of the bankruptcy court for a period of years after they come out of it in order to discipline the regulator in California. We felt it was a disservice to our customers and our shareholders to go into bankruptcy. PG&E had to get approval from the courts on everything they did and, consequently, forfeited a significant amount of managerial control.

The financial community has developed an enormous distrust of California. It has very little respect for what the regulator did during the crisis, and they believe that what PG&E has done is, in many ways, an indirect discipline of the regulatory process in California. Because PG&E, now that it's emerged from bankruptcy, has a court that will enforce that bankruptcy agreement. So, if the PUC decides that it's going to do something that would damage the credit worthiness to PG&E, that court can step in and indicate that that's contrary to the bankruptcy agreement. I understand why many in the financial community would think that PG&E took a superior path to Edison. However, that's not who we are and that's not how we serve our customers. I think your reputation gets damaged substantially as a result of it.

Now why would it be difficult to educate the chair of the PUC on what you need, since he was a president of Edison?

Actually, this commission, with the appointments of Michael Peevey, Susan Kennedy, and Jeff Brown, has done a remarkable job in rebuilding the regulatory structure in California in the last two years. We would not have come out of our financial distress as quickly, nor would we have been able to get to where we are as an investment grade company without scores of actions and decisions by the PUC. They've done a remarkable job. But, you must recognize that the PUC doesn't just deal with electricity; they deal with natural gas, telephone and water as well. They have an enormous workload, and you can't know everything-and this is a complex business.

If we come back a year from now to interview you, Bob, what will have changed?

The number one goal in the company is to get a workable, durable framework within which investments can be made. Our ability to assist in having that adopted in this state would be one thing by which I'd like to be judged. Secondly, we're going to have to pay a lot of attention to the reliability and the adequacy of this system to serve customers. That's going to be a real challenge, and we have to be judged by that as well.