Contract Killings

How the state's contracts with crucial electric power providers actually encourage them to gouge us

What the modifications did, essentially, was allow Duke to exploit a clause designed to keep prices down by using a middleman firm, which Duke just happened to own.

The grid operator alleged that, for six months after the contracts were introduced in 1998, Duke's generators sold the power from their "must-run" plants exclusively to Duke's marketing wing, Duke Energy Trading and Marketing, at prices described as "suspiciously low" by several sources privy to the process. Duke's marketing unit could then sell the electricity it purchased without having to return any of its profits to the grid operator, as the "must-run" contracts required Duke itself to do. As alleged, this worked out pretty well for Duke's parent corporation, which pocketed the huge spread between the price of "must-run" power and market rates, while insisting that all the transactions were made at arm's length.

The case was eventually settled confidentially.

It was quickly apparent that Band-Aids weren't going to be sufficient to patch the gushing "boo-boos" in the contracts of the state's most crucial generators. In the messy, nasty, and seemingly endless legal wrangling that followed, utilities, energy firms, the grid operator, and federal regulators fought over every detail. At stake: hundreds of millions of dollars and the reliability of the state's transmission grid.

It was, by all accounts, not pleasant.

"If you're ever talking to people at the ISO, and you want to change the subject," jokes Mike Florio, president of the Utility Reform Network and a former consumer representative on the ISO's board, "all you have to say is "This is going to be another RMR.'"

Even today, the settlement process over the RMR contract debacle that began back in 1998 drags on. The loosest end is a dispute between Mirant and the California grid operator over the payment structure of the new contracts. The two sides are more than $50 million apart, and a decision from a FERC judge is expected sometime in the near future.

Aside from a few similar, straggling disputes over payments, most at the ISO felt as though they'd fixed the most egregious flaws in the "must-run" contracts by April 1999, when a new contract structure was introduced. The new deals supposedly purged the "perverse incentives" from the pacts. When the ISO actually caught a generator and an energy marketer profiting off a sizable loophole in the new "must-run" contracts last spring, most would have expected that line of thinking to cease. It didn't.

As they have become remarkably adroit at doing, federal energy regulators sent consumer activists and market analysts into a state of full-blown hysteria last month. The trigger, this time, was an $8 million settlement with an energy trader that allegedly had made $11 million in about three weeks through a price manipulation scam that involved shuttering some of its "must-run" plants in Southern California.

"It's like making a bank robber give back 80 percent of what he stole," shrieks Doug Heller of the Santa Monica-based Foundation for Taxpayer and Consumer Rights. "He gets no jail time, no punishment whatsoever, and he even gets to keep some of the money he took."

If Heller's sentiments are widespread among those who have read the brief daily news accounts of the settlement, those closer to the situation fume for a slightly different reason. The case involved AES, which owns reliability plants, and the energy trader it buys gas from and sells power to, the Tulsa-based Williams Co. Allegedly, the pair used a FERC rule to exploit a glitch in the latest reliability contract revision. This allowed Williams to charge 10 times as much as it could otherwise have gotten by reporting its reliability plants to be out of order, and by subbing in a replacement unit. What drove those familiar with the "must-run" contracts craziest was that federal energy regulators -- at the grid operator's urging -- caught Williams with its plants down, and acknowledged the loophole.

And then didn't bother to plug it.

What AES and Williams allegedly did during the spring of 2000 is not subtle: The pair responded to the grid operator's dispatching (that is, ordering into operation) of one of their "must-run" plants -- which the grid operator pays millions to keep available -- by saying that the dispatched plant was out of service for repairs, thus making the grid buy electricity from other units, also owned by AES/Williams. Those replacement units were able to charge full market rate, rather than the preset, much lower rate that "must-run" plants can charge when they are dispatched. That the ISO tried to order the plants online means the reliability of the grid was imperiled by an electrical shortage at that time. That is to say, the ISO needed power, and quickly, or a significant portion of the Southern California electric system could fail, an event that could create blackouts.

By keeping its "must-run" plants down, Williams was able to charge $750 per megawatt hour, instead of the $63 designated in its "must-run" contracts.

After about a week and a half, the "must-run" plant that had been taken off-line was running again. But on the same daythat reliability plant came back up, AES informed the grid operator that its other reliability plant in the area had gone down. Again, a substitute unit would be paid -- per federal regulations -- well more than 10 times what its dispatched reliability units would have garnered. A chart posted on the ISO Web site underlines the symmetrical nature of the reliability plant outages.

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