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ru ILllYC UT 3 IMC IrrCRCIYLL3 AND SIMLARITIES BETWEEN CALIFORNIA AND h.tlnols

Foreward This paper outlines some of the signifiant differenes and similarities between the eletri power environments whih exist in California and Illinois. It losely parallels a memorandum I reently wrote to members of Governor Ryan s Illinois Energy Cabinet This paper is one of several reports I have written during past months relating to the implementation of the Illinois Eletri Servie Customer Choie and Rate Relief Law of 1997. These reports are available on the Commere Commission web site at www.i.state.il.us. This paper does not neessarily reflet the views of other Commissioners or of the staff of the Illinois Commere Commission. Rihard L. Mathias Chairman Illinois Commere Commission February, 2001

Table of Contents Part I. Some Differenes and Similarities: California and Illinois Divestiture of Generating Failities Power Exhange (PX), Long Term Contrats and Hedging Ativities Capped Retail Rates/Unapped Wholesale Eletri Pries Supply Adequay Fuel Mix Transmission Constraints Conservation Ativities Part II. Eletri Power Related Challenges Faing Illinois Supply/Demand Mismath New Generation Failities Transmission Constraints Appropriate Regional Transportation Organization Conservation Measures Competition Among Eletri Suppliers Utilities/Customers at Prie Risk Length of Transition Period 8 i 9 10 ii

This memo first outlines several of the signifiant differenes and as well as some of the similarities between the eletri power environments whih exist in California and Illinois. It onludes by noting that, with vigilane, a California style energy debale need not our in Illinois. Part I. Some Differenes and Similarltles: California and Illinois Divestiture of Generating Failities The California eletri restruturing law was enated by the California legislature with no dissenting votes in 1996. It provided, among other matters, that any California eletri publi utility wanting to ollet stranded osts was required to divest its nonnulear and non-hydroeletri generating failities to a non-affiliated entity. As a result, the three major investor owned eletri utilities - Paifi Gas and Eletri, Southern California Edison and San Diego Gas and Eletri - now purhase most of the power they sell to their ustomers from unrelated third parties whih own most of the generating failities. The Illinois Eletri Servie Customer Choie and Rate Relief Law of 1997 (Illinois Customer Choie Law) has no suh divestiture requirement. The Illinois law allows the utilities to unlok the hidden value in their generating failities by other means. Many Illinois eletri utilities have simply transferred ownership of their generating failities to affiliated ompanies. For example, Central Illinois Publi Servie transferred its generation failities to an affiliate, Ameren Energy, and Illinois Power Company (I.P.) transferred its generation failities to a generation subsidiary of I.P s Houston, Texas based parent, Dynegy In. These affiliates are free to sell eletriity to their affiliated utilities and to unrelated

third parties at market rates. In additin, ComEd sold its oal and gas Bred generating failities to an unaffiliated entity, Mission Energy Mid West, whih is an affiliate of Southern California Edison. Also, Illinois Power Company sold * its Clinton nulear generating fadtii ties to Amergen, a joint venture of Exelon and British Energy unaffiliated with Illinois Power Company. Both ComEd and Illinois Power Company havff power purhase agreements with their respetive buyers, whih gives eah the right to purhase substantial portions of the power produed by their divested failities for several years. In Illinois therefore, with the two exeptions noted above, in general, the same holding ompany owns the generating failities, whih were previously owned by the eletri utility. The ownership may be thmugh an unregulated affiliate or through the regulated utility. More on this Illinois situation below. Power Exhange (Px). Long Term Contrats and Hedging ativities The California restruturing leglslatton required all eletri utilities to purhese the eletriity they supply their ustomers through the California Power Exhange, a non-profit, state reated ageny, whih is overseen by the Federal Energy Regulatory Commission (FERC). Though the PX is ostensibly a voluntary market, the majority of the transations (approximately 80%) were onduted by or on behalf of the three major Investor owned California eletri utilities whih were raquired by the California restruturing law to ondut all of their transations through the PX until Marh 2002. Not only must the utilities purhase eletriity only through the PX, the eletrlity ould only be purhased for the following day or for the day of use. Long term supply ontats and other hedging atiiities were prohibited. In addition, the rules governing how eletrtoity was to be bought and sold on the Power Exhange reated some finanial inentives whih, in hindsight, fre-

quently resulted in highly dysfuntional market learing pries being harged by the PX. Another fator that may have exaerbated daily prie swings has been the role of the California tndependent System Operator (Cal ISO) in buying daily and hourly power in order to fulfill its responsibility to assure the integrity of the California eletri transmission system. Also, several ommentators have been rtttal of the separation of the market making and transmission operating funtions in two separate entities, i.e., the California Power Exhange and Cal ISO. Aording to published reports the California Power Exhange is being disbanded, and Cal ISO s operations are under intense srutiny. Illinois has nothing similar to the Power Exhange Illinois eletri utilities and Alternative Retail Eletri Suppliers of power in Illinois an and do enter into long term supply ontrats and are allowed to engage in various hedging ativities. It is widely belleved that these ontrats and hedging stretegies an result in lower, less volatile eletri supply pries. Currently in Illinois there is no opersttonal independent system operator omparable to Cal ISO. More on this below. Capped Retail Rate&Unapped Wholesale Ektrl Pries The California restruturing legislstion apped residential and small business retail eletri rates until the earlier of the date the utility reovered its stranded osts or until Deember 31, 2001. In addition, residential and small business rates are to be redued by 10% to 20%. The California law provides no ap on the prie the utility must pay to purhase the eletriity (i.e., wholesale eletri prie) that it supplies to its ustomers. The Illinois Customer Choie Law aps all ustomer rates until at least January 1, 2005. In addition, the 3..,.. I. aa,-,_,,._

... Customer Choie Law provides that approximately 80% - 85% of the residential ustomers of Illinois eletri utilities reeive roughly a 20% rate derease. Residential ustomers of lower ost utilities reeive lesser rate redutions. There is no ap on the prie the Illinois eletri utilities must pay to purhase the eletriity that they supply to their ustomers. In addition, the Illinois law provides some safety valves that the California restruturing law may not. For example, even while rates are apped, if an Illinois utility s return on equity falls below the benhmark levels in the Illinois Law, the utility may petition the Commere Commission for rate relief. Supply Adequay As has been well doumented, California and the states whih neighbor California experiened very signifiant eonomi growth during the past several years. As a result, base and peak eletri load usage soared. Very few new generating failities were built in California during past years and neighboring states no longer have exess supply whih an be transmitted into California. As a result there now is a signifiant eletri supply/demand imbalane in California both in base and peak load. California must grapple with its upoming summer supply problems, inasmuh as the summer, not winter, is the season of California s highest eletri demand. Customarily the Paifi Northwest supplies California and the Southwest with power in summer months and the Southwest sells power into the Northwest in the winter months. This seasonal exhange system may well be ollapsing due to several fators suh as high natural gas pries, low water levels and a general shortage of apaity to meet demand. This winter the Northwest has been selling large amounts of power into California, as have the Southwestern states. 4

Most ommentators agree that Illinois urrently has adequate base load supply and peak load likely is adequate as well. However, there is onern for supply in future years. More on this Illinois situation below. Fuel Mix California has been served by a mix of hydroeletri, nulear, oal and gas fired generating failities, some of whih are loated in neighboring states. It is more dependent on gas-fired failities than is Illinois, has more limited gas storage apaity and has far fewer nulear failities. While hydroeletri failities omprise a relatively small portion of the power supply, in times of short supply this hydropower is extremely important. In years past, low reservoir water levels have hampered California power prodution. Illinois has virtually no hydro power, has many oal fired failities, is well positioned with a supply of natural gas beause several interstate gas pipelines traverse the state and, as of now, the eleven Illinois nulear power plants appear to be operating effiiently. However, in years past Illinois nulear failities have performed poorly. Also, on oasion during extended summer hot spells warm water disharges into Illinois.rivers from nulear faility ooling lakes have been in exess of Illinois Environmental Protetion Ageny standards and have threatened the shut down of the related nulear generating failities. Transmission Constraints States west of the Roky Mountains are dependent upon eah other for power supply beause these states, in general, are not interonneted with states east of the mountains. There are transmission onstraints among/within these western states and within California as well. 5

There are onstraints in some servie territories in Illinois regarding the import and export of eletriity as well as onstraints on the import and export of power into Illinois. For instane, the Chiago metropolitan area appears to be a load poket with limited import apability in summer months. In addition, the Midwest Independent System Operator (MISO), whih was to determine how eletriity is to be delivered in Illinois and surrounding states, Is in disarray. Several Illinois eletri utilities are attempting to withdraw from MIS0 and to join a different organization. This would bifurate the governane of the transmission system in Illinois and likely lead to a dysfuntional system. Conservation Ativities Reports indiate that California eletri utilities have fewer megawatts of power than Illinois on interruptible power supply ontrats in spite of the fat that California is a muh larger state. Although the data available is inomplete, it appears that ComEd alone may have more interruptible and urtailable demand (roughly 1500-1900 megawatts) than utilities in the entire state of California. A reent report3 from the California Publi Utilities Commission and Eletriity Oversight Board to Governor Davis onluded that California eletri utilities should not have to, in effet, pay ustomers not to take power in times of tight supply. It reflets a muh different approah than that of Illinois. This California report states in part: Many ompanies have volunteered to redue their eletri use when it is really neessary. We applaud their efforts and ask a// Californians to join in onsetving eletriity usage for the next three months when

requested. We rejet the notion that omoanies must be Raid to do the rtoht thino - to redue load on those davs when eletriitv reserves beome soarse. (Emphasis added) Part II. Eletri Power Related Challenges Faing Illinois Many ommentators appear to agrea that the most signifiant flaws that led to the California debale relate to the supply/demand imbalane, the limitations of the Power Exhange and inability of utilities to enter into various types of long term supply ontrats and hadging agreements. These flaws urrently do not exist in Illinois. Therefore, through vigilane and thoughtful initiatives, Illinois an avoid a California style eletriity debale. However, some fundamental issues still must be addressed. Supply/Demand Mismath Supply and demand in Illinois must not beome mismathed, but instead must remain roughly in balane. This applies to base supply as well as peak load. Adequate supply an be aomplished by having enough generating apaity available to Illinois onsumers, by ensuring the ability to transmit eletriity into, out of and within Illinois, and/or by energy onsentation measures that redue or slow the growth in demand. New Generation Failities Adequate supply likely will require the onstrution of additional generating failities. In order for this to our there must be an aommodation of the very real fears of those who oppose the onstrution of peaker plants and other generation failities as well as a reognition

that peaker plants and intermediate and base load failities provide power when Illinois itizens are most in need. These failities also an signifiantly improve eletri reliability and forestall the onstrution of additional transmission lines. Transmission Constraints As noted earlier, there are onstraints on the transmission of eletriity into, within and out of Illinois. Many argue adamantly that there are genuine wholesale power liquidity problems in Northern Illinois and other areas of the state. If there is to be effetive wholesale and retail ompetition, these onstraints must be orreted. Appropriate Regional Transportation Organization The struture, governane and ownership of the regional transmission organization whih ontrols power imports and exports into, within and from Illinois must be resolved in the best interests of the publi and not alone by onsidering only the eonomi self interests of the eletri utilities and generation ompanies. Unfortunately, this issue is largely subjet to the jurisdition of the Federal Energy Regulatory Commission, whih historially has been very timid in implementing orretive initiatives. Generating supply &td transmission onstraints are somewhat analogous to the onstraints of the airline industry. No one will order a new 747 airplane unless they are assured of good routes and landing slots loated at desirable airports. Likewise, no ompany will ommene the long proess of aquiring the land and permits and designing and building a generating faility unless assured of being able to transmit eletriity to speifi, targeted loations. Whoever ontrols the desirable routes and landing slots - or the transmission lines - has a hoke hold on ompetition. Regulators term this market power. 8

Conservrition Measures While muh has been aomplished, more onservation and voluntary, ompensated load urtailment ativities need to be undertaken in Illinois to redue or slow the rate of growth of eletri demand. The Clean Energy Trust, the Commere Commission as well as other state agenies should be able to play pivotal roles here. Competition Among Eletri Suppliers Although the terms ompetition and ompetitive appear more than 70 times in the Illinois Customer Choie law, most observers agree that outside of the ComEd servie territory there is very little ompetition in Illinois. Some observers even are unwilling to onlude that ompetition exists in the ComEd servie territory.4 If signifiant ompetition among suppliers does not soon develop, Illinois onsumers - and the eletri utilities that have the obligation to serve - may have bleak supply alternatives available for they will be subjet to the pries harged by the orporate owners of the generation failities, and these orporations likely will have very substantial market power. Utilities/Customers at Prie Risk Until Deember 2004, the risks of prie flutuations are born by the Illinois eletri utilities. This risk is quite similar to the risk struture in California, although Illinois utilities do have the ability to enter into various risk management arrangements not available to California utilities. After 2004 Illinois eletri ustomers are subjet to the whim of the market and of the marketers. Although subsequent rate inreases must be approved by the Commere Commission, the Commission will have little diret authority over generating ompanies that are selling the eletriity to the vestiges of eletri utilities whih in most instanes will be merely distribution, i.e., wires ompanies. The affiliate or unrelated third party that owns the generating faility is under no

statutory obligation to sell power to the Illinois utility. In fat, the owners of the generation failities have an obligation to their shareholders to maximize the profit on the power they market. None of this is unlawful or neessarily faulty publi poliy. However, this winter Illinois onsumers of natural gas have learned what an our when they are subjet to market pries. Length of Transition Period The Illinois transition period runs until at least 2005 and perhaps longer when transition harges are onsidered. This is a longer transition period than California. However, this longer time period will not of itself result in a smoother transition to ompetition5 Illinois an learn from its own and others errors, undertake orretive ation where neessary, and in so doing avoid the California debale and problems of Illinois own making.