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<td width="75%" valign="top"><p ALIGN="left"><font face="Arial"><b><big><big><big><strong>INTERESTING
FUTURE CHANGES IN THE CALIFORNIA MARKET MODEL?</strong></big></big></big></b></font></p>
<font face="Arial"><p></font><font face="Arial" size="3"><strong>By Bj�rnar Otterstad</strong></font><font size="4"><br>
</font><font size="2">(<em>originally published by PMA OnLine Magazine: 12/98</em>)</font></p>
<i><b><p></b></i> </p>
<font face="Arial" size="2"><p ALIGN="JUSTIFY"></font><font size="2">Deregulation of
electricity markets is happening worldwide, and the Scandinavian countries and California
are among the first electrical power system to open to competition. There are though some
important differences between the Scandinavian and Californian deregulation models.
Scandinavian generators participate in the competitive sector similar to all other market
participants. Generators may sell their power to whomever they want, either bilaterally or
on the power exchange, Nord Pool. Likewise, the electricity suppliers buy wherever they
get the best offer, taking market prices and their own supply situation into
consideration, and resell to the consumer. As a result, end-users are offered products
based on market prices, either spot or forward prices.</font></p>
<p ALIGN="JUSTIFY"><font size="2">The situation in California is currently somewhat
different than in Scandinavia due to:</font></p>
<blockquote>
<ul>
<li><p ALIGN="JUSTIFY"><font size="2"><strong>Mandatory trade with the Power Exchange (PX):</strong>
All generation of the Utility Distribution Companies (UDCs) is required to be sold at the
California Power Exchange (PX) and all UDC load must be bid into the PX.</font></p>
</li>
<li><p ALIGN="JUSTIFY"><font size="2"><strong>Generation a part of a regulated entity</strong>:
The parts of IOU generation not requiring divestiture upon deregulation remain in the same
companies responsible for distribution - generation remains a part of the regulated UDCs.</font></p>
</li>
<li><p ALIGN="JUSTIFY"><font size="2"><strong>Fixed end user prices:</strong> The regulated
UDCs are required to offer the end-users a rate 10% below the June 10, 1996 level - UDC
rates are capped. The rate for Energy and the Competition Transition Charge (CTC) vary
relative to each other. The Energy Charge reflects the PX-price directly, while the CTC is
the residual value based on the fixed price and the PX-price.</font></p>
</li>
</ul>
</blockquote>
<p ALIGN="JUSTIFY"><font size="2">The situation today is illustrated by Figure 1.</font><font FACE="Arial" SIZE="2"></p>
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</center></div><p ALIGN="JUSTIFY"><font size="2">Figure 1 shows that a low PX-price gives
a high CTC and vice versa. Since the CTC is mandatory for end-users, Electricity Service
Providers (ESPs) must offer their customers a lower price than the PX-price. But why
should anybody be interested in selling at a lower price than the PX-price, the cleared
spot market price?</font></p>
<p ALIGN="JUSTIFY"><font size="2">The obligation to deliver at a fixed price, together
with the existence of the CTC, prevents competition and market-based price policy in the
end-user market. However, the basis for the present market model in California is changing
somewhat. The UDCs are currently divesting much of their generation, and selling prices
thus far have been above book value. PG&E for instance, announced November 24 that
some of the company’s fossil and geothermal power plants in California had been sold
for $1 billion, $422 million above book value. In addition PG&E is considering either
to move the company’s other generation resources to an unregulated affiliate, or to
divest further (San Francisco Chronicle, November 1998). </font></p>
<p ALIGN="JUSTIFY"><font size="2">There are several reasons why this is of particular
interest:</font></p>
<blockquote>
<ul>
<li><p ALIGN="JUSTIFY"><font size="2">Lessons learned from several divestitures of
Scandinavian hydropower resources show that the market value of a generation resource
often exceeds book value. The consequence of hydropower resources and other generation
plants being sold in California at a higher value than book value will be a corresponding
reduction in the collection of the CTC.</font></p>
</li>
<li><p ALIGN="JUSTIFY"><font size="2">Divestiture of UDC generation resources will leave the
regulated UDCs with limited in-house generation capacity. The UDCs are required to buy
from the PX, without having the opportunity to reflect supply side risk in the end user
products. As long as generation is kept in the regulated UDC, it is possible to require
fixed retail prices from the UDCs without leaving them with disproportionate high risk. A
high PX price will in that case give high income from generation. Without generation, the
UDC is fully exposed on the supply side with no opportunity to pass on supply side price
volatility to the end user. The most likely way to reduce this risk is to remove the
obligation to deliver at a fixed price.</font><font FACE="Arial" SIZE="2"></p>
</font></li>
</ul>
<font FACE="Arial" SIZE="2"><p ALIGN="JUSTIFY"> </p>
</blockquote>
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<p ALIGN="JUSTIFY"><font size="2">Assembly Bill 1890 mandated power industry deregulation
in California and established the year 2002 as the time at which most components of the
CTC be eliminated and the transition phase to deregulation wind to a close. The sale of
UDC generation assets will certainly decrease the amount of time required to collect the
CTC. It is CALPOL’s belief that these changes are long overdue can’t be forced
through soon enough. </font></p>
<p ALIGN="JUSTIFY"><font size="2">California Polar Power Brokers, LLC (CALPOL) is a
full-service marketplace matching buyers and sellers of electricity and related financial
contracts. CALPOL is a certified Scheduling Coordinator with the California Independent
System Operator (ISO) and a certified market participant with the California Power
Exchange (PX).</font></p>
<p ALIGN="center"><strong><font size="2">This article was taken from the CALPOL Market
Report, issue no. 4.<br>
Visit our web site at <a href="http://www.calpol.com">http://www.calpol.com</a> for
more information.</font></strong></td>
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