California Energy Crisis ,
 ---------------------- Forwarded by Vince J Kaminski/HOU/ECT on 03/22/2001=
=20
07:45 AM ---------------------------
  =20
=09Enron North America Corp.
=09
=09From:  Ken Lay and Jeff Skilling @ ENRON                           03/13=
/2001=20
04:17 PM
=09

Sent by: Ken Lay and Jeff Skilling@ENRON
To: All Enron Worldwide
cc: =20
Subject: California Energy Crisis

California=01,s power crisis has generated heated debate over the last seve=
ral=20
months.  Unfortunately, this debate has generated more heat than light.  We=
=20
want you to know what the facts are and what we are doing about the crisis.=
 =20
Please spend a few minutes reading the following overview on the situation=
=20
and our position on California energy issues.

What happened in California

The source of California=01,s current problem is as straightforward as supp=
ly=20
and demand.  California=01,s economy grew 29 percent since 1998.  This incr=
eased=20
the demand for electricity by 24 percent.  At the same time, regulatory=20
restrictions prevented new generation from getting built in the state.  So=
=20
demand grew but regulations prevented supplies from being added.  The resul=
t,=20
predictably, is a shortage.  This summer, peak capacity will be about 10=20
percent shy of peak demand, leading to further blackouts in the state.

In addition to the supply and demand imbalance, there are two other related=
=20
factors that led to the current crisis.  First, the state=01,s regulations=
=20
forced all sales and purchases into the spot market.  The spot market for=
=20
power is extraordinarily volatile.  The way firms behave in a free market=
=20
when faced with such volatility is to construct a portfolio of purchases lo=
ng=20
term, medium term and short term, to reduce exposure to this volatility.  I=
n=20
California, state regulation prevented this strategy.  This would be the=20
equivalent of putting the entire state on an adjustable rate mortgage in th=
e=20
most volatile interest rate environment imaginable.  Everything was fine=20
while the power surplus persisted, but when shortages ensued, every megawat=
t=20
was purchased at the sky rocketing spot price.

Second, retail markets were not deregulated.  Regulated retail rates remain=
ed=20
in effect, and stranded cost recovery charges were structured to keep=20
competition out.  This meant that utilities were forced to pay high wholesa=
le=20
prices in the spot market but were only able to recover costs at the=20
regulated retail rate.  They are now nearly bankrupt.

In short, California=01,s problems were caused by regulation, not deregulat=
ion. =20
Regulations prevented competitors from entering the market, prevented new=
=20
generation from being built, and prevented prudent hedging against volatile=
=20
spot prices.

At the time California was developing its restructuring plan, Enron warned=
=20
the state=01,s policy makers about these risks and proposed alternatives, w=
hich,=20
if adopted, would have averted the current crisis.

Enron=01,s Role

Many political leaders in the state have elected to fix blame rather than f=
ix=20
the problem.  Power sellers, including Enron, have been vilified by the=20
politicians and the media.  Here are the facts:

? Other than a small amount of wind power, Enron is not a generator in the=
=20
state of California.  Every megawatt we sold in California we bought in the=
=20
same market available to other California purchasers.  Because we are a=20
market maker, not a generator, we are not biased toward high prices.  We ar=
e=20
interested only in having a market that works so that we can package produc=
ts=20
for our customers.
? As a seller to end-use markets in the state, we provided protection from=
=20
the problems the states=01, utilities, and their customers, now face.  We=
=20
protected, and still protect, our customers from price volatility.

You may have read that EES recently elected to have the utilities supply=20
power directly to its customers in California instead of procuring power on=
=20
the open market.  Early reports mischaracterized this as a =01&turnback=018=
 of our=20
customers to the utilities.  Here are the facts:

? As a result of a variety of factors existing in the current California=20
market, it made more sense for EES to source power for its customers direct=
ly=20
from the utilities.  This decision reduced EES=01,s market price risk by=20
allowing EES to access lower utility rates.
? EES did not terminate any customer contracts, and our customers continue =
to=20
receive the financial benefits of their contract prices.
? EES is continuing to work with its California customers to provide them=
=20
with other energy-related products and services, including assistance in=20
reducing the demand for power, particularly at peak times.

Enron is currently proposing solutions to help California work out of its=
=20
crisis; Enron continues to sign up customers in the state; and Enron=20
continues to actively manage its risks and capture opportunities in Western=
=20
power markets.  Enron=01,s primary business is managing risk for our custom=
ers=20
with solutions customized to meet their needs.  There has never been more=
=20
demand for our products and services.

The Solution

The solution to California=01,s crisis is also straightforward.  In summary=
, the=20
state must increase supply, reduce demand, reduce reliance on the spot mark=
et=20
and shore up the financial stability of the state=01,s utilities.

Increasing Supply

California=01,s process for siting and permitting new generation is nothing=
=20
short of Byzantine.  Enron has built plants elsewhere in the country in les=
s=20
than a year.  In California, it often takes 5 to 7 years.  California simpl=
y=20
must streamline this process.  Ironically, while many of the regulations=20
generators must overcome are aimed at improving environmental quality, the=
=20
regulations are preventing new clean technology from coming online and=20
displacing current plants, which emit 40 times as much NOx.  California can=
=20
have abundant power and cleaner air by expediting the permitting of new=20
facilities.

Reducing Demand

Customers in California today have no incentive to reduce or shift demand. =
=20
They pay the same rate no matter what the market price is.  An open retail=
=20
market would trigger demand responses, which would balance supply and deman=
d=20
at lower prices than today.  California should fully open its retail market=
.

Reducing Reliance on the Spot Market

In a truly deregulated market, customers would protect themselves from=20
volatile spot prices by purchasing some of their requirements on a longer=
=20
term, fixed-price basis.  The state has instead left procurement in the han=
ds=20
of the utilities, which it has forced to buy exclusively in the spot market=
. =20
Opening the market at the retail level will give customers control over the=
ir=20
price risk.

Restoring the Financial Integrity of the State=01,s Institutions

The utilities in California are not paying their bills.  This has led to=20
greater uncertainty in the market, higher costs, and reduced flexibility to=
=20
arrive at lasting solutions.  California must permit its utilities to recov=
er=20
their costs so they can pay their bills and invest in the transmission and=
=20
distribution assets necessary to get power from where it is to where it is=
=20
needed.

Just as important as doing these things, the state must avoid policies that=
,=20
while politically attractive, do not fix the problem or even make matters=
=20
worse.  Price caps have been proposed.  They don=01,t work; have never work=
ed;=20
and they will not work here.  Price caps succeed only in creating shortages=
,=20
which then have to be allocated among competing users.  Imagine how=20
ineffectively the government would be in determining, for example, whether =
it=20
is better to make its limited power supplies available to the Imperial Vall=
ey=20
or Silicon Valley.  Price caps are a surefire way to make the current=20
shortage worse.

The state has also proposed to take over generation and transmission in=20
California.  There is no reason to believe, and every reason to doubt, that=
=20
the state will be more effective than free markets at investing in,=20
constructing, operating and maintaining assets.  This will also result in=
=20
California tax revenues being spent on power transmission and power=20
generation -- which the private sector can do -- instead of education, road=
s=20
and other public goods -- which the private sector cannot do.

As you are approached by people outside the company or are learning about t=
he=20
crisis from the media, it=01,s important for you to know this:  We at Enron=
 will=20
continue to serve our customers and we will continue to propose real=20
solutions to the state.
vkaminski@aol.com