California Update 8/24/01 ,
 EXECUTIVE SUMMARY
?=09A New MOU Takes Shape in the Assembly
?    The Fate of Direct Access
?    DWR Rate Agreement


California's Assembly Rallies 'Round a New MOU
The lights were burning late in the California Capitol last night as lawmak=
ers in the Democratic caucus volleyed final versions of the newly consolida=
ted Edison MOU bill, AB82.  Details leaked to the public concentrate on dis=
putes over the valuation of SoCal's transmission line assets, however, sour=
ces report this matter is only a prelude to even greater contentious langua=
ge buried in the bill's various sub clauses.  Earlier media reports noting =
that the bill would be based on Senator Burton's preferred legislation are =
also far off the mark.  The draft bill tries to get the State out of the po=
wer business as fast as possible and binds power users to decades of high p=
rices.  The proposed language also significantly reduces the chance of a So=
Cal Ed bankruptcy and provides the company with lavish concessions.  SoCal =
Ed is complaining about some technical details in public, but the draft bil=
l offers probably the most generous deal any electricity utility has seen f=
rom regulators.  Sacramento insiders tell us the bill has "a pretty good ch=
ance" of passing in the next 3-4 days, but could touch off a political and =
legal storm because of its draconian impact on Californian power users.=20

The Assembly's AB 82 contains three primary additions that distinguish it f=
rom thee Senate's SB 78XX bill and:=20

1)=09The Governor and Assembly Democrats propose to charge a massive 'exit =
fee' to any end user wanting to switch a future alternative power providers=
.  All California electricity users will be liable for the cost of Governor=
 Davis' expensive long-term power contracts for their whole term (save muni=
cipalities like SMUD and LADWP).  This is apparently the only acceptable co=
mpromise for legislators that would both secure revenue to cover the State'=
s long-term power costs and maintain the promise of direct access establish=
ed at the onset of California's deregulation.  The clause sidesteps some of=
 the obstacles the California State Constitution places in the way of stopp=
ing direct access, particularly for municipalities.  But it could still be =
open to legal challenge.  California officials hope that it will be enough =
to quiet the issue until the October power bond sale is finalized.

2)=09The Assembly expanded the rate base of "commercial class" users to pay=
 back SoCal's bailout bonds by incorporating small businesses that use 20 k=
W.  It appears likely that this change was made because S&P told the state =
that a larger rate base would be needed to support the bailout bonds.  S&P =
wants all ratepayers to help repay and secure the bailout bonds; including =
small businesses.  This change is likely to draw heavy fire from the powerf=
ul California Technology and Manufacturers' Alliance (CTMA).

3)=09The PUC will be mandated to set rates at any level necessary to preser=
ve SoCal Edison's solvency and borrowing ability.  This regulation essentia=
lly links consumer electricity rates with maintaining SoCal's investment gr=
ade credit rating.  Arguably, SoCal would need to do little more than make =
a case that that S&P might downgrade them and the CPUC would necessarily re=
spond with a rate increase. If SoCal can get this concession, the nickel an=
d dimes issue of transmission line valuation will be muted, a promising sig=
n to those fearing bankruptcy.

Sources within the Sacramento Capitol inform us that the Governor and Hertz=
berg are likely to get their way for now. The precise wording of the clause=
s may be toyed with in the final markup session, but we understand there is=
 considerable momentum behind the substance.  There are some indications th=
at the Governor may have overestimated the amount of support AB82 has in th=
e Assembly.  Republicans are not on board, so if the bill passes it will be=
 subject to 90 days delay before taking effect.  It remains unclear whether=
 the plan will come to a vote next week.  When/if the plan does pass, it wi=
ll likely have no more than a 50% chance of escaping the Senate.  Senator B=
urton, the consumer advocates, and the CTMA are staunchly against any plan =
that would include small businesses in paying off SoCal's bailout bonds.  S=
en. Minority leader Burlte told several lobbyists yesterday that the Republ=
icans would walk away from any amended SB 78XX that emerged in the House, h=
aving already agreed to the Sher bill (SB 78XX) before the recess. This is =
reportedly the same attitude Brulte's counterpart in the Senate, John Burto=
n, has articulated -- and not a good sign for Edison.

Direct Access=20
Contrary to the CPUC's press release explaining their decision to delay the=
 direct access ruling to allow more time to review the case, sources report=
 the reason for the delay is that the Commission prefers to wait for the Le=
gislature to act on SB 18XX (bond repayment) before ruling.  Key business c=
ommunity leaders expect the PUC to formally end direct access on Sept. 6. H=
owever, the Legislature has the authority to reinstate direct access in wha=
tever form it may choose.=20
Presuming the PUC carries out the expected action and permanently suspends =
direct access; the following are some possible outcomes:=20

?=09The Legislature, under pressure from a unified business community, coul=
d restore direct access before the end of the session allowing moderate Dem=
ocrats in swing districts to say they protected the economic climate, but o=
nly with exit fees and time commitment restrictions that are unpalatable to=
 businesses. Many in the business community are willing to accept having to=
 "eat" a DWR surcharge for long-term power contract commitments and a surch=
arge to pay for a substantial portion of Edison's accumulated debt. But acc=
ording to our sources, Legislative Democrats are insisting on exit fees sub=
stantially beyond these surcharges to head off the need for additional resi=
dential rate increases that might be needed to satisfy DWR commitments.

?=09If this occurs, or if the Legislature simply stands idle and declines t=
o restore direct access, business leaders may likely give up on direct acce=
ss and shift their efforts to restructuring the rate allocation to shift a =
greater portion of the burden to the residential ratepayer classes. (The Ma=
rch rate increase by the PUC placed a disproportionate share of the revenue=
 requirement burden on the industrial ratepayer classes.) This would presen=
t a huge political challenge. But because the amount of net short power exp=
ected to be available for direct access agreements is so small -- one estim=
ate places it at no more than 5000 MW (or about 10% of demand) through 2007=
 -- there is growing sentiment in the business community that it is no long=
er really worth fighting for direct access given the political obstacles.

?=09Additionally, there is the interesting prospect that DWR itself might e=
xpand and dominate the market for net short power sales, given the agency's=
 expected surplus supply via the forward contracts. There is nothing in law=
 or regulation currently that would prevent DWR from acting as a market par=
ticipant and selling excess power; indeed, DWR already sells excess power t=
o municipal utilities, private utilities and power managers outside Califor=
nia.=20

DWR Rate Agreement and Edison Rescue=20
In the Senate informational hearing today on the DWR rate agreement, DWR re=
presentatives acknowledged that the agency is still negotiating contracts f=
or additional forward power.  This prompted concern by some legislators and=
 consumer activists who believe DWR has already over-purchased long term po=
wer, causing sales by DWR of excess power for as little as $1 per MW at tim=
es this summer.
john.lavorato@enron.com, louise.kitchen@enron.com, david.delainey@enron.com