Ken Silverstein EnergyBiz Insider Editor-in-Chief

Significant supply shortfalls and a fatally flawed market design combined to make a fertile environment for price manipulation in California, which caused short term electricity prices to skyrocket, FERC has said. It's all worked to impede confidence in electricity markets and to give pause to investors. FERC aims to have new capital infused into the energy sector through a variety of initiatives. In a report it just released to Congress, the agency says that its response to the California debacle would have been far different if the law had given it more teeth.

"The commission lacked the necessary statutory authority to respond more robustly with meaningful civil penalties and express anti-manipulation authority," says FERC Chair Joe Kelliher. "The commission played a weak hand rather well," he notes, adding that the refund process has "gone on far too long (and) electricity markets remain vulnerable."

Meantime, San Diego-based Sempra just settled a major case against it in the Nevada courts. It will pay $350 million to litigants, who had asked for $20 billion. The case before it in the California courts remains.

Also, Houston-based Reliant Energy faces a criminal trial as it relates to market manipulation. If convicted, former workers there could also receive up to five years in prison while the company could pay millions in fines. The U.S. Department of Justice presented transcripts of taped conversations indicating traders had shut down all of Reliant's generators in California to drive up prices. The tape reveals that "as a group" traders there "turned almost every power plant off."

Undoubtedly, California regulators and legislators created an environment that fostered abuses. They had curtailed power generation development and required utilities to buy from the spot market, which saw prices skyrocket to $2,000 a megawatt hour while averaging about $325 per MWh -- 10 times the cost of producing power at the time.

And they capped prices to consumers, which left the state's utilities unable to recoup their costs -- a move that helped thrust Pacific Gas & Electric into bankruptcy. Transmission constraints also influenced electricity prices and the operations of the state's power markets, which contributed to the rolling blackouts in Northern California in 2001.

"It has been well-established that the worst of California's wounds were self-inflicted," says Gary Ackerman, executive director of the Western Power Traders Forum.

But regulatory pitfalls are not an excuse to rig prices and the legal threshold to assign fault has been broached. Some traders have pled guilty to providing false pricing information and more are being investigated. Additionally, companies have admitted to "round trip" trades that are intended to inflate volume and drive up short term prices -- evidence used to bring companies to the table.

FERC Embattled

A host of public interests have criticized FERC for its handling of California's energy crisis. Federal and state officials along with consumer activists have said that FERC sat on the sidelines while consumers there were getting ripped off. And its inaction is estimated by some to have cost the state $70 billion -- all while proprietary interests were getting rich.

FERC has responded that it acted within the powers granted it - powers that have since been extended under the newly passed energy law. Reliant previously settled with FERC, paying a $50 million fine. Duke Energy, Mirant Corp. and Portland General Electric also settled with FERC in civil actions, paying $2.5 million, $3.6 million and $8.5 million, respectively. At the same time, California has re-negotiated several long-term power contracts with suppliers and says that it has saved consumers at least $5 billion by doing so. It, furthermore, says that it has settled with other electricity providers and taken in another $1 billion as a result.

"The incentives to game the market and create disruption appear, for the most, to remain in place," says a report issued by California Attorney General William Lockyer.

The trading pursuit thrives on aggressive buyers and sellers, and on commodities that exhibit a great amount of volatility. But power trading is particularly complex, largely because the commodity cannot be stored and the price fluctuates even in real time. And, some markets such as the one in California could be ripe for abuse because of weak regulatory structures. The confluence of those dynamics meant that one organization -- or a group of traders -- could corrupt the process.

Egregious acts, such as keeping plants out of service so as to restrict the supply and therefore raise power prices and company profits, is intolerable. Williams Cos. and AES Corp. shut down a plant for three days in April 2000 to reportedly fix a boiler, but records now indicate that it was a planned closure. A Mirant trader, meanwhile, is on record via e-mail saying, "Stick it to em!!" And then there are the Enron tapes: "All the money you guys stole from those poor grandmothers in California? Yes, Grandma Millie, man."

While a legal distinction exists between unlawful behavior and unsavory behavior, the public sees little difference between the two. And it is this motivating force that has caused regulators and companies alike to instill meaningful corporate reforms. There's a concurring force relevant to the power and gas sectors to institute rational policies that ensure adequate supplies -- all to avoid similar circumstances in the future.

The overriding goal must be the continued improvement of an industry that has been through the toughest of times. The animosity now targeted at out-of-state energy providers must be dispelled and the efforts that will bring the whole debacle to a close must accelerate. It's the formula FERC has chosen, which is the most sensible way to get to the bottom of the matter and to clear the way for better times.

For far more extensive news on the energy/power visit:  http://www.energycentral.com .

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