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Priory is chairman and chief executive officer of Duke Energy, a
power-generating company based in North Carolina. He believes that a
deregulated, free market in electricity is the only way to send appropriate
signals to consumers and to normalize power supply and demand. Like Enron
Corp., Duke Energy's annual revenues increased dramatically, rising from $21
billion in 1999 to $49 billion in 2000.
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[The California power market has been profitable for Duke]?
... Most years; not all the years.
But in the last couple of years?
Yes. ... One has to keep in mind that most of our electricity is not sold in
the spot market, or most of our electricity is negotiated on a bilateral basis
and sold forward to various entities.
You mean you sell on year-long or longer contracts at a fixed price?
That's correct. ... The vast bulk of our power is actually sold forward. It's a
hedging mechanism to protect our risk, if you will. We hold out a small
fraction of that in the event that one of our plants doesn't operate. Rather
than having to go to the spot market to buy the power to replace it, we'll hold
our least efficient plant and be able to utilize if one of the plants that's
currently doing our production comes down. ...
We know that from estimates that have been made by the California
authorities that we spent $7 billion on electricity and energy, I think, in
1999. In 2001 we're supposed to spend $70 billion. People could hear a great
sucking sound going southeast from California and believe that the money has
come here. You're saying it's spread around a lot more.
I'm not familiar at all with those numbers that you just stated. There's no
question the price has evolved dramatically in that marketplace. There's a
tremendous shortage, and there is no doubt that certainly some people will
benefit by that. ...
Electricity gets extremely volatile if there's scarcity as a market.
Electricity is the most volatile priced commodity that we deal with, really, on
the face of the earth.
Which a number of people have raised in interviews we have done. ...
Electricity is needed. We can't do without it and it's instantaneous. It's
different, and it should not be part of an open-ended marketplace.
Well, I would disagree completely with that. If you want an efficient,
well-run marketplace, the free enterprise system is very effective in being
able to cause that to happen. ... It sends out market signals that will affect
both the demand and the supply side of the equation. I see it operate quite
effectively in Argentina--we've been there since 1991--Brazil, go down the
list. I mean it. Deregulated markets operate all around the world today. ...
Do you see California really as a transitional situation--that this will
change, whatever is going on there?
Yes, there is no question about that. I believe the market is going to work
quite effectively in California. But the markets have to be allowed to work
effectively in California. As you know, as a result of the way in which it was
deregulated, the markets operated very differently, I suspect, than many people
thought they were going to, because of the constraints that remained on that
marketplace.
What do you mean "constraints?"
For example, the utility companies--I'm sure you're well aware of this
point--were left in a position where they believed that it was appropriate for
them to buy all of their power requirements, or the vast majority of their
power requirements, on the spot. That's very, very unusual. Ordinarily you'd
be buying a small fraction of your requirements on the spot market. You will
have contracted long term for the vast bulk of your needs, to assure that you
could maintain and control your pricing. Heavens knows if you're buying it all
out of the spot market and the spot market becomes short [on] supply and
nothing happens on the demand side, then prices do nothing but shoot up. ...
A number of the people that we've spoken with say that the way the
California market--at least where that kind of spot market is set up--can be
manipulated. ... We've heard from Commissioner [William] Massey at the FERC and
from Ms. [Loretta] Lynch of the Public Utilities Commission that there was
manipulation of power prices in California over the last year, year and a half.
True?
... It's clearly true the allegation has been made. I've not seen a shred of
evidence that has suggested that that was done, nor be able to illustrate how
in fact that was done by whatever player in that market place. There have been
numerous studies done, including one by the Federal Energy Regulatory
Commission that Commissioner Massey sits on that concluded that that was not
the case. ...
They say it's based on numbers provided to them by the industry of your
power plants and how they are operating and on what days they were
operating.
... They could have mixed our numbers up with anybody's numbers. I have no
idea what numbers they're using. But when we do, we will clearly respond to
it, and explain any of our pricing that they'd like us to explain.
So if the FERC says that in January and February of this year, Duke
overcharged $17.8 million ...
They said that we may have. ... They asked us to explain our pricing
that was above a certain level. ... They basically said, "Everyone in that
marketplace that charged a number higher than this, we're going to identify it
and we're going to ask you to come in and explain. And if you can't explain it
and if there isn't a good justification, we're going to ask you to refund it."
And so what you saw was a series of companies that went in and simply explained
how their pricing mechanism worked.
In our case, we explained it quite clearly. ... They were people who could not
pay, who said they were not going to pay, and yet we were supplying them
electricity. ... As a consequence, we included a commercially accepted practice
of putting credit premiums basically for non-creditworthiness, as is done in
virtually all businesses out there. ... There are various methods available for
calculating the credit premium. We did just that. ...
You're out over $100 million, as I understand it right now.
We're out a substantial amount of money. At the end of March or the end of
December of 2000, we said we had receivables in California of $400 million ...
and it changes every day and every hour.
It's not getting smaller.
Yes, it is getting smaller at this point in time. And so we told them
fundamentally that, if we were paid and the credit issue was resolved, then we
would certainly drop any credit premium we included in that bill. So that's
been our response, if you will, to the so-called overcharge that FERC has asked
us about.
I think you've told the state of California that with your own numbers, the
spot market price ... may have gone up to $200, but that the average that Duke
has been charging or bidding into the market has been well below that.
That's correct.
That you really haven't been exploiting. You've been a good citizen. You
haven't been exploiting the marketplace. Is that correct?
No, we weren't talking about exploiting anything. The market is what the
market is. All we were saying is that the vast bulk of our power was being
sold in at negotiated prices with a variety of entities which were
substantially below what the then-market was. If I had sold all of my power in
at the market price, I wouldn't have described that as exploiting anything. ...
You'll take what the market will bear.
Well, absolutely. ...
On the other side is the issue that electricity is something that everyone
must have. It's the oxygen of industrial society and you should charge a "just
and reasonable" price as stated in the federal law. ... Isn't that the conflict
that we're having here?
Oh, I don't know that that's the case. Your assertion that electricity is
something you simply have to have and therefore it ought to be not
monopolized--I think it's incorrect. We've demonstrated time and again that if
a market signal flows through to a normal customer base, people will react to
that to show that they don't have to have it. ...
So I think it's clear with regard to electricity, just like any other
commodity. If the pricing rises and the consumer is faced with a rising price,
the consumer tends to reduce the amount of the product that it actually needs
to run its house. ... It's not that you have to have a certain amount of
electricity to operate. It's that you have to be able to see that price
signal, reduce your demand at times of high price, and then increase your
demand at times of low price. ...
First, let me read to you an opinion of Loretta Lynch, the president of the
California Public Utilities Commission. "These people," she says--meaning the
generators and marketeers--"will make whatever profit we allow them to make.
They are selling us something we absolutely have to have. These people are
going to bleed us to death like leeches, unless we stop them." She's talking
about you.
I have absolutely no response to that sort of rhetoric.
Then she refers to the fact that prices simply on May 22 of last year
started moving forward, and they began charging whatever they wanted to charge.
Prices went from 5 cents a kilowatt to 18 cents a kilowatt last summer,
tripling, and never really came down after that. Now, it would be one thing if
the prices were spiking. ... It's another thing if they've gone up and in a
sense disciplined the market in California to expect those kind of prices. Is
that what happened?
I would consider that to be simply a sound-bite statement that really doesn't
have any relationship to what actually happened in California. ...
You've been in negotiations ... with the Department of Water Resources about
long-term contracts. And these long-term contracts, some of them though have
pretty high prices. ...
I don't recall exactly the number, but I think it's on the order of $79 per
megawatt-hour.
You have a number of contracts at $74.25 a megawatt-hour, according to our
information, and some at $65, some at $35, depending upon the length of the
contract. But the real question is that [in those negotiations], you are
concerned about the effect of all of these investigations and litigation. Has
that become a factor in your negotiations with the governor?
Well, I don't think it's become a factor with regard to the negotiations with
the water. We're not negotiating with the governor. We've not been involved
with the governor at all. ... It's just a pure commercial negotiation. ...
We know you've offered long-term contracts and that you have been a leader
in this area in making it available. But we also know that you're upset about
the credit situation in California. Were you asking last week for some kind of
collateralization of your deals with California before you could make long
term--?
First of all, we certainly did have a payment problem. We hadn't been paid.
It is a consequence. Some of the payments stretch way back to really last year
at this point in time. So, yes, it was a serious credit problem to begin with.
Number two is that this is, in essence, selling power long term into a contract
no different than we do in many, many states here in the United States, as well
as many different countries. Virtually all of those kinds of contracts have
normal commercial terms associated with them, which include collateralization
and margining and what-have-you in those contracts. So we're asking for the
same sort of commercial terms that we would have in virtually any of the
markets.
The good faith of the state of California isn't good enough?
I'm not aware that the good faith of the state of California has been pledged
to support the credit of these contracts.
I thought the governor has said that they will be paid for with bond issues
or, if necessary, it'll be the general tax credit.
I'm not aware of exactly what he said in that regard, nor am I aware that the
full faith of the California government has been put behind these power
contracts.
So as a prudent businessman, you're waiting to see if there's money in the
bank.
All we're suggesting is that they just be done on a commercial basis consistent
with the way power contracts are done really all over the country.
But in your negotiations with the governor's office, you have raised the
issue that you are owed a lot of money, and that you may in fact be willing to
negotiate potential refunds that you may have to give because of overcharging
against that balance.
I'm afraid I'm not in a position to comment on any dialogue that may be going
on. I'm not privy to it. I'm not sitting in those rooms. There certainly are
people in my organization that have had dialogue with regard to resolving the
overall problem in California. But I'm certainly not going to sit here and go
through a series of provisions that I'm not even aware of. ...
What I'm getting at is that we have information, and I believe there are
documents, in which Duke makes a presentation to the state of California that
you have been a responsible citizen, that you haven't had any unplanned outages
that were deliberate, but that you see a very critical situation and that you
see a situation where you want to get in there. It actually says you want to
get in there first, and make a deal to set up a model for the way California
should work. Would that be a fair characterization?
Yes, I think that fits pretty neatly with our strategy. We think we have to
find a solution to this problem, and all the people associated with it have to
work together effectively to be able to find that.
And I've seen some of the numbers that you've given to the state of
California. So I gave those numbers to an economist and he came back to me and
he said, "Well, they look good." "But," he said, "if these numbers are true,
then it's true that Duke has not been getting in the marketplace what the
market would pay them for their products."
That's correct.
Your shareholders should know that you haven't--
Our shareholders, I'm certain, have understood--because we've said it over and
over again until we're blue in the face--that we signed contracts years ago to
sell power at what was then very reasonable cost-based prices. We continue to
honor those contracts and we continue to sell that electricity at those prices.
...
In fact, the governor found some of our contracts so desirable that he actually
commandeered some of them, because they were so low cost relative to what the
market was requiring. We continue to honor those contracts and deliver the
power for those prices.
This is one of the pricing documents that your office submitted. It shows
your activity in the spot market and it compares that with the actual prices
that were available. It shows Duke that you will be very restrained in terms
of profits that you were gathering. It seems unusual, given the
characterization that you are all pirates. ...
You have to understand that we have contracted to sell that power. ... Other
people in fact own that power. They bought it at very reasonable prices and we
will continue to deliver it. Unfortunately, because of all the rhetoric that's
occurring in California, people are believing that we're selling into the spot
market at those high prices, and the reality is we're selling the vast bulk of
our power ... dramatically below the market price, simply because we've
contracted with parties previously. We were trying to manage their price risk,
and therefore we will continue to deliver as long as those contracts are valid
at that price.
I'm the ratepayer in California sitting here listening to you and what I
hear you saying is, "It's not us. We got a basically a fair long-term price."
... So where did all the money go?
I have no idea. There are numerous investigations underway. I think the
[independent system operator] just issued a report. I think it shows that some
of the top organizations were able to sell excess power they had into that spot
market at high prices. ...
And Duke is one of them.
Whoever happened to have ... large amounts of excess capacity that could have
been sold into the market at that price obviously took the market price.
So your organization did take this excess price?
As I mentioned, when we took the market price, we didn't take any excess price,
I can assure you of that. I can assure you that the vast bulk of the power we
sell, as I mentioned earlier, is under contract. ... Of the remainder of it, we
hold out 10 percent for the purposes of assuring that we don't get exposed to
that market price if one of our plants goes down. If our plants are running
well--and our plants are run extremely well--then that 10 percent we, of
course, sell to maximize the benefit for our shareholders. And so we sell that
at whatever the market price is. ...
So you don't believe that it's possible, despite these statements we have
from Commissioner Massey or ... others, for anybody to have really manipulated
the electricity market in California by withholding capacity?
I just have to rely on the five or six or seven studies that have been done now
that basically say that they couldn't identify any manipulation. We've had a
variety of regulatory people on our plant sites when our plants were down.
They ended up concluding that we were doing everything that should be done;
that we hadn't intentionally withheld any power.
So yes, I'm relying upon all that data that basically says there's been no
indication of that at all. I know in our case there hasn't been. ...
No, but [Stanford Economics Professor Frank] Wolak and the monitoring
committee in California says there was definitely market manipulation in
California.
And has he given the evidence of that and identified the players and shown how
it's done?
He's identified the main suspects, and sent that information to FERC. And
the ISO has sent it there, and asked the FERC to refund almost $7 billion now
back to California from generators and others. Your company is on that list.
I must tell you, your information and my information is actually quite
different. It's surprising to me in that I'm not aware of this professor
having identified any specific technique of manipulation or anything of that
sort that people engaged in that led to breaking of any of the rules. ...
He says that his study is that over the last 2 1/2 years there have been
five times as many unplanned outages in California as there [were] at the
beginning of that 2 1/2 year period. But all of a sudden last year, plants
were being taken out of line and off the grid.
So he then simply jumps from that one fact to the belief that that's
intentional manipulation. And there's where I would disagree, heartily. The
fact of the matter is, most of these plants are 40-50 years old, and they've
been run like they have never been run before. We'll have to show you the
charts on our plants that give you the historical capacity factor up until the
last two years. The capacity factor shoots up like this. These are the oldest
plants in the mix. ... Our force outage factors are lower than the national
average; our availability is higher than the national average for these 40- and
50-year-old plants. All I can tell you is, in our case, people worked
double-time and triple-time to get the plants back on faster when they went
down. ...
And you're very confident about this. But your representatives, in their
negotiations with the governor, have said [that] the key thing that your
company wants is a settlement of all the complaints either that may result from
all these various investigations or are pending for refunds, as well as all the
class action suits. If you could possibly do that, you want to make one
payment, basically.
One payment?
One payment to resolve everything.
We talked of a global settlement--to try to find some way to bring all of the
parties to the table, determine what their issues are, and see if we can find
common ground. The intent here is to try to get a solution for California. If
it's going to continue to degenerate into a whole series of allegations,
lawsuits, and what-have-you, the fact of the matter is that the real problems
are not being addressed. And thus what could have been a one-year problem, or
a six-month problem, can easily turn into a five-year problem or a 10-year
problem, with dramatic effect on the state.
So I think it calls for that kind of leadership to be able to step up, pull the
parties to the table, and structure an arrangement to close all these issues if
California wants to be successful and move forward with a growing economy.
That is where we're coming from. ...
It looks to me like you're one of the few people we've run into in this
matter whose willing to step up to the plate and try to deal with this in a
holistic, almost apolitical way.
I don't know about that.
The governor hasn't been able to do it. He's talking publicly about you
guys being pirates and ...
Look, I run a corporation. I don't have time for all these different pathways,
and what-have-you. When a problem arises, we have to go to the meat of the
problem, and we have to try to solve the problem quickly, if we want to be
successful in our business. We're simply applying those same kind of
techniques to where there is a giant business problem in California, and our
attempts to be able to pull it together in a way in which we can resolve the
problem. ...
Just a last question, then. For the person at home who is watching this,
who sees in most places their utility bills have been going up over the last
couple of years, is this just a period of transition? How long will we, in a
sense, have to endure this pain before we get to the perfect world you'd like
to see?
I think you have to recognize--we all have to recognize--that there hasn't been
a lot of new supply built over the last decade or so in this country, anywhere.
In some cases, it's been because of environmental restrictions, such as in
California, where it has not been built very effectively. In other areas, it
just hasn't been built, primarily because prices rose very rapidly back in the
1970s and early 1980s, and as a result, we talked about deregulation. Thus
we've been betwixt and between on deregulation. This has retarded, if you
will, the growth of the new supply that's necessary.
My belief is that supply is going to have to come in, and as a consequence, it
all comes in paid for by 2000, 2001, 2002, kinds of dollars. It's
undepreciated. And prices have to rise a bit to be able to accommodate that
new generation. ...
But you're talking to people, for instance, on fixed incomes, who have to
make real-life choices.
They should have a good utility company that goes out and really moderates that
risk and reduces that variability for them, which is exactly what we do. ...
So you're saying, "Have faith--things are going to get better?"
I'm saying let the markets work. Let the free enterprise system that we've
built this country upon work, and work effectively, without undue constraints..
...
Read more about the allegations involving Duke Energy.
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