Power Exchange: A Lightening Rod for Blame.

The California Power Exchange Corp., originally the gleaming symbol of the power industry's long-sought deregulation, has suddenly become the whipping boy.

Thousands of businesses and residents, after getting hammered by soaring electricity prices this summer, are on the warpath. True to form, state and local elected officials -- including Gov. Gray Davis -- are following suit.

As with most fiascoes, the aggrieved parties are looking for someone to blame, and the natural culprit is the Power Exchange in Pasadena and its 175 employees.

"People are gunning for the Power Exchange now," said Arthur O'Donnell, editor and associate publisher of the Bay Area-based California Energy Markets Newsletter. "The Power Exchange is part of the overall discontent with the entire structure of the deregulated market."

As one of the first market exchanges in the country for the buying and selling of electricity, the 2-year-old exchange handles about 85 percent of all the electric power buying and selling in California, through its trading computers.

But now a growing army of critics is pressing to allow more trades between buyers and sellers outside the exchange. Some want the exchange eliminated entirely. Gov. Gray and Davis is calling for state control and tighter oversight of the exchange.

And just last week, U.S. Energy Secretary Bill Richardson proposed stricter rules for bidding on power sold on the exchange.

Power Exchange officials acknowledge that some reform is inevitable and that they will lose some of their clout. But they are digging in their heels on some of the broader calls to gut the exchange, saying those moves might backfire, and actually worsen the state's power crisis.

"Our exchange market performs a vital function that people don't appreciate," said George Sladoje, president and chief executive of the Power Exchange. "If you take away an open exchange, where transaction prices are published instantly for everyone to see, what you're left with is guesswork in determining prices, and that can lead to rampant speculation, much worse than what we've seen so far."

Sladoje was responding to recommendations by federal regulators earlier this month that would allow more bilateral transactions between buyers and sellers of electricity to take place off the exchange, essentially eliminating much of the exchange's business. A final order from the Federal Energy Regulatory Commission is due out next month.

State regulators, meanwhile, have already allowed some of these long-term bilateral contracts, saying they are necessary alternatives to the high prices on the exchange.

Summer turmoil

The three investor-owned utilities -- Southern California Edison, Pacific Gas & Electric and San Diego Gas & Electric -- are the Power Exchange's biggest customers. And until recently, these utilities were required to buy and sell all their power on the exchange.

But that all changed this summer, as a classic supply-demand crunch hit the state' s electric power market and sent electricity prices through the roof. With demand at record levels both in California and other Western states, and no new power supplies coming online, prices on the Power Exchange, which had been averaging about $15 per megawatt hour, jumped as high as $700 per megawatt hour.

The huge run-up in prices coincided with the onset of full deregulation for San Diego Gas & Electric customers in San Diego and southern Orange counties. Starting in June, these customers saw their bills go up three or four times over the previous summer's levels, causing a furious political backlash.

Of course, the Power Exchange, with its constant publishing of these high prices, became a prime target.

"The Power Exchange should have been able to see this coming and given us some warning," said Michael Shames, executive director of San Diego-based Utilities Consumer Action Network. "They were the cops on the beat, and it disturbs me that they didn't catch this."

But Sladoje said no one could foresee the extent of the price hikes that took place this summer.

"Sure, our longer-term markets did experience some price hikes earlier this year, but nothing that gave any inkling that we would see prices go up as high as they did," he said. "That caught everyone by surprise."

Within weeks, state regulators stepped in and capped prices on the exchange at $350 per megawatt hour, then lowered that cap again to $250 per megawatt hour. Last week, the state Public Utilities Commission endorsed further unspecified price caps. Also, federal regulators proposed lowering it to $150 per megawatt hour.

Sladoje takes issue with the way price caps are being implemented or proposed. Any such price caps must apply to the entire Western U.S., not just to the Power Exchange or to California, he said.

"With so much of our power generation in the hands of outside suppliers, all price caps would do, is prompt those sellers to conduct transactions not only off our exchange but outside of California altogether," Sladoje said. "Some of that power would be sold at much higher prices to California distributors, while some of the power that might otherwise go to California would end up being sold in other states not subject to price caps."

New bidding rules proposed by U.S. Energy Secretary Richardson may partially address Sladoje's concerns. Richardson. last week proposed requiring that all power generators selling into the exchange -- whether in-state or out-of-state -- be required to sell the power at cost for the next two years.

Meanwhile, in a possible harbinger of things to come, the state Public Utilities Commission in September allowed SDG&E, Rosemend-based Southern California Edison, and San Francisco-based PG&E to enter into bilateral long-term contracts off the exchange.

No turning hack

But that's still not enough for the critics, who contend that entire scheme of a marketplace for electricity is seriously flawed.

While a return to set prices and guaranteed rates of return for utilities is widely seen as impractical now that much of the power supply is in the hands of out-of-state power companies, there is growing pressure for tighter oversight.

Gov. Davis, for example, said in testimony earlier this month that he is considering a proposal to remake the Power Exchange's board. Currently, that board consists of representatives from utilities and the power industry. Davis said state-appointed board members might be more appropriate.

Other critics, including the investor-owned utilities, want much broader ability to buy power directly from suppliers outside of the Power Exchange, arguing that the power could be purchased at cheaper rates through direct bilateral trades.

But not all state officials are in a rash to so completely transform the Power Exchange.

"There was a reason for setting up a transparent central marketplace: It keeps players honest," said state Sen. Debra Bowen, D-Marina del Rey, who chairs the Senate Energy and Commerce Committee. "I'd rather see the PX develop a full market for forward contracting than to see a lot of that move to private transactions where you don't get the transparency of a full market."

Power Exchange officials have indeed set up such a "forward market," where electricity is bought and sold in three-month or six-month contracts. But Sladoje says the forward market is underutilized; most transactions are still conducted on a daily basis, either using spot-market prices or locking in power just 24 hours in advance. (Unlike soybeans or other commodities, electricity can't be stored, so long-term contracts carry much higher risks.)

Sladoje said that the investor-owned utilities have saved an estimated $700 million by entering into these long-term contracts; but he said they still didn't use them as much as they could have.

One of the key reasons is that last winter, when in retrospect it would have been prudent to enter into these long-term contracts, the utilities balked at locking themselves in so heavily at Prices higher than the spot market.

Sladoje said the PX is willing to live with the prospect of losing some of its business to bilateral trades.

"We will have to make adjustments and offer services that are increasingly attractive to the investor-owned utilities and others on a voluntary basis," Sladoje said in testimony before federal regulators earlier this month.