Restructuring the Northwest power system.

I want to address the Bonneville Power Administration (BPA) and the institutions that run the Columbia River, because those institutions will have more to say about what happens to the future of Columbia Basin salmon than anything else. This subject involves regional power markets and the enormous changes that have put us in a situation today in which we must think radically about the future of the federal power assets in the Pacific Northwest.

BPA has been in existence for nearly sixty years. It has gone through a series of changes over the years, but it has basically continued to serve a set of utility customers as well as direct service industries, mostly aluminum companies. BPA also sees surplus power primarily on a short-term basis to either the investor-owned utilities in the Pacific Northwest or utilities in California and the Pacific Southwest.

Now BPA's costs are such that it no longer has a great advantage in the marketplace over other suppliers, particularly on a short-term basis. Why has this happened? It is a long story. From a legal standpoint, it began with the Public Utility Regulatory Policy Act of 1978,(1) which allowed non-utility competitors to compete in the market place. It continued through the Energy Policy Act of 1992,(2) which allowed larger entities to enter the marketplace as independent power producers and obtain access to the transmission grid. And now it is manifested through the efforts of the Federal Energy Regulatory Commission to allow more competition and more openness on the transmission grid as a common carrier,(3) similar to what has happened in the natural gas system.

As a result of industry deregulation in the 1970s and 1980s and some other technology factors, we find that the price of natural gas has continued to drop. When I was a regulator with the Oregon Public Utility Commissioner's office in the late 1970s, natural gas was considered so extremely valuable that a federal law was passed that prohibited its use to generate electricity.(4) But it now is the preferred fuel of choice for generating electricity, because it is so plentiful and inexpensive. Today the variable cost of electricity from gas put through a turbine is about one cent a kilowatt hour. If you are looking for bargains in the power market, the ultimate bottom of the market is this ten mils, or one cent a kilowatt hour. If somebody has a generator and access to a transmission grid, and he is merely trying to recover the costs of generation - that one penny gas and its transmission, which may be about three mils - if they can sell that power for fifteen mils, they can do so at a profit. We now have a market floor of thirteen to fifteen mils - an unbelievable change from what we were facing only a few years ago, when we thought that the floor was somewhere in the range of twenty-five to thirty mils.

BPA, which has a set of fixed costs that it largely cannot control, finds itself in competition with these gas generators. Now, BPA should be in the driver's seat because it has the cheapest power in the western world. It has all of those advantages that Al Alexanderson laid out.(5) It has free dam sites; it has the lowest cost of capital of any entity in the U.S. power market; it has free fuel. But it has some other costs. It is saddled with the debt from the three nuclear plants of the Washington Public Power Supply System (WPPSS), only one of which is operating, that being WPPSS 2. (Incidentally, that plant's operating costs, to say nothing about capital costs, are higher than the full costs of a new combustion turbine burning gas at market prices. That is, the operating costs of WPPSS alone are higher than combustion turbine power, even if you have to build the combustion turbine from scratch.)

BPA has to deal also with a mammoth bureaucracy. It has very little flexibility, unlike an investor-owned utility. Before I became Governor John Kitzhaber's salmon policy advisor, I consulted periodically for both Portland General Electric and PacifiCorp and watched them go through restructurings in which they were able to lay off employees based upon their needs. It did not matter, in most cases, what seniority somebody had. They were able to do things that allowed them to move employees. BPA does not have that flexibility, and I know that in state government we do not have that flexibility either. Thank goodness the state is not in the power business, because we would not be able to move fast enough to make the changes that would be required to meet this current market. However, the federal government is in the power business, in the form of BPA.

So BPA has a large bureaucracy. It has WPPSS costs. It has other costs it has to pay on the dams - irrigation costs, navigation costs, and flood control subsidies. It also now has some environmental costs that are rising, unlike other producers in the power business who have been able to take advantage of new technology and whose environmental costs over time have actually leveled off as a unit of production, or even begun to decrease. BPA's environmental costs are going up, largely due to salmon restoration efforts. I refer to these as environmental costs of production because they are similar to a coal plant having to deal with sulphur dioxide pollution or a gas plant having to deal with nitrogen oxide pollution. These are real costs of generating power, not frivolous costs of "social" programs, as some industry observers contend.

If PacifiCorp could not generate power at a coal plant cheap enough - including its environmental costs - to meet the market, it would shut the plant down, not operate it. BPA does not have the option to quit generating power at the dams. BPA has no stockholders who can absorb its fixed costs like an investor-owned utility. Therefore, BPA went to some lengths this year to avoid having to pay some of the fish costs of the hydropower system. BPA was frustrated in this effort, and we now have an agreement on a BPA fish budget that the State of Oregon, and Governor John Kitzhaber in particular, worked very hard on to get adequate, at least in the near-term, salmon restoration expenditures.(6)

The larger, long-term concern is that the market price BPA is charging may not be low enough to meet the market that is out there. I did not really quite comprehend how much the market had changed until entities like Enron, Lehman Brothers, and Louis Dreyfus got into this. Think about how many power plants Enron owns, or how many power plants Louis Dreyfus owns. They do not own any. They are in the business because they have certain advantages that they can offer as a buyer and seller of power. Enron owns lots of gas. Louis Dreyfus and Lehman Brothers are financial enterprises that have the ability to offer hedges, futures, and the kinds of financial instruments that people in other markets are very familiar with, and there is no reason why they will not operate in the power market as well. This is now going to be an extremely competitive, active power market. And BPA is going to be a participant in it, at least in the short-term, until we figure out what the federal government ought to be doing in this power. market.

Where are we going? When I started in this business twenty years ago, we always looked at a twenty-year time horizon, and the Northwest Power Act(7) calls for a twenty-year forecast of power demand and available resources.(8) Well, that is absurd today. No one is thinking twenty years out. If we are thinking five years out, that is a long-term period. Today the market is so fluid, nobody wants to sign up for a twenty-year deal. You may be so wrong about the future that you would be desperate to get out of a three-year deal. That is exactly what happened in the natural gas industry. It used to be natural gas deals were on a fairly long-term basis. Then we had deregulation - of both production costs and pipelines. The result is that suddenly everyone started buying to take advantage of the low cost in the spot market. Long-term deals started disappearing as a percentage of the market. And what is happening now in the natural gas industry is that lots of companies that have big obligations to deliver gas to their customers are operating exclusively by buying that gas in the spot market. Buyers are willing to take the chance that the spot market will always be there. They assume that the spot market will always deliver gas, just like when you shop at the supermarket, you expect there will always be peanut butter on the shelf. You do not buy fifteen years' worth of peanut butter when you go grocery shopping because you assume the spot market will always supply the product.

The fact that there will no longer be a twenty-year planning horizon alone means BPA must change, because BPA is an institution with very long obligations: WPPSS obligations are over twenty years, and U.S. Treasury obligations are over fifty years. BPA cannot operate easily where its customers can come and go on a thirty-day or six-month basis. BPA needs much more certainty about its revenues. We know BPA will be forced to change, and it will not have anywhere near the stability it had in the past. BPA's traditional customers have started to look for better deals elsewhere, and they will continue to do that. Direct service industries and publicly owned utilities have found better deals, or at least what they perceive as better deals elsewhere, and they have signed up. If that continues to happen, and BPA is faced with increasing competition from outside suppliers, questions arise. The first question is, How can BPA meet its financial and environmental obligations? How can it continue to repay the Treasury? How can it continue to repay the WPPSS bondholders? And how can it continue to pay the salmon costs due to the damage done by the hydroelectric system?

The second major question that arises is, What happens to the public values that we expect BPA to provide? The Northwest Power Act required BPA to fund conservation programs.(9) BPA also continues programs begun as long ago as the 1930s, like postage stamp rates, which means everybody pays the same electric rates no matter where they live. What will happen to that public value? What will happen as BPA's stability decreases its obligation as a representative of the federal government to meet the treaty obligations that the federal government has with the Umatilla Reservation Tribes, the Warm Springs Reservation Tribes, the Nez Perce Tribe, and the Yakama Tribe?

Finally, what should BPA be allowed to do with the power that its traditional customers no longer want? What is important to remember here is that BPA under current law is limited to charging rates based on its costs.(10) It is not allowed, like Portland General Electric or PacifiCorp are in some circumstances, to go into the marketplace and sell power and components of power based on the price it can command in the marketplace. It must charge only its costs. One solution advocated by Brett Wilcox, the President of Northwest Aluminum Company, is what we might call the "free BPA solution" - liberate BPA from this cost-based constraint, let it compete openly in the marketplace, and let it sell its power for what the market will bear.(11)

I do not think that the "free BPA" solution is a good one, because BPA represents fifty percent of the generation in the region and eighty-five percent of the transmission capacity. Freeing BPA is similar to what would have happened if airline deregulation occurred in the country, and the federal government - like many European governments - had fifty percent of the seats in the marketplace. The government corporation either would have gone into immediate bankruptcy, which the taxpayers would have had to bail out, or it would have become an extraordinarily unfair, ruthless competitor. Those are exactly the two alternatives that frighten everybody when thinking about the future of BPA, Unfortunately, those are the only two visions - becoming either a ruthless competitor or not being able to compete at all - that are now talked about for a future BPA. There are not many good ideas about how we can preserve the institution in a competitive environment other than those two relatively unattractive alternatives. Other possibilities that should be considered, however, are regional ownership of the federal assets, which I think raise Indian treaty right issues, and private ownership with federal regulation, which also raises treaty right issues that are difficult to resolve.

What is Governor Kitzhaber's role in this? He and the other Northwest governors are putting together a regional review of BPA, the entire federal power system, and how it relates to the rest of the power system in the region.(12) That review will be assisted by the Northwest Power Planning Council (NPPC), which will convene various forums to try to bring together the stakeholders to try to solve this problem. These forums will address what we do to bring the benefits of competition to the Northwest while still meeting treaty obligations, fish and wildlife needs, and environmental obligations. We want to move this federal power system into a competitive environment. And we are asking NPPC and the regional stakeholders to come together and come up with a consensus-based solution by the end of 1996, so that we can introduce new legislation for the federal power system by January 1997.

What is going to make people want to deal with the regional power problem? What is going to make them come to the table? I hope what will make them come to the table is the understanding that the status quo institutional arrangement will not work very much longer. Each entity that is at the table - whether it be an investor-owned utility, a publicly owned utility, a direct service industry, an environmental group, a tribal government, or a state government - will need to understand that there are risks in not negotiating out a regional solution to these very difficult problems. I look forward to being in that dialogue with many of you over the next year or so. Believe me, it will be an exciting time.

(1) 16 U.S.C. [subsections] 2601-2645 (1994). (2) 42 U.S.C. [subsections] 13201-13556 (1994). (3) Federal Energy Regulatory Commission, Proposed Rules, 60 Fed. Reg. 17,662 (Mar. 29, 1995). (4) Powerplant and Industrial Fuel Use Act (Fuel Use Act), Pub. L. No. 95-620, 92 Stat. 3289 (1978) (repealed 1987). (5) Al Alexanderson, Rethinking the Federal Role in a Competitive Electric Market, 26 Envtl. L. 657 (1996). (6) See Letter from Alice M. Rivlin, Director, Office of Management and Budget, to Senator Mark Hatfield (R-Or.), Chairman, Senate Committee on Appropriations (Oct. 24, 1995) (on file with author) (describing BPA funding plan). (7) Pacific Northwest Electric Power Planning and Conservation Act (Northwest Power Act), 16, U.S.C. [subsections] 837, 838i, 838k, 839-839h (1994). (8) Id. [sections] 839b(e)(3)(D). (9) Id. [sections] 839d. (10) Id. [sections] 839e. (11) See Letter from Brett Wilcox, President, Northwest Aluminum Co., to Randy Hardy, Administrator, Bonneville Power Administration (July 19, 1995) (on file with author) (describing theory of converting BPA into an independent transmission company). (12) See Bill MacKenzie, Northwest Energy Conference Opens, The Oregonian, Jan. 5, 1996, at C1.