Legislative Analyst's Office

Analysis of the 2002-03 Budget Bill

Department of Water Resources, California Energy Resources Scheduling (3860)

The California Energy Resources Scheduling (CERS) division procures electricity on behalf of the state and is part of the Department of Water Resources (DWR). (Please refer to the "Resources" chapter of this Analysis for the remaining programs within DWR.)


CERS Formed to Buy Electricity. The CERS division was created by Chapter 4x, Statutes of 2001 (AB 1x, Keeley) as the entity to purchase electricity on the wholesale market and sell it to the customers of the state's major private investor-owned utilities (IOUs). This activity was taken over by the state in January 2001 in the wake of supply disruptions and rolling blackouts in Northern California, skyrocketing natural gas prices, and wholesale electricity prices that continued to stay high throughout the traditionally low-demand season of the year. The state's IOUs found themselves purchasing electricity at prices far above what they could legally charge customers, which in turn caused their creditworthiness to deteriorate and eventually made them unable to finance further electricity purchases.

Since CERS has been purchasing electricity on behalf of the IOUs, the division has entered into long-term contracts for electricity valued at over $40 billion that extend over the next 10-plus years. The CERS division is also presently responsible for purchasing the entire "net short" on the California spot market. (The net short refers to the amount of electricity needed to serve the demand in the IOUs' service area that exceeds the IOUs' supply of retained generation resources, qualifying facility contracts, and other bilateral contracts.) This activity is set to expire at the end of calendar year 2002; however, at present, there is no agency or entity in line to take over these responsibilities.

Funding Mechanism. The electricity purchases made by CERS and its administrative expenses are paid for from DWR's Electric Power Fund (EPF), which is the depository for payments received from ratepayers for using the electricity bought by the state. Because the state was purchasing electricity during most of 2001 at prices that were well above the regulated retail rate charged to electricity consumers, these payments to the EPF have been inadequate to cover the costs of purchasing electricity on behalf of the IOUs. As a result, the EPF has also received a $6.2 billion General Fund loan and the proceeds of a $4.1 billion interim loan sale, neither of which has been repaid. To accomplish this repayment, DWR is preparing to issue a revenue bond that could total as much as $13.4 billion before the end of the current fiscal year. The proceeds of this bond sale would go to pay back the General Fund and the interim-financing note, as well as continue to support the division's ongoing electricity purchase activities.

Another revenue source of the EPF includes the California Procurement Adjustment (CPA), created by AB 1x. This adjustment is defined as the difference between the generation component of the retail rates and the average cost of the utility-retained generation and contracts. However, there continues to be confusion and controversy regarding the CPA and, at this time, the utilities have not been remitting this payment to DWR.

Governor's Proposed Spending

The Governor proposes expenditures for CERS of $7.7 billion in the current year and $5.2 billion in the budget year. The budget year amount represents a decline of over 30 percent from current-year spending levels. The CERS expenditures are split into two categories: (1) administrative expenditures subject to budgetary appropriation by the Legislature, and (2) expenditures for electricity purchases and debt financing that are off-budget expenditures.

Administrative Expenditures. The Governor proposes $28.4 million for administration of the CERS division in 2002-03. This is $33 million less than the current year, or a 54 percent reduction. This reduction is mainly due to significant one-time expenditures incurred in the current year relating to information technology projects to manage the state's electricity portfolio, and various other one-time start-up costs to establish the division's electricity purchasing activities.

Off-Budget Expenditures. The Governor's budget also proposes expenditure of $7.6 billion in the current year and $5.1 billion in the budget year for the purchase of electricity and other expenditures related to DWR's electricity debt financing. Specifically, the budget estimates expenditures of:

Factors Affecting Off-Budget Expenditures. The amount proposed in the budget for expenditure on electricity purchases over the entire 2002-03 fiscal year is $3.1 billion less than what was spent the last six months of the 2000-01 fiscal year. This reflects the extremely high prices the state was facing when it first started purchasing electricity on the spot market on behalf of the IOUs. Since that time, the state has negotiated over $40 billion in long-term contracts and is less reliant on the spot market. The DWR estimates that it will have a larger proportion of the "net short" in long-term contracts over the next few years, with as much as 75 percent under contract by 2004. These long-term contracts average $84/megawatt hour (MWh) over the next five years and $74/MWh over the next ten years. In addition, spot market prices have declined from prices previously well over $400/MWh to around $40/MWh. The stability provided by a larger portion of the state's energy portfolio in long-term contracts and the lower spot market prices are projected to lower total expenditures on electricity purchases in the budget year. The budget-year reduction is also due in part to the assumption that the state will no longer be purchasing the net short by the end of calendar year 2002, for a half-year 2002-03 impact.

Possible Duplicative Federal Representation

We recommend that the Department of Water Resources (DWR) report at budget hearings regarding its plan to coordinate with the state's other energy agencies to avoid duplication in representing the state's energy interests at the Federal Energy Regulatory Commission (FERC). Thus, we withhold recommendation on $750,000 requested by DWR for legal representation at the FERC until a plan has been submitted and evaluated by the Legislature.

The budget proposes $750,000 for a contract to provide CERS with legal representation before FERC--the federal agency that oversees the state's wholesale electricity market. The California Public Utilities Commission (CPUC) and the Electricity Oversight Board (EOB) both already represent the state's interests on energy matters before FERC. Therefore, it is important to ensure that further representation would not duplicate activities already being provided by other agencies. (It should be noted that DWR has represented its interests before FERC prior to the establishment of CERS on a number of issues regarding the State Water Project. This recommendation does not apply to funding for this representation, but only for the legal representation provided on behalf of CERS' operations.)

In order to avoid duplication of efforts among agencies and to present a coordinated and cohesive message before FERC, we recommend the CERS division report at budget hearings regarding its plan to coordinate with the CPUC and the EOB regarding the specific areas for which it would seek representation and determine how to attain the services needed at least cost. Therefore, we withhold recommendation on the funding for this legal representation until a plan has been submitted and reviewed by the Legislature. As indicated in "Part V" of our Perspectives and Issues, this is but one of several examples of why improved coordination among, and organization of, the state's energy activities is needed.

State Needs to Move Away from Contracting

We recommend that the Department of Water Resources (DWR) report before budget hearings on its progress in establishing a new personnel classification series with the Department of Personnel Administration and its ability to fill its vacant positions. Thus, we withhold recommendation on $4 million requested by DWR for personal service agreements and consulting contracts to perform daily trading and settlement activities until more information is available.

The CERS division continues to heavily rely on contracts for work that otherwise could be done by state employees. The DWR has indicated to us that, because of the unique nature of some of the CERS positions--especially those in the settlements, energy scheduling, and energy trading areas--it needs the Department of Personnel Administration (DPA) to establish new position classifications so that it can hire people with the appropriate backgrounds. The department has indicated to us that, because of processing delays, it has had to retain many high-priced contract workers in lieu of hiring civil service employees. These include $2 million in additional contracts to handle settlements with the Independent System Operator and another $2 million to schedule and dispatch electricity from DWR's long-term contract portfolio, as well as purchase electricity on the spot market (this estimate assumes that the latter activity will expire at the end of calendar year 2002).

Given the relatively high cost of retaining these contract agreements, we recommend filling the vacant positions as soon as possible to minimize the costs of running CERS' power purchasing program. However, we understand that filling these positions quickly may be difficult, given that CERS has not yet successfully established the needed new personnel classification series with DPA. Therefore, we recommend that CERS report to the Legislature before budget hearings regarding its progress in establishing a new personnel classification series and filling these vacancies. Upon receiving this information, the Legislature should be able to assess any savings that can be achieved--whether it be from salary savings relating to projected unfilled vacancies or contract savings due to filled positions at DWR. Therefore, we withhold recommendation on $4 million requested by CERS for personal service agreements and consulting contracts.

Return to General Government Table of Contents, 2002-03 Budget Analysis