Inside The Deal That Shaped San Diego County’s Power Picture
Wednesday, June 22, 2016
San Diego's two biggest sources of electricity were approved in a deal brokered by Michael Peevey, the embattled former president of the California Public Utilities Commission.
Inside The Deal That Shaped San Diego County’s Power Picture
Chris Young, reporter, inewsource
San Diegans probably remember little about how they got the two massive stations in Escondido and Otay Mesa that are now their biggest sources of electricity. But more than a dozen energy experts interviewed by inewsource remember it well.
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The year was 2003. California had recently gone dark repeatedly as traders colluded to ratchet up power prices and some operators shut down and held back their power. Silicon Valley manufacturers lost $100 million in a single day because of the outages.
Now, with concerns about electric adequacy front and center, San Diego was going to add its first significant new power in years. San Diego Gas & Electric asked companies that build power stations to submit offers for enough to light some 300,000 homes.
That would have cost about $200 million, according to averages from the power plant rush at the time. Instead, San Diego bought four times that much power at a cost of $1.4 billion.
Some say all that electricity turned out to be needed nearly a decade later, when overnight 2,200 megawatts that pulsed from the beach near the Orange County line into high-voltage lines over Interstate 5 was lost as the San Onofre Nuclear Generating Station went down in 2012.
But many believe the deal for the Palomar and Otay Mesa power plants was dirty, and some believe it set the stage for years of similarly sullied agreements that helped determine what San Diego County residents pay — or overpay — for power to this day. Some say it also established a pattern for over-reliance on natural gas — something energy decision-makers are discussing today in the wake of a natural gas storage disaster in Los Angeles County.
The deal shows that the California Public Utilities Commission, responsible for regulating corporate utilities, dictated winners and losers, toying with decisions that should be based on who can provide reliable electricity at least cost. And it reveals that Michael Peevey, who was then the commission’s president, was out of bounds long before the actions that triggered the current criminal investigation of him by the California Attorney General’s Office.
The deal set a “horrific precedent” for future power plant decisions, said Loretta Lynch, a former utility commissioner. In the wake of the energy crisis, “This was one of the first cases where the PUC failed, and they failed because President Peevey from the start was engaged in backroom, secret deals that produced premium prices, premium profits for the utilities.”
San Diego powers up after blackouts
In 2003, California was still recovering from the energy crisis.
Lawmakers were persuaded in the 1990s that electricity should be purchased on markets rather than generated in power company-owned plants. That, in a word, was deregulation. Utilities sold off their plants. They began buying all their power. But trading firms such as Enron, along with generators and utility companies manipulated the market for profit.
The result: dramatic rate hikes — San Diego’s rates tripled — and flickering brownouts and blackouts across the state in 2000 and 2001.
In the aftermath of that, “regulators were focused on stemming the hemorrhaging,” said Scott Anders, director of the Energy Policy Initiatives Center at the University of San Diego School of Law. Their most pressing concern, he said: “‘How do we keep the lights on?’”
Many regulators and energy officials thought the answer was more power plants. And in May 2003, the San Diego utility, now allowed to build again, made its first move to stock up on power post-crisis.
The utility invited bids for 291 megawatts of electricity to meet the region’s needs from 2005 to 2007.
Twenty-two proposals flowed in, 13 of which seemed to qualify. Some were for smaller power projects, including renewables, while others were for power generated in large, modern natural gas-fired plants.
One of the companies was seemingly prohibited from making its offer because it is a sister company of San Diego Gas & Electric. Both are owned by Sempra Energy. Such transactions are usually banned. But the utilities commission allowed Sempra Energy Resources to offer to sell its 555 megawatt Palomar plant in Escondido.
Another large bid came from Calpine Corp. to sell power from a 570 megawatt power plant it was already building in Otay Mesa.
As the round of bidding closed, the San Diego utility asked the commission for permission to ink deals with six bidders — including Sempra Energy Resources and Calpine. Altogether, the contracts would generate enough electricity to power 1.2 million homes — four times as much power as the company originally said it needed.
“We were stunned,” said Matt Freedman, staff attorney for The Utility Reform Network, a San Francisco-based consumer advocacy group, recalling his reaction to the utility’s request.
Freedman suspected something amiss in the bidding and thought it might be revealed in the notebook of James Boothe.
Boothe was an economist at a private law firm, and in August 2003, the San Diego utility hired him as a watchdog to make sure its sister company, Sempra Energy Resources, didn’t get special treatment. He found it did not.
“SDG&E conducted the negotiations in an impartial, arms-length manner,” he wrote in a report to the commission. He “detected no trace of favoritism or bias” in the company’s negotiations with its affiliate.
But Freedman’s organization and another consumer group, the San Diego-based Utility Consumers’ Action Network, wanted to know more. They requested handwritten notes taken during the negotiations from San Diego Gas & Electric. Then they matched those notes with private meetings between Peevey and Calpine officials.
A troubling narrative soon emerged. In the meetings, San Diego Gas & Electric was rejecting Calpine’s offer of Otay Mesa power, saying it was overpriced. Yet the notes showed California’s regulatory agency “repeatedly pushed” the utility to include Otay Mesa as part of the package.
“That’s when we decided we had to oppose these deals,” Freedman said.
Boothe, the hired watchdog, said in his long utility career what he witnessed in this case stands out.
He remembered a negotiating session at San Diego Gas & Electric headquarters. Calpine was there. So was an emissary representing Peevey.
He was “very blatant in saying to San Diego that he was there to make sure that a deal got done with Otay Mesa,” recalled Boothe, who now works at the commission, in the water division. “I was a little shocked. I just didn’t see that as the role of the commission to be weighing in on picking a particular project.”
Boothe grappled with whether he should notify the commission that Peevey was dictating the outcome of a power plant deal. But after consulting with colleagues at his law firm, he concluded he should focus on the impartiality of the San Diego utility, not the behavior of a government official.
Another key individual was witness to Peevey’s intervention. Sempra Energy Resources attorney Kelly Foley, in written testimony submitted to the state Senate last year, remembered a conference call in the summer of 2003. Representatives from Sempra Energy Resources, Calpine, San Diego Gas & Electric and the utilities commission were on the line.
Peevey ran the call. He opened with an ultimatum: “If SDG&E wanted to buy Palomar from its affiliate, SDG&E would also need to make a deal with Calpine for Otay Mesa,” Foley said. Otherwise, the utilities commission “would not approve the proposal to acquire Palomar.”
As other companies were rejected from consideration, many also sensed something was improper, even if they were unaware of the extent of Peevey’s involvement.
A costly, unnecessary power plant
A chorus of filings from companies, including Coral Power LLC; Dynegy Marketing and Trade and InterGen Services Inc., sounded alarms about the proposed deal for Palomar and Otay Mesa in late 2003 and early 2004. They stressed to commissioners that the Otay Mesa project was poorly located and had no connection to the grid. It would require more than $150 million of new transmission lines to bring the power up from South County.
Several companies raised one point: San Diego Gas & Electric had tossed out bids on the grounds that they wouldn’t be up and running soon enough — by 2007 — yet Otay Mesa wasn’t expected to be ready until the following year.
One of the bids eliminated was a 727 megawatt gas-fired plant at the Miramar Marine Corps Air Station. The bidder, Enpex Corp. of Del Mar, offered a lower-cost alternative to the Palomar and Otay Mesa projects.
“The prices being proposed for the two large combined cycle power plants by SDG&E are significantly in excess of today’s fair market price,” Enpex president Richard Hertzberg wrote the commission in October 2003, creating “unnecessary costs to San Diego ratepayers.”
The Office of Ratepayer Advocates, within the utilities commission, is a sizeable section of about 150 analysts and engineers devoted, as its name suggests, to the defense of ratepayer interests. It concluded that the Otay Mesa deal was unnecessary. It said so bluntly to CPUC Commissioner Geoffrey Brown during one meeting, filings show. Otay Mesa “is not needed, not urgent and will not serve any of the needs SDG&E claimed in this proceeding," officials from the ratepayer office told Brown, according to a summary of one meeting.
The Utility Reform Network and the Utility Consumers’ Action Network also detailed their concerns in a nearly 100-page filing. They cited exorbitant costs for Otay Mesa’s electricity, Peevey’s involvement in negotiations and a bidding process that was not competitive.
“The rush to approve this motion without serious consideration of ratepayer interests could set a very poor precedent” for future power deals, the consumer groups wrote.
Most of the documents cited in this story, which are not available online, were retrieved by inewsource in paper copy from the Public Utilities Commission records room in San Francisco.
To respond to what was looking like a done deal, The Utility Reform Network and the Utility Consumers’ Action Network filed a motion seeking to have President Peevey recused, citing his improper role. Peevey himself denied the motion.
The groups "have failed to show that I have a closed mind with regard to the outcome” of the Otay Mesa agreement, he said.
In June 2004, the commission approved the deal in a 3-2 vote. Peevey voted with the majority.
Peevey did not respond to multiple requests from inewsource for comment on this story.
A "bulldog" of a president
Peevey came to the utility commission from a career in the private sector. A former president of Southern California Edison, he was appointed to the five-member panel in 2002 and months later elevated to president by Gov. Gray Davis.
His former colleagues remember him as an aggressive leader with a penchant for deal-making and a distaste for public process.
“He was a bulldog of an individual,” said fellow Commissioner Brown. “Once he made up his mind, that was the way it was gonna be.”
Most of the people interviewed for this story — even Peevey’s vocal critics — don’t suggest he profited from the Otay Mesa deal. Instead, they say he was driven by a responsibility to restore financially strapped power companies to health and aggressively power up California — the latter a mandate handed down from Davis and Gov. Arnold Schwarzenegger after the energy crisis.
“He was hoping they’d build a bust of him and put it in the courtyard of the PUC because he was the guy who got things done,” said Freedman with The Utility Reform Network. “While Rome burned, he wasn’t fiddling. He was actually trying to put out the fire.”
Boothe, the economist hired by SDG&E to monitor negotiations, suggested Peevey may have acted to help Calpine, which had gambled big during deregulation and already sunk millions into the Otay Mesa project. Calpine was in need of help — a customer willing to buy its power so it could borrow and complete the power plant. It won this but filed for Chapter 11 bankruptcy anyway in late 2005.
Calpine did not respond to requests from inewsource for comment.
An insurance policy
Despite the furor, Commissioners Peevey, Brown and Susan Kennedy approved Otay Mesa as an insurance policy for the San Diego region.
“Our approval of the Otay Mesa [agreement] will allow a clean, new and efficient generator to be built within SDG&E service territory,” the decision said. Both of the new plants were combined cycle, the most efficient type of gas-fired power plant.
Two plants are better than one, they reasoned, calling all those in opposition “minimalist.”
Palomar and Otay Mesa did have supporters. The Coalition of California Utility Employees and California Unions for Reliable Energy said adding the two plants would help the San Diego region replace power generation from older, dirtier plants and result in a “substantial reduction” in air pollution.
San Diego Gas & Electric called both plants cost effective and environmentally sound.
Larry Chaset, the attorney who attended negotiations in San Diego on behalf of the commission president , disputed that Peevey overstepped his authority. “Peevey's involvement was simply — and was nothing more than — an effort to get the two sides to talk with each other so that they could reach a deal between themselves,” Chaset wrote in an email to inewsource. He declined to be interviewed.
Commissioner Brown did acknowledge concerns about Peevey’s “‘behind-the-scenes’ meddling.” But, he wrote, “I believe the public and the business community in the San Diego area are willing to pay a little extra for insurance [so] that the past will not be repeated.”
But the plan was to close down older, dirtier plants in the region regardless of which company won this bid. And any large investment in electricity can be viewed as insurance, said Jan Reid, an energy consultant who formerly worked in the state ratepayer advocate office. “That’s what they say. ‘It’s an insurance policy,’ but what’s it going to cost us?”
Hard numbers for the actual cost of this deal are not something you can simply Google. Filings with the Public Utilities Commission often have “public” versions in which the figures — the cost to the public — are blacked out. inewsource asked the commission how much ratepayers will pay in total for the Otay Mesa contract. The request was routed to the legal department. The answer: between $670 million and $720 million. The Utility Reform Network estimates $739 million over the 10-year contract.
Add to that $209 million for new transmission lines to bring that electricity into the San Diego network plus $494 million for the Palomar Escondido plant, according to the commission, for a total of $1.4 billion.
Some commissioners and renewable energy experts believed that committing the San Diego region to gas, or fossil-fueled power in excess of what the company had said was needed, would have a chilling effect on renewable energy in the coming years. It may have slowed renewables.
But the newest figures show San Diego Gas & Electric now gets 35 percent of its power from clean sources, putting it well ahead of state requirements. It has had large year-over-year increases in the share of its power that is clean each year going back to 2009.
Bill Powers, a mechanical engineer and power plant expert who appears as a witness before the commission, said the real effect of this deal and subsequent ones is not that it edged out renewable energy. It’s what that energy costs. California law mandates renewables. But the commission still keeps approving gas-fired plants as well.
“Our rates are among the highest in the country and people like to say, ‘Oh, it’s because California has all these different special requirements.’ But not true,” Powers said. “It’s just that we have a compliant PUC that basically finds a way to approve all of these projects that are unnecessary projects and is conducting us along a renewable energy path that the utilities have blessed.”
Blessed because building more plants and putting up more transmission lines is the way utilities make money. They don’t earn it by how much electricity they sell. They earn a guaranteed return on their invested capital — 10.3 percent, according to the commission. (The utility requested 11.65 percent on Palomar, but the commission rejected that.)
“SDG&E supported approval of the Otay Mesa PPA because the price was fair,” Stephanie Donovan, a spokeswoman for the utility , said in an email. “History has proven that both the Otay Mesa and Palomar Energy Centers have helped SDG&E meet our customers’ energy needs and maintain a reliable electrical system over the past decade.”
Setting a precedent
The biggest cost may have been to the democratic process.
Some argue that the deal for Palomar and Otay Mesa set the stage for the corruption scandals that have rocked the California Public Utilities Commission and are prompting calls for reform or even a breakup of this powerful agency.
Peevey’s critics say his early success in brokering this deal in the face of widespread criticism emboldened him.
“This is an important case,” Freedman said, “because it helps you to understand that this was the way he operated throughout his tenure.”
It took more than a decade for Peevey’s deal-making to finally catch up with him and the agency he led.
State and federal prosecutors have launched investigations into the commission’s handling of the 2010 San Bruno pipeline explosion and the 2012 closure of the San Onofre nuclear power plant. Both of those probes center on the agency’s cozy relationships with utility executives and how they may have cost California ratepayers billions of dollars.
In the case of San Onofre, a raid on Peevey’s home turned up notes showing he and an executive from Southern California Edison sketched out the terms of a $4.7 billion settlement during a private meeting in 2013 in Warsaw, Poland.
State lawmakers are demanding changes. They passed six bills to reform the commission last year, but Gov. Jerry Brown vetoed all of them. Three of those bills were authored by Anthony Rendon, D-Lakewood, who is now the Assembly speaker, meaning agency reform is a priority for one of the state’s most powerful politicians.
Another sponsored by Democratic state Sens. Mark Leno of San Francisco and Ben Hueso of San Diego would have restricted private communications between utility officials and state regulators and made it easier to recuse biased commissioners — two issues that tainted the process leading to the approval of Palomar and Otay Mesa. That bill is again making its way through the Legislature.
Two weeks after the veto of the six reform bills last fall, the Aliso Canyon gas well disaster began in Los Angeles County, adding new voices to those calling for reform, including a re-examination of reliance on natural gas.
This month, the state Senate passed a bill that pushes the commission to require more battery storage, which allows more reliance on sun and wind, to “better diversify the state’s energy supply.”
Also this month, the Assembly overwhelmingly passed a proposal that would bypass the governor, change the California Constitution and potentially lead to the disassembling of the commission’s broad responsibilities over utilities, communications, rail and even ride-hailing companies.
Looking back, former Commissioner Carl Wood wonders why the calls for change didn’t come sooner. He recently reviewed the opinion he co-wrote with Lynch challenging the 12-year-old deal for the Palomar and Otay Mesa plants.
“It looked like it could have been written yesterday, in terms of describing the corruption of the process,” Wood said. “It’s remarkable that this didn’t become a scandal at that time.”
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