Dear Gov. Schwarzenegger:

As academics and former government officials with a broad understanding
of energy and regulatory issues, we followed with interest your discussion
of
these concerns during your campaign. We would
like to take this opportunity to share some thoughts to help your new administration
address California’s energy future. We therefore offer this open letter
for your consideration.

By way of background, we were among a larger group of industry experts who
authored two manifestos on the California electricity crisis. The first, written
at the height of the crisis in January 2001, spelled out timely, workable remedies
that were largely ignored by those in authority, to California’s detriment.
The second, drafted two years later, suggested reforms to move ahead from the
aftermath
of the crisis in a positive manner. We draw from each of these, and from intervening
developments, in framing our advice to you. We also note that our suggestions
are consistent with many of the specific recommendations that were offered
in your energy policy agenda during the campaign.

Here are the energy policy priorities we recommend:

Complete the Recovery

From a short-term supply adequacy perspective, the crisis has been over for
some time. As a longer-term institutional and financial matter, this is not
the case, and significant challenges persist.

As of this writing, the state Public Utilities Commission (PUC) has approved
a settlement in the PG&E bankruptcy that would repay creditors and re-establish
a viable utility under California jurisdiction. Southern California Edison,
operating under an approved recovery settlement, is laboring to become fully
credit-worthy as its finances gradually improve. The high-cost, long-term
electricity contracts (signed by the state against our advice at
the height of the crisis) have been alleviated slightly by renegotiation
and slightly more by mandated refunds. However, the contracts are still expensive,
and California advocates continue to press federal authorities for further
relief. In short, the financial fallout has persisted long past the turmoil
that created it.

This fallout has had its own consequences, particularly in impeding
the ability of major utilities and independent power generators to invest
in California. Litigation and financial uncertainty discourages investment
in
our state.
A stable climate is a necessary base for the new policies and initiatives
that can take us forward from here.

Therefore, completing the recovery from the crisis should be the first,
necessary energy policy objective for your administration. This includes
the successful
implementation of the two major utility recovery plans, along with a recognition
that the outstanding claims and litigation against power producers should
be settled soon, once and for all (realistic terms are inconsistent with
the large
sums some advocates have advanced). The benefits of just about any other
policy initiative can occur only when California’s energy markets are
again made attractive to investors.

Rationalize State Agencies

A related priority that stems in part from restructuring and the crisis
(but also has earlier roots) is the need to rationalize the state’s energy
bureaucracy, which has become fragmented, complex, and duplicative. Beyond
questions of cost and effectiveness, the current structure contributes to a
harmful ambiguity of policy that augments the risk associated with investing
in California’s energy infrastructure. At present, California has the
PUC, the California Energy Commission, the Oversight Board, the Independent
System Operator, the California Power Authority, and all the related agencies
and boards that can affect all energy infrastructure decision-making (such
as Cal EPA).

It is not clear, for example, which agency or agencies have the authority
over the approval of new electricity transmission lines. In theory, the ISO
determines
when new lines are needed, after which the PUC determines proper routes for
them, before the Federal Energy Regulatory Commission sets rates for their
use. But both the PUC and the ISO believe they are in charge of what new
lines are needed and have demonstrated their ability to disagree on specific
projects.
Analogous turf wars and policy conflicts have played out between California
energy agencies for decades, even before recent additions led to the roster
of departments we have now.

It is probably time for some agencies to be eliminated or consolidated. The
governor’s office itself can play a pivotal role in coordinating energy
projects if it so chooses, and such a role could be an important facilitator
in getting things done within the state bureaucracy.

Appointments Are Critical

The quality of regulatory oversight, and those who conduct it, can make or
break successful energy policy. Good regulatory policy starts with good appointees
who understand the importance of balanced regulatory outcomes that send the
right signals, and who are willing to challenge a highly regulatory status
quo, with continuing support from the governor and his staff. California
has more than enough rules, mandates, and threats. What’s needed is some
aggressive trimming of the regulatory underbrush to eliminate costly and
problematic requirements that are no longer needed or wanted.

Appointments to positions such as PUC commissioner are critical and require
a maturity of judgment and perspective that is not always easy to find in
prospective appointees. These selections merit the full attention and care
of the governor
and his senior staff.

Stand With Markets

For the production of energy, the market needs to win the great debate against
central planning. Contrary to some popular accounts, the problems of the
crisis did not stem from reliance on markets but from
a half-hearted and poorly executed market process.

The production of electricity is not a monopoly function. There is no good
reason why a particular firm (or the state, in its place) needs to own all
power plants. Costs will be lower and service more effective and innovative
if multiple producers compete to produce the electricity California needs.
The existence of wholesale electricity markets is also an irreversible fact
that is backed by many years of federal regulatory policy. Wholesale electricity
markets are here to stay regardless of California’s preferences.

Any sensible policy approach to electricity procurement is compatible with
competition for the production of electricity. Efforts to turn back the clock
to deny a role for market alternatives will only prove costly and counterproductive
to the people of California.

Seek Realistic Pricing

Most customers still pay for their electricity on a simple, cents-per-kilowatt-hour
basis through prices that are uniform during all times of day or all seasons
of the year. However, the cost and value of electricity varies widely over
the time of day and season. Electricity on a hot summer afternoon is a completely
different commodity than electricity
at midnight in winter. Yet both are priced the same. It is as if all restaurants
were required to charge a uniform price per pound for all food they serve,
no matter what its quality or cost.

There is an urgent need to move toward pricing electricity more closely with
its unique economic characteristics. Encouraging realistic pricing through
use of time-of-use meters and options for term pricing for utility service
are logical steps. Beyond using our resources more efficiently and effectively,
such pricing will also give consumers new opportunities (e.g., to control
their bills by using power at less costly times or to save money through
a longer-term
buying commitment). While it will take some time and investment to create
these opportunities, California should take advantage of new metering technologies
to let customers distinguish gourmet electricity usage from its fast-food
equivalent.

Further, the lack of realistic pricing can create unacceptable market
risks for utilities and suppliers in a direct-access environment, as
we saw all too regrettably in the electricity crisis. Therefore, realistic
electricity pricing will also permit California to consider potentially beneficial
market options, such as a core/noncore division of electricity consumers
to again open up direct access to competitive wholesale supplies for large
customers.

Alternatives Are Good, But …

Alternative energy sources have lately received new press coverage, spurred
in part by your campaign statements favoring such technology. California
has also embarked on an alternative fuels commitment for utility generation
that
will ultimately require a fifth of the state’s electricity to be so
generated.

Here, we need to sound a cautionary note. Alternative technologies have an
inherent appeal, and can appear to promise much. Some
new technologies succeed terrifically. But others never deliver on their
promise, especially to become affordable and economically viable as
a large-scale source of energy. The problem is public policy favoring alternatives
inevitably puts customers and/or taxpayers at risk when
the results fall short of the promise. If the technology fails (or even falls
short of the state of the art), then rates go up and taxes are higher.

Therefore, while we share everyone’s enthusiasm for innovative technologies,
we observe that the demand for such breakthroughs calls forth its own supply
of promoters seeking subsidy or governmental favor, just as it always has.
To protect the interests of the public will often require you, or your appointees,
to say no.

Don’t Forget Natural Gas

Natural gas remains a critical and attractive fuel, and one upon which
California has become highly dependent. The price and availability of
natural gas were
critical concerns at key points during the crisis. The environmental advantages
of natural gas over most other fuels remain important today, even as other
energy sources are sought through alternative technologies.

Although the price spikes of the crisis have passed, concerns about supply
constraints and cost volatility are genuine. Market prices have not returned
to the relatively benign levels that prevailed for years before the crisis.
California will always have to import most of the gas needed to sustain
current consumption levels. It is time again to pay attention to this
infrastructure, and we encourage your administration to lead in promoting
new resource
development,
including facilities needed for California to take advantage of liquefied
natural gas.

In Closing

Gov. Schwarzenegger, you have an opportunity to move California past
the aftermath of the crisis and on to a new and productive course
of energy
policy. We wish
you well in that critical effort. We are delighted to have had this
opportunity to share our thoughts and recommendations with you on these
critically
important issues. We encourage you or your staff to contact us for
further specifics
of these proposals or any other assistance we might be able to offer
to your new administration.