Cal ISO focuses on Enron 2, not Cap & Trade manipulation

July 20, 2012

By Wayne Lusvardi

A rerun is playing on TV of the inaccurate 2005 “documentary” movie, “Enron: The Smartest Guys in the Room” about Enron manipulating the California Electricity Crisis of 2001. It features Sen. Barbara Boxer, D-Calif., and former Gov. Gray Davis, D-Calif.

Back in the real world: the California electricity grid operator has accused JP Morgan, Barclays, Deutsche Bank AG, and several other banks of more recently manipulating the California electricity market.

Concurrently, as Katy Grimes reported on CalWatcdhDog.com, the California Legislature passed a hidden trailer bill as part of the 2012 state budget package that shrouds public information on its green energy trades under its Cap and Trade Program trading hub in Delaware.

Apparently, if you’re in the private sector, you have to disclose not only your energy bid, you have to disclose its intent. But if you are in the public sector, you can get away with not disclosing green energy bids at all.  Such is the double standard in California, where the private sector is criminalized before its day in court and the public sector can get away with anything it wants without the mainstream media even reporting it.

Media Focus: “Make-Whole” Payments in the Day-Ahead Energy Market

The energy-trading arm of JP Morgan is said to have cost electricity ratepayers $73 million since 2010 in self-serving energy trades.  The Federal Energy Regulatory Commission is investigating the allegations made by the California Independent System Operator that coordinates 80 percent of the electric transmission grid in California.

At issue to Cal-ISO are trades made by JP Morgan Chase, Barclays, Deutsche Bank AG, and other banks in what is called the “day-ahead” wholesale electricity market.  After the 2001 California Energy Crisis, the California electricity market was reformed to require all retail energy providers to schedule their bids one day ahead of time to prevent market manipulation.  Cal-ISO was established to serve as a coordinator of the grid and also to bring transparency to energy trading. Cal-ISO is an impartial, non-governmental grid operator.

In order to encourage competitive bidding for the provision of retail electricity, Cal-ISO reimburses bidders twice the preparation cost of their bids.  This practice is called “full cost recovery” or “bid cost recovery.”  Where bid manipulation enters the rules of the bidding game is where a bidder bids so low that they qualify for the ISO’s roster of potential electricity suppliers. Once on the roster, the bidder qualifies for double reimbursement for preparing a bid.

The same bidder would then price its electricity so high in the real time “spot market” that the ISO wouldn’t buy it.  Thus, the bidder was assured of never having to actually sell power, but would get reimbursed for submitting a bid.  This bid splitting practice is what Cal-ISO has referred to FERC for review.  Cal-ISO alleges that banks using such bidding strategies never had any intent on selling power, just skimming bidding fees.  This may have cost electricity ratepayers hundreds of millions of dollars.

Shrouded Cap and Trades

Meanwhile, the Committee on Budget and Fiscal Review of the California State Senate attached a rider to its 2012-2013 State Budget Package, Senate Bill 1018, to allow the California Air Resources Board to end run around the California Open Meeting Act on its pollution-credit energy trades.

CARB’s private Delaware Corporation, Western Climate Initiative Inc. — set up to manage air pollution emissions trading under its Cap and Trade Program –- doesn’t have to comply with California’s transparency law for its Delaware trading activities.  This action was snuck into Senate Bill 1018 on July 26 and signed into law with the state budget on July 27.  The same rider on SB 1018 also allows Cap and Trade taxes to be siphoned into designated accounts for use by the State Legislature.

On July 27, Gov. Jerry Brown used his veto power to reduce the amount of funding for State Parks and Recreation, but left CARB’s exemption from the state Open Meeting Law unchanged.

The final vote on SB 1018 in the State Senate was 58 percent in favor.  The minority Republican Party was unable to gain any compromise, amendments, or vetoes to the State Budget Package or rider bills. This was because Proposition 25 eliminated the previous two-thirds vote requirement for taxes and the state budget.

Voters originally passed Prop 25. to permit the passage of a state budget on time, to not delay funding for public schools and the needy.  The state budget was barely passed on time on the June 15 deadline by the Legislature.  Prop. 25 is now being abused to approve items having no bearing on taxes or the state budget. This is one of several reforms sought by political reformers in California in the name of greater “democracy.”

Of course, the mainstream newspaper media, such as the Los Angeles Times and San Francisco Chronicle, have focused on reporting the alleged bank abuses of energy bids. But the same newspapers have “blacked out” any coverage of the Legislature’s granting to CARB an exemption from state meeting laws for its out-of-state pollution credit-trading arm.

Why should the public’s attention be focused only on manipulated energy bids and not also on hidden legislation that would shroud green energy trades?

Is this Enron 2?  We Don’t Know Yet

Times columnist Michael Hiltzik writes that what banks have recently been doing is the same as what Enron did:

“What’s worse, it shows that we haven’t learned anything from Enron’s bogus energy trading, the disclosure of which helped destroy that firm in 2001 and land several of its executives in jail. To the extent it was designed to exploit loopholes in energy trading rules, experts say, the scheme allegedly perpetrated by JPMorgan Ventures Energy Corp. is cut from the same cloth as Enron’s infamous ‘fat boy’ swindle, which cost the state’s ratepayers an estimated $1.4 billion in 2000.” 

From what Cara Ellison writes on The Enron Blog, Enron’s “Fat Boy” trading strategy would have been similar to what JP Morgan is presently accused of.  She quotes California Treasurer Bill Lockyer:

“According to Bill Lockyer and other anti-Enron types, Fat Boy was less a trading strategy than just a plain old lie: Enron traders would tell electricity officials that it was going to use more power than it actually intended to use. That way, Enron would reap extra payments by appearing to deliver more power on a high-demand day when, in fact, it was merely using less power than promised.”

However, I believe Ellison accurately states Enron’s Fat Boy trades were numerically “minuscule, rare, and inconsequential” and a case of prosecutors piling on charges. This in no way denies that Enron executives committed accounting fraud and other crimes for which they were prosecuted and convicted.  All it indicates is that Enron did not cause the California Energy Crisis of 2001 and its energy trading practices were overblown mainly for political gain to keep the focus away from government’s complicity in the Crisis.

Katarzyna Klimasinska of the San Francisco Chronicle says price-manipulation charges against JP Morgan are not the same as for Enron, which was accused of driving up prices by shutting down power plants during the California Energy Crisis of 2001:

“The price-manipulation allegations against JPMorgan’s energy-trading unit appear to differ from charges against Enron Corp.’s power traders during the California energy crisis of 2000 and 2001, John Olson, managing partner of Pool Capital Partners LLC in Houston and former energy analyst at Merrill Lynch & Co., said. Enron was accused of driving up prices by persuading operators to shut down, he said.”

As someone who was behind the curtain of government during the 2001 Energy Crisis, I personally investigated the accusation that Enron manipulated power prices by shutting down power plants.  There’s an infamous tape from Jan. 17, 2001 of Enron traders asking an operator to shut down a 52-megawatt power plant in Las Vegas. But that was grid congestion, not lack of power. Relieving grid congestion would have lowered, not raised, electricity prices.

My experience with the California Energy Crisis of 2001 indicated that it was public utilities such as the Los Angeles Department of Water and Power, the city of Pasadena, and the Southern California Power Authority that gamed the energy trading system the most and reaped huge monetary windfalls.  Moreover, it was private power providers such as the Mirant Corporation that kept electric “spinning reserves” available and were the unheralded heroes of the crisis.

Do Regulators Have a Duty to Keep the Regulated Legal? 

What the media typically know little about the electricity and energy markets.  And is not known typically is misreported and ensationalized.  The press usually asks the wrong questions and thus gets the wrong answers.  To pre-indict the banks named in this energy trading case is premature and irresponsible.  Here are some questions that might be more helpful at this stage of the investigation based on my experience on a 2001 Energy Crisis Task Force for a large water utility, my experience as a real estate appraiser and manager and some plain old common sense.

As pointed out by online newspaper commentators, imagine that California decided to sell off surplus equipment for a few dollars and you knew you could re-sell it for $100 on eBay.  Would it be wrong for you to do so?

Or if an elderly person advertised their old, but historical car with low mileage for sale but you knew you could re-sell it for big bucks, would you buy it?

Or if you are a real estate broker and someone keeps submitting tricky high bids full of weird conditions, should you take the high bid or just take the simple lower cash bid?  If a broker recommends to his client taking the tricky high bid and later gets the seller ensnarled in a lawsuit, can the seller sue them? Most brokers I have encountered prefer to just take the most straightforward bid, despite the price.

Is the problem inherent in such situations the abuse of the buyer or the problem of an unknowledgeble seller?  Should you be able to call in the cops, the district attorney or a small claims court judge to recover what you later learned you lost on your old car?

These questions seem to be how the average person in the street or a professional real estate broker would frame such a problem.  But that is not how Cal-ISO and the mainstream newspaper media frame it.  They frame it as likely criminal or pre-concluded unethical activity.

Indeed, taking advantage of energy trading rules may be found to be an abuse.  But if so, who is to blame?  Is Cal-ISO just covering up the public perception of its own ineptness or is it cracking down as it should as a regulator?  Is it the role of regulators to “acquire” violators, just as cops may be said to acquire criminals? Is the proverbial “thin blue line” of social order to be kept first by citizens or solely by the police?  Do regulators have a fiduciary duty to keep those they regulate out of legal trouble?  Or is using the media to bring attention to such trades a way to publicly shame those who straddle the line between what is legal and what is moral?

And in the case of Legislature, now with no limits on what it can get away with, who will help the public focus on abuses of the Open Meeting Law? Certainly not the mainstream media in California.