Both companies are prominent players in the state’s power market. The move to combine their strength is raising some concerns.

Los Angeles Times

Dynegy Inc. of Houston has been hailed as a hero on Wall Street, as it rides to deliver cross-town rival Enron Corp. from its self-inflicted ills and save energy markets from serious distress through its proposed $9-billion buyout of the world’s largest energy trader.

But in California, Dynegy has a different image.

Dynegy, co-owner of several Southern California power plants, has been the quietest member of the “Big Five” group of energy producers commonly portrayed as villains by California politicians and regulators. Gov. Gray Davis and others have called Dynegy and its fellow energy suppliers “gougers” and “pirates” who manipulated the market and charged too much for electricity, precipitating California’s blackout-studded energy crisis. Partly because of the heightened political sensitivities to all things surrounding California’s energy problems, the state is expected to play a central role in the proposed merger between Dynegy and Enron, antitrust experts and others say. The state’s Attorney General’s office already has begun scrutinizing the proposed combination.

If it merges with Enron, another favorite Davis target, Dynegy would be a powerhouse in energy trading, electricity generation and natural gas transmission. And the combined firm would have a strong presence in California, which some find troubling.

“I would hope that the people who look at the antitrust implications would consider this one carefully,” said state Sen. Steve Peace (D-El Cajon), one of the architects of California’s failed foray into electricity deregulation, who became a fierce critic of power producers and resellers. “If anything, Dynegy would be in an even stronger position to be able to manipulate markets than it was before.”

Dynegy agreed on Nov. 9 to buy Enron through a stock swap valued at about $9 billion and to inject $2.5 billion into crumbling Enron provided by cash-rich ChevronTexaco Corp., the San Francisco-based oil company that owns nearly 27% of Dynegy. But a continuing trickle of disturbing financial disclosures keep slamming Enron‘s stock price, indicating that investors have their doubts that the deal will be completed as negotiated.

The Enron purchase would hurl Dynegy, which is about a quarter of Enron‘s size, into the top ranks of energy merchants.

In California’s energy world, Dynegy already is a key company. At every significant twist in the state energy crisis, Dynegy was there, although not as visibly as some of the other power-plant owners and electricity resellers.

Enron and Reliant Energy Inc., also of Houston, and Duke Energy Corp. of Charlotte, N.C., drew particular fire from politicians and consumer advocates during the last 18 months as energy leaped higher. But Dynegy also was accused by the state’s grid operator of reaping excessive profit through its electricity bidding practices and, to a lesser extent, by holding back some electricity from its Southern California power plants.

In addition, Dynegy signed long-term electricity contracts with the state that have been singled out by critics for containing potentially lucrative clauses requiring that the state pay emissions costs and other costs.

The California Independent System Operator, which runs the long-distance power transmission grid serving much of the state, has asked federal regulators to ban Dynegy from selling power at market prices. Cal-ISO has made the same request concerning the other major power plant owners: Duke, Reliant, Atlanta-based Mirant Inc. and AES Corp. of Arlington, Va., which markets its power through an agreement with Williams Cos. of Tulsa, Okla.

“Dynegy has sort of slid by under the radar,” said Doug Heller of the Foundation for Taxpayer & Consumer Rights, a consumer activist group.”Not only did Dynegy do very well, but particularly its trading and marketing division did very well over the course of the last two years. It profited wildly.”

For its part, Dynegy rejects accusations of market manipulation, saying it has played a constructive role in the California marketplace, stepping forward to be one of the first companies to sign long-term contracts with the state when its need was greatest despite an electricity debt of $300 million owed the company by the state and its utilities.

“Dynegy has acted ethically and responsibly in California,” said Dynegy spokesman John Sousa. “The fundamental problem in California is that supply did not keep up with demand.”

“Dynamic Energy”

Accused of Overcharging

Dynegy was created in 1984 as a natural gas trading operation known as Natural Gas Clearinghouse to take advantage of the deregulation of natural gas prices. Under Chief Executive Chuck Watson, the company has expanded into natural gas processing and distribution and electricity generation, changing its name along the way to Dynegy, a word created by combining “dynamic” and “energy.”

In California, Dynegy owns power plants capable of generating 2,800 megawatts of electricity through a partnership with NRG Energy Inc. of Minneapolis. (A megawatt can supply about 750 average homes with electricity.)

The state’s big investor-owned utilities were required to sell some of their power plants by the landmark 1996 deregulation legislation. By the end of 1998, the Dynegy/NRG partnership had purchased three large power plants in Long Beach, El Segundo and San Diego and a collection of 17 small “peaker” plants from Southern California Edison Co. and San Diego Gas & Electric Co.

Under the arrangement between the partnership, NRG operates the power plants and Dynegy markets the electricity from them. It is Dynegy‘s bidding practices in selling that power into state markets that put it, along with other energy producers, on the wrong side of the state grid operator and federal energy regulators.

Among the allegations:

* In a report released in March, Cal-ISO accused energy producers and resellers, including Dynegy, of overcharging Californians by $6.7 billion between May 2000 and March 2001. Power suppliers have denied the allegations. The report also found that Dynegy reaped about $32 million in “monopoly rents” between May and November of last year, or profits beyond what a competitive market would bear. That was the fourth-highest total for any company noted in the report. Enron was ranked sixth, taking $27.9 million in such profits.

* Cal-ISO said Dynegy maximized profits primarily through a practice known as “economic withholding,” or bidding electricity at prices so high that they would be rejected, thereby pushing up the price charged for the remaining generation sold into the market. Dynegy also did some “physical withholding,” Cal-ISO said, meaning that the company withheld electricity supplies to drive up the price.

* Dynegy was accused last April in hearings before state legislators of hoarding space on a key natural gas pipeline into California in 1998 and 1999, causing natural gas prices to soar. Dynegy executives testified that the charge was untrue.

* When federal regulators ordered $125 million in potential refunds for the first four months of the year, Dynegy‘s portion was the largest among the power sellers named, representing slightly more than one third. Dynegy said its prices were justified by high natural gas prices, emissions costs and other factors.

Dynegy President Stephen Bergstrom said in April that the company was “unfairly and inaccurately accused of withholding power from the California market.”

“As we have repeatedly communicated to California policymakers and regulators and to industry officials, we remain ready and willing to generate and sell power to any and all buyers at fair and reasonable prices when they are able to provide appropriate assurances that they will fulfill their obligation to pay for those purchases.”

A recent report by the state Department of Water Resources backs up Dynegy‘s assertions that its prices have been in line with the rest of the market.

During the first three months of this year, after sky-high prices pushed Edison and PG&E so close to insolvency that the state had to step in and buy power for their customers, Dynegy sold power to the DWR at an average price of $239.63 per megawatt-hour for electricity. That was slightly below the average of $268.90 per megawatt-hour charged by all sellers.

Dynegy portrays itself as a minor player in the California market, representing about 4% of the state’s generation. But Cal-ISO, in asking federal regulators to revoke Dynegy‘s authority to sell power at market rates, said “Dynegy has profited systematically from the exercise of market power to the significant harm of California’s electric consumers and economy.” A decision is pending.

Officials reviewing the Dynegy–Enron merger will closely review the companies’ operations in California.

Although Enron owns no power plants in California, it is believed to have long-term contracts with some generators, although spokesman Eric Thode refused to detail them.

In addition, Enron has a hand in 25% of the energy trades around the nation, with a significant portion of that in California. Thode would not detail California operations, citing company policy.

Finally, Enron controls an undetermined amount of natural gas, which is used to generate about one-third of the state’s electricity, through its transwestern pipeline, which crosses into California, and through natural gas marketing and trading arrangements.

It is those largely unregulated energy trading operations that have many energy watchdogs worried. They say that middlemen such as Enron and Dynegy can drive up the price of power by reselling it at higher prices each time.

A lawsuit filed in May against the Big Five generators by Lt. Gov. Cruz Bustamante, acting as a private citizen, described it this way: “The Dynegy trading floor, working with the trading floors operated by Williams, Mirant, Reliant and Duke Energy is one of the principal tools the defendants used to inflate the price of electricity within their respective markets, as well as throughout the state of California.”

“These defendants engaged in trading of electricity futures, forwards, options and other risk products that had the effect of manipulating and inflating the price of electricity within their respective markets,” the suit charged.

“These defendants engaged in ‘megawatt laundering,’ in which they made trades with the primary purpose of inflating the costs of electricity within their respective markets.”

State Is Examining Proposed Merger

California Atty. Gen. Bill Lockyer has begun examining what effects such a merger would have on California, spokeswoman Sandra Michioku said. The Federal Trade Commission and the Federal Energy Regulatory Commission also will scrutinize the merger in a process that Dynegy and Enron expect will take no more than nine months.

Senate Energy Committee Chairwoman Debra Bowen (D-Marina del Rey) said she plans to urge FERC to look beyond traditional measurements of how much the companies own in the market to examine “inputs” into the market such as gas pipeline capacity controlled by the companies and gas trading by Dynegy and Enron.

“It really raises many questions about how the market works,” Bowen said.

Opposition by California could be a severe hindrance to the merger, said Garret Rasmussen, a lawyer with Patton Boggs in Washington, D.C., and formerly a Federal Trade Commission antitrust investigator.

The state, if it chooses, could play as pivotal a role as it has in negotiations over the antitrust settlement between the federal government and Microsoft Corp., he said.

“While this administration has been quite tolerant of mergers … an action by the California attorney general could have a significant chance of success,” Rasmussen said.

Merger Might Reopen Contract Negotiation

The proposed merger might give California leverage to renegotiate its power contract with Dynegy, which contains the unusual provision that the state would pay for any emission costs that the company incurred, said V. John White, director of the Center for Energy Efficiency & Renewable Technologies in Sacramento. Dynegy‘s large San Diego plant lacks crucial pollution control equipment, he said.

“The California attorney general needs to carefully examine Dynegy‘s environmental stewardship activities and renegotiate that provision in the long-term contract,” White said. “Dynegy has a Texas, the-least-we-can-do attitude as far as the environment is concerned.”

David Freemen, the former Los Angeles Department of Water & Power general manager who helped negotiate Dynegy‘s and other long-term contracts, said that while opportunities to renegotiate may present themselves, the agreements, now maligned as too expensive, were key to stabilizing the electricity market. Freeman praised Dynegy for its part in that process.

“There’s a difference between companies that bargained hard with us and reached agreement–like Dynegy, Calpine and Williams–and those that were reaching for the moon and we didn’t reach agreement,” Freeman said. “Dynegy knew that they wanted to do business in California, and do it in a businesslike manner.”