San Diego Business Journal

State Threatens $7B Sempra Contract

Staff Writer

State officials are threatening to cancel Sempra Energy's long-term $7 billion contract, alleging the San Diego firm pulled a "bait-and-switch" tactic with the promise of new electric generation at its Elk Hills plant.

Sempra officials said the state is playing political games in an effort to abrogate the contract.

Since November, the California Department of Water Resources, which buys power for the state, has been interested in renegotiating $43 billion in long-term contracts. In all, 56 contracts were signed with 29 providers during the height of the energy crisis. Negotiations with many power producers have been ongoing for months.

No new deals had been cut by press time. However, DWR recently canceled Soledad Energy's $36 million contract, the only termination so far.

Sempra remains the only other provider to date whose contract has been threatened with cancellation, said DWR spokesman Oscar Hidalgo.

Sempra's new Elk Hills plant near Bakersfield sits at the crux of that threat.

DWR believes its contract with Sempra includes partial operation of Elk Hills this year, Hidalgo said. Without new generation from the plant this year, he said, Sempra violates its contract.

Sempra spokesman Tom Murnane said the contract is not tied to the Elk Hills facility; Sempra can deliver electricity from its plants or the open market.

The company delayed firing up Unit 1 of Elk Hills, which was slated to start up March 2003, because of changing market conditions and to enhance the plant's efficiency, Murnane said.

Elk Hills is a combined-cycle plant. It includes two gas-fired units and a heat-recovery system that captures waste heat and uses it to generate electricity. When the entire plant is operational, it will generate 45 percent more electricity with the same amount of natural gas as compared to existing single-cycle plants, Murnane said.

"So we're not going to bring the first unit on line when we could," he said. "We're going to wait until all the equipment is in place and benefit from the waste heat to make more electricity from the same amount of natural gas."

Sempra stands ready to renegotiate its long-term contract with DWR, Murnane said. "But any changes must benefit both parties."

Market Power

Hidalgo said the company plans to buy power on today's market for $30 to $40 a megawatt and sell it to the state at the contract price of $160. That puts Sempra in competition with DWR for market power, which may tighten supplies and raise prices, he said.

"That's not what was agreed on," Hidalgo said. "Obviously, our goal is to make sure we have new power for 2002. We don't want market power. We can get market power."

Mike Heim, an A. G. Edwards analyst in St. Louis, Mo., who follows Sempra and other utility stocks, said Wall Street has taken notice of the Sempra-DWR situation. Heim said Sempra stock came under pressure after news broke that DWR threatened to cancel.

After reading Sempra's contract with DWR, Heim sided with the company. "The wording is explicit in saying (Sempra) can provide power any way they want," he said.

Sempra sold power to the state at below-market prices last summer, Heim said. "Sempra isn't going to walk away from a contract that has been negative by design for Sempra up to this point without recognizing the upcoming positive aspects of the contract."

Along with the threat to cancel Sempra's contract, DWR recently ended a $36 million contract with Soledad Energy.

Early on in Soledad's contract, low-pressure blades in the plant's German-made turbine failed and reduced the central California biomass plant's production to eight megawatts. Its contract called for 13 megawatts. DWR said the company defaulted and sent a termination letter in March.

Soledad spent $5 million to restart the plant, which sat dormant for six years. General Manager Sheldon Schultz said he tried to work with DWR officials to keep the deal afloat, even offering to donate the facility to the state as a tax-deductible gift and operate it for a year at cost.

The DWR turned a deaf ear, he said. Schultz recently laid off 15 of the plant's 21 employees.

"I think the state is being particularly brutal with our situation," he said.

Assemblyman Keith Richman fears several factors may add to market instability and make electric companies more skittish about investing in new California power plants.

Although not at the top of the list, he cited state officials using "heavy-handed tactics" to retool or end long-term contracts it signed during the energy crisis.

State Needs To Be Fair

Richman, R-Northridge, sits on the Assembly's Committee on Energy Costs and Availability and was among those who sued Gov. Gray Davis last year in order to access information on newly cut electricity deals. Because he felt they were pricey at the time, Richman asked the state to renegotiate.

"However, the governor should renegotiate those contracts in a fair and businesslike manner without heavy-handed tactics being used," Richman said.

Besides revisiting long-term contracts forged during the crisis, Richman said, other issues may make companies think twice.

"(Electric producers) are unsure what the regulatory environment will be and they are unsure what the financial situation will be," he said. "And so, companies that are making decisions on how to allocate their capital investments are going to continue to be very hesitant to invest in new power plants here in California."