For months now, L.A. city officials have touted the Department of Water & Power as being immune from the effects of the power crisis plaguing the rest of the state. There would be no rolling blackouts in L.A., no rate increases and no utility bankruptcies, they have repeatedly assured Angelenos.

But things may not be as rosy as they seem.

In recent weeks, it has become increasingly clear that the DWP is not immune to the state's energy crisis. The utility is facing soaring natural gas costs and an uncollected tab from excess power sales approaching $200 million. It also faces a protracted political battle with Sacramento over just how much it should charge the state for power, at the same time it faces a lengthy leadership transition as former general manager David Freeman has become energy adviser to Gov. Gray Davis.

And while the DWP remains in an enviable position for the present, there is concern that the agency could be drawn deeper into the crisis, particularly as that crisis drags on into next year.

"We're seeing some cautionary flags emerge. There are trends out there now that, if they go unchecked, could affect its financial picture," said Stephen Erie, a political science professor at UC San Diego who has long tracked regional water, power and transportation issues.

That feeling is shared by at least one key member of the L.A. City Council, which has jurisdiction over the utility.

"The feeling of immunity from the power crisis is clearly behind us," said L.A. City Council President Ruth Galanter, who also chairs the council's commerce, energy and natural resource committee. "We have quite a challenge before us, both with the natural gas prices and with all the politics going on here with the power crisis."

Gone for now is any discussion of across-the-board rate decreases that were on the table as recently as earlier this year.

"As long as these natural gas prices stay up, we might not be able to reduce rates as quickly as we had hoped to," Galanter conceded.

Natural gas woes

Indeed, the biggest concern is over the natural gas prices. The DWP is now spending $400 million a year on natural gas to fuel roughly one-third of its generating capacity. That's more than double the $180 million it spent in the fiscal year ended June 30, 2000, but it's still only a small portion of the DWP's $2.5 billion annual budget.

The DWP now has the capacity to absorb the cost increase, especially considering that about half of the natural gas-generated power is now being sold to the state at 15 percent above cost. The big concern is what would happen one or two years from now if gas prices don't go down significantly, especially as the agency repowers several plants that were set to be mothballed. Those plants will all run on natural gas.

"It's a cloud that hangs over the future," said Freeman, reached last week in Sacramento. "If we continue to pay current prices for natural gas for a year or more, it's likely to trigger a rate increase."

Several months ago, Freeman tussled with aides to L.A. Mayor Richard Riordan over what to do about the spiraling natural gas costs in a debate that was eerily similar to the dilemma confronting the state in its electricity purchases. Freeman wanted to lock in some long-term contracts to lessen the reliance on the expensive spot market.

Riordan aides, though, were wary of signing 10-year contracts at the top of the market. They said last week they had been assured by several major natural gas providers that prices would come down almost to their pre-crisis levels in another 12 to 18 months and, in anticipation of this, only wanted to commit the DWP to three-year contracts.

In the end, the Mayor's strategy prevailed and Freeman was forced to abandon his quest for 10-year contracts.

Utility owed money

Another major area of concern is the money owed to the DWP by the state Independent System Operator and the now-defunct California Power Exchange. That amount is pegged either at $180 million or $193 million, depending on whom one talks to. Whatever the actual amount, the debt was run up last fall as Pacific Gas & Electric, Southern California Edison and San Diego Gas & Electric all bought DWP-generated power through the ISO and Power Exchange.

The big questions, of course, are: When will the DWP get paid and how much of the money will it see? PG & E;'s share of the debt is now tied up in federal Bankruptcy Court; it could fall to U.S. Bankruptcy Judge Dennis Montali to determine how much of the debt will be paid to the DWP.

Edison's share is pending the outcome of a tentative deal it has reached with Gov. Davis to sell its transmission grid to the state for $2.76 billion. Many regard that deal as dead on arrival in the state Legislature, which could mean those dollars remain in limbo for months to come.

The consensus among DWP and city officials is that the agency could survive the loss of those funds.

DWP Board of Commissioners President Ken Lombard said that, when the DWP made those power sales to the utilities last fall, steps were taken to ensure that the agency would escape financial harm if the money could not be paid back.

"We are doing everything we can to recover those funds," Lombard said. "But let's be clear, even if we don't see any of that money back, it will not affect the financial rating of the agency."

Former general manager Freeman concurred, noting that the DWP made at least $400 million in profits from the sale of excess power during that same period. "Even if we don't see a penny of that money, we will still come out some $200 million ahead."

Nonetheless, that $180 million to $193 million is money that could have been used to continue paying down the DWP's debt, or even for possible rate decreases. As it is, the missing funds and run-up in natural gas prices have forced the agency to slow its debt pay-down schedule slightly.

"We're off by about $9 million from our target," said Frank Salas, the newly installed chief operating officer for the DWP.

Nonetheless, Salas said, the DWP had accelerated its debt pay-down earlier last year, bringing the debt down to $1.3 billion from $4.1 billion when Freeman took the helm in late 1997.

Political problems

Another major concern is more rooted in politics than finance: how much the DWP should charge the state for its surplus power. Early on in the crisis, the DWP sold power at market rates. But, bending to pressure from Gov. Davis and other Sacramento politicians, Freeman earlier this year agreed to sell the power at 15 percent above cost, well below market rates. That decision was made despite protests from some City Council members that DWP ratepayers would end up subsidizing the rest of the state.

"We want to be a good neighbor," Freeman said at the time.

But three weeks ago, word leaked out that the DWP was listed in a confidential ISO report as one of a dozen public agencies that should be investigated for price gouging the state. Since then, DWP officials say, the ISO has admitted it erred in placing the DWP on that list. (ISO spokesman Patrick Dorinson said that, because the report was still supposedly under seal, the ISO could not comment on it.)

Whatever the veracity of the report, the political repercussions continue to be felt. Some officials in Sacramento believe the DWP should sell its surplus power at cost, with absolutely no mark-up, a move that would leave the DWP hard-pressed to cover rising natural gas costs.

"There is certainly pressure from the state to have the DWP sell at cost," Galanter said. "And there is countervailing pressure here in Los Angeles to sell at market prices and make money. My chief concern is that this could lead to a game of chicken that could harm all sides."

Galanter, Lombard and Freeman all said they believe a compromise can be reached that would allow the DWP to earn a "reasonable rate of return" for the sale of its surplus power.

Crucial to this effort, though, is the stability of the DWP's negotiating team. The DWP has a big advantage in that Freeman will be at the other side of the negotiating table.

And the new interim general manager, David Wiggs, is widely cited for his extensive experience in a crisis power environment. He guided El Paso Electric Co. through its recovery from bankruptcy in the early 1990s, consulted to the DWP as it prepared for deregulation back in 1997, and most recently, has served as Assembly Speaker Robert Hertzberg's point man on the power crisis.

Nonetheless, considerable uncertainty remains around the future leadership of the DWP. The Board of Commissioners, in its April 20 meeting, set Wiggs' term until Sept. 30, to give the new mayor and new City Council time to agree upon a permanent replacement for Freeman.

"There is bound to be some turmoil during this transition period and, given what the agency faces in the next few months, that can't be good," said Robert Phillips, former general manager and chief engineer at the DWP during the 1970s.

For reprint and licensing requests for this article, CLICK HERE.