Otay Mesa Energy Center entrance

Operated by Houston-based Calpine, the Otay Mesa Energy Center is a 608-megawatt natural gas-fired power plant that supplies electricity to San Diego Gas & Electric customers. 
Nelvin C. Cepeda/San Diego Union-Tribune

The Otay Mesa Energy Center was built amid controversy and intrigue

Sitting squatly along the foothills not far from Chula Vista, the 608-megawatt Otay Mesa Energy Center natural gas plant owned by Calpine, an energy company based in Houston, has delivered electricity to San Diego Gas & Electric customers for the past decade.

In February, it appeared the companies finalized an agreement to extend their power purchase arrangement for five more years after the California Public Utilities Commission approved the deal on a 3-2 vote.

But an appeal of the decision by a local environmental group may trigger a quirky and controversial stipulation in the original contract between SDG&E and Calpine in which the local utility could end up being compelled to buy the plant for $280 million within a matter of months — even though SDG&E officials don’t want to own it.

The standoff has each side pointing fingers at the other.

The environmental group, the Protect Our Communities Foundation, insists it is standing on principle and defending San Diego ratepayers from costs related to a gas plant it says is not needed.

Calpine calls the protests “meritless” and SDG&E officials accuse the group’s board member leading the charge, Bill Powers, of “fundamentally misleading the public.” They contend the challenge will cost ratepayers more money and result in the utility taking ownership of a natural gas plant — producing a fossil fuel Powers and environmentalists despise.

“We believe the five-year deal that we proposed is a better option for our customers,” said Kendall Helm, vice president of energy supply at SDG&E.

Powers, who operates his own engineering company in San Diego, vows to take his case outside of the commission if need be. “We are going to the mat on this,” he said, describing the contract that brought the Otay Mesa Energy Center into existence as “squirrelly.”

It certainly was complicated. And it involved one of the most noted and controversial leaders in the 108-year history of the California Public Utilities Commission, also known as the CPUC.

Back in 2003, Michael Peevey was one year into his tenure as CPUC president and the state was climbing out of the wreckage left by the rolling blackouts experienced during the 2000-2001 energy crisis.

Looking to bolster grid reliability, SDG&E at the time wanted to buy a natural gas-fired power plant in Escondido called the Palomar Energy Center, which was owned by a subsidiary of Sempra Energy, the parent company of SDG&E.

SDG&E ended up not only acquiring the Palomar plant but buying power from Calpine’s soon-to-be constructed Otay Mesa Energy Center, known as OMEC for short.

Years later, a utilities sector attorney said before a state Senate committee and in a letter to the director of a consumer group that Peevey orchestrated the deal in a conference call that included representatives of SDG&E, Calpine and the CPUC.

Michael Peevey

Former California Public Utilities Commission president Michael Peevey, center, at a 2013 meeting in San Diego. 
(Peggy Peattie/San Diego Union-Tribune)

Peevey said “if SDG&E wanted to buy Palomar from its affiliate, SDG&E would also need to make a deal with Calpine for Otay Mesa,” attorney Kelly Foley said in a 2015 letter to The Utility Reform Network. “If SDG&E did not reach an agreement with Calpine, the CPUC, based on utility affiliate transaction concerns, would not approve the proposal to acquire Palomar.”

In June 2004, the CPUC approved the deal on a 3-2 vote, with Peevey voting with the majority.

Now retired and living in the Los Angeles area, Peevey told the Union-Tribune, “I can hardly remember a damn thing” about the transaction.

“I just tell you flatly I don’t remember that at all,” he said in a telephone interview. “I’m not saying we didn’t have such a phone call … We wanted those power plants built because it looked like there was going to be a shortage of power in San Diego. It didn’t turn out that way but there was certainly no quid pro quo or anything of that type involved, to the best of my memory.”

The subsequent 10-year power purchase agreement between SDG&E and Calpine’s OMEC subsidiary went into effect when the power plant opened in 2009.

But the agreement included an unusual provision — something known as a “put-call” option. Under the terms of the “put,” Calpine can force SDG&E to buy OMEC for $280 million when the 10-year deal expires this year.

Gary Ackerman, an energy and utilities expert based in the Bay Area, said he has never seen a put-call arrangement quite like the one in the OMEC deal.

“All contracts between private generation asset owners and utilities lean on the buyer’s balance sheet,” Ackerman said in an email. “But in the particular example of a put-call, (the OMEC deal is) the only instance that I know of using that arrangement to lean against a utility’s balance sheet. Usually it’s simply a letter of credit that expires when the contract expires. But here, the seller has an iron-clad assurance that termination of the power-purchase agreement could trigger a sale of the asset to SDG&E at the seller’s discretion.”

Peevey said he had no involvement with the OMEC put-call option.

“Why would I give a damn about a put-call set up?” he said. “What’s in it for me? And what’s in it for the PUC, other than at the time there looked like there was a need for another natural gas facility. I don’t have any financial relationship with Calpine. I never have. I don’t now. I didn’t before. I never had any in between.”

Fast-forward to the CPUC’s vote in February.

Even though California policymakers are eager to reduce the use of natural gas to move to its legislated goal of deriving 100 percent of its electricity from non-fossil fuel sources, CPUC analysts determined power from OMEC will be needed over the next five years.

The California Independent System Operator, which oversees the grid for about 80 percent of California’s electricity consumers, agreed.

Nonetheless, SDG&E was hardly eager to spend $280 million to buy OMEC outright. Calpine came back and proposed a nearly five-year power purchase agreement with SDG&E and that’s what the commissioners accepted in their 3-2 decision.

But Calpine insisted it would only agree to the deal if the commission’s ruling was a “final and non-appealable order.” That meant no organizations contested it.

Enter the Protect Our Communities Foundation. Just before the 30-day filing deadline expired, Powers submitted an application to the CPUC for a rehearing. No other organizations appealed the February CPUC vote.

Five days later, Calpine exercised the put option. According to the terms of the contract, that means SDG&E must buy OMEC for $280 million and come October, the plant would be completely operated and staffed by SDG&E employees.

But Calpine did not shut the door completely.

In an April 4 letter, Calpine’s vice president of government and regulatory affairs, Avis Kowalewski, said OMEC “still intends to relinquish” the put option “if and when all conditions … are satisfied.”

No details were provided as to what can be done to revive the deal. Calpine’s media spokesman said the company had no comment beyond what was written in the letter.

Helm of SDG&E said the company is hopeful the five-year contract can be salvaged but ultimately, as per the existing contract, she said the decision belongs to Calpine.

“That’s all out of SDG&E’s control,” Helm said. “It’s up to Calpine what they do with the ‘put.’ We know what they’ve told us so we have started the work we need to do to able to take on that plant and operate it.”

Powers and his group persist, though.

They want the CPUC to eliminate the $280 million purchase option and they want the five-year deal between SDG&E and Calpine thrown out, too.

The original 10-year power agreement that ends this year between SDG&E and Calpine at Otay Mesa cost $739 million.

“You’ve been paid a prince’s ransom for 10 years on this contract … The terms were more than fair” to Calpine, Powers said. “We want this contract to end after those 10 years are up.”

Helm said the $739 million figure does not represent the true cost that SDG&E customers actually paid for energy from OMEC because the contract allowed the utility to bid the plant into the Independent System Operator’s energy market every day and when SDG&E received revenue from that market, the money was given back to customers to offset the contract’s costs.

Regardless, isn’t the proposed five-year contract better than making SDG&E pay $280 million and owning OMEC?

Maybe not, Powers said, because under the CPUC rules, contracts between utilities and power generators remain confidential for three years. Commissioners, however, are aware of the numbers and prior to the vote in February, commissioner Liane Randolph described the contract as “high-priced.”

Powers suspects that after payments are completed, the five-year deal may be just as expensive as the $280 million purchase option.

“It could be that the economic deal (for OMEC) is functionally the same,” Powers said.

Helm dismissed that theory, pointing to a CPUC administrative law judge who reviewed the case and said SDG&E “demonstrated potential incremental benefits” to the five-year deal over the potential $280 million purchase of OMEC.

And the Public Advocates Office — the independent organization within the CPUC that looks out for ratepayers — said SDG&E’s data showed the five-year deal provided a “ratepayer benefit,” compared to the utility buying the plant.

Powers sees parallels to SDG&E’s purchase of another natural gas plant, Desert Star in Nevada, the CPUC approved earlier this decade. The deal came to $300.744 million, with payments spread over five years.

But Helm said Desert Star is not comparable to Otay Mesa. First, Desert Star supplies system capacity while OMEC provides local capacity, which typically costs 1.5 to 2 times more than system capacity.

And second, Desert Star was already built when SDG&E bought it while OMEC came before the CPUC as new construction, with all the attendant expenses related to financing, building and other risks associated with a new power plant still to be resolved.

Protect Our Communities also objected on the grounds that the five-year deal made by SDG&E and OMEC amounts to modifications to the original deal and violated CPUC procedures.

“The process is for a specific purpose,” Powers said. “It’s supposed to be for non-controversial business … This is anything but non-controversial.”

The group filed a petition to the CPUC challenging the details of the contract but all five commissioners last month signed a decision agreeing with a CPUC administrative law judgewho forcefully denied the petition on multiple grounds, including “the sanctity of contracts.”

Otay Mesa Energy Center from above

The Calpine Otay Mesa Energy Center near the U.S.- Mexico border in San Diego. 
Nelvin C. Cepeda/The San Diego Union-Tribune

“The Commission will not revisit the (power purchase agreement) more than 12 years after its initial approval,” the decision said, “based on broad and vague assertions of changed circumstances by a party (Protect Our Communities) that was not involved in the original proceeding.”

But the main reason Powers said his group is fighting the deal centers on Community Choice Aggregation, or CCAs.

Created in the aftermath of the California energy crisis, CCAs have sprung up across the state, boasting they offer customers cleaner sources of power at the same or lower prices than traditional utilities.

Under the CCA model, investor-owned utilities like SDG&E still maintain many of their conventional duties, such as taking care of poles and wires and handling customer services such as billing.

But a CCA assumes responsibility for one major role — it purchases the power for the community it services, rather than the utility. CCAs promise to more aggressively seek out power contracts from renewable energy sources.

San Diego’s city council is looking into formally creating a CCA this fall that may expand to include other towns and cities in the area. Last year, Solana Beach became the first communityin San Diego County to establish a CCA.

One of the sticky issues involving community choice energy relates to exit fees that CCA customers pay each month to the legacy utility — in San Diego’s case, SDG&E.

Over the years, utility customers — through their rates — have paid power companies to build things like power plants and sign long-term power contracts with independent power producers. The exit fee is designed to make sure those costs are not unfairly shouldered by customers who decide to remain with their traditional utility instead of joining a CCA.

Determined by the CPUC, the size of the exit fee is crucial. Utilities argue if the exit fee is set too low, it does not fairly compensate them for their investments; if it’s too high, CCAs complain it reduces the financial incentive for their potential customers.

Powers is a big supporter of San Diego community choice aggregation and fears the costs associated with OMEC will push up the exit fees paid by customers of a potential local CCA, calling the plant “an additional, totally unnecessary burden.”

Helm pushed back, saying if SDG&E has to buy the plant for $280 million under the put option, the exit fee will continue for two decades. “So you have five years (of CCA exit fees) or 20 years. This makes no sense.”

The Public Advocates Office agreed, saying CCA customers would have lower exit fees under the five-year deal than if SDG&E owned OMEC.

A lower exit fee “would allow CCAs to offer more competitive pricing,” the advocates office said. “Additionally, CCAs would have greater financial ability to procure their own resources if they are not burdened by the costs of OMEC and are likely to develop renewable and storage resources that could decrease future need for OMEC.”

So far, the CPUC has turned back all the environmental group’s arguments but Powers said his group is looking beyond the commission, which he accused of being “so accommodating” to utilities when it comes to exit fees. Last October, the commission adjusted the exit fees higher, prompting the state’s CCA trade association to apply for a rehearing.

“We have filed a petition for rehearing.” Powers said. “And frankly, we don’t expect to get much of a hearing at the commission … For us to get a fair hearing, it’s almost certainly going to be in an appellate court, but we have to exhaust our administrative remedies to get that to the appellate court. And that’s what we’re doing here.”

Helm said the five-year deal is “a better option for our customers … We also believe that a shorter term commitment to the asset (OMEC) is beneficial for supporting our (greenhouse gas) goals in the state as well as supporting CCA formation.”

In the meantime, Helm said SDG&E is working on the presumption it will take over the plant later this year.