Can Crisis Repeat Itself Here? We May Find Out Soon

By Peter Behr Washington Post Staff Writer Sunday , December 3, 2000 ; Page H01

In July, with electricity rates three times normal levels, Dennis Branham began turning off his new $2,200 air conditioner at night, despite the relentless oppression of 100-degree days that baked his double-wide trailer home in a canyon just east of San Diego.

He screwed in energy-saving light bulbs throughout the place, but he couldn't shut down the power-hungry compressor that pumps oxygen to him as he sleeps--he literally can't live without it. Branham, a disabled 60-year-old retiree, scraped the money together to pay his $400 monthly electricity bills. "And then I really began to scream."

Branham's plight is one that Washington area energy officials and regulators are determined to avoid as competitive electricity services begin in the region, allowing customers a chance to pick an electricity provider.

"All we can do . . . is say that's not going to happen here," said D.C. People's Counsel Elizabeth A. Noel, referring to the wild price spikes, electricity shortages and public furor that struck California's restructured electrical industry this summer.

"We've had longer to think about this," says John M. Derrick Jr., chairman and chief executive of Potomac Electric Power Co., the principal electricity provider for the District and its Maryland suburbs. "I think we have it right."

Plans for delivering competitive electricity service in the region differ from California's in fundamental ways that will protect consumers here, officials insist.

But the Washington region's deregulation plans also contain some of the same internal tensions between electricity providers and regulators that lie at the root of California's crisis.

To make competition work, prices and profits from making electric power must be high enough to attract new suppliers and prompt continued expansion of power plants.

In the long run, proponents say, competition should yield lower costs for making electricity and better bargains and choices for consumers.

In the short run, however, there is the risk of sharp price swings. For legislators and regulators, the political remedy is price caps that temporarily establish a top rate for electricity. Competing electricity providers must come in below those rates or offer customers added services or inducements (such as costlier, "green" electricity from wind power).

The caps effectively limit the amounts companies can charge consumers for electricity during transition periods while deregulation takes place. In parts of the Washington region, those transitions will extend into the middle of this decade.

The result is an industry that is not regulated, but not fully privatized either.

The Washington area is about to find out how well the balance between energy-company goals and consumer protection has been struck here.

An End to Old Ways

Maryland consumers were cleared to begin choosing electricity suppliers in July and August. The District's electricity choice program begins Jan. 1, and consumers are expected to be receiving offers from suppliers by spring. A pilot project offering supplier choice is now underway in Fairfax County, with electricity deregulation scheduled to be phased in statewide in Virginia between January 2002 and January 2004.

In the Washington region, as in others, the old regulated utilities have been split apart to separate the generation of electricity at power plants from its distribution to homes and businesses.

Pepco has sold most of its generating plants to Atlanta-based Southern Co. Its business now is distributing electricity in the District and suburban Maryland, which means it maintains the physical power lines to people's homes. It has a new subsidiary, Pepco Energy Services, that plans to actually sell the electricity to consumers around the region. It will purchase that electricity from generators such as Southern.

Baltimore Gas and Electric Co. is now a distribution company as well, part of a new holding company, Constellation Energy. BG&E buys electricity from other Constellation units that now operate the former BG&E plants.

And in Virginia, Dominion Resources Inc. has likewise divided its generating, retailing and distribution companies.

Architects of electricity competition expect that other companies will come to the Washington area from Texas, North Carolina and other regions, offering consumers options for lower electricity rates and a mix of services.

Customers who don't want to switch can remain with their current distribution companies, Pepco, BG&E and Dominion Virginia Power. These companies are "providers of last resort"--obligated to buy electricity and keep it flowing to customers at government-set prices during the transition periods, extending four to seven years in the Washington region.

The dilemma is, if these price limits prove to be too low, competing suppliers may not show up.

That won't hurt consumers as long as the price controls remain in place. But in a worst-case scenario, if controlled prices are too low, power suppliers may cut back on plans to build new generators, and that could mean shortages and price spikes when controls are lifted in mid-decade.

In fact, competition has gotten off to a slow start in Maryland, where the region's lowest price caps are in place in the BG&E service area.

Pepco Energy Services, the utility's new retailing arm, is selling electricity to residential customers in Pepco's distribution region in Washington's Maryland suburbs, slightly undercutting its parent company's capped price.

But Pepco Energy is not currently offering basic residential electricity service in the northern half of Maryland served by BG&E, because it can't sell power below the price cap in that part of the state and make a profit, says Ed Mayberry, the company's president.

"Given current wholesale prices, that's a price we can't beat," Mayberry says. There are no other competitors in that part of Maryland currently, says Maryland's Public Safety Commission.

Likewise, Washington Gas Energy Services hasn't yet jumped into the competition for Fairfax electrical customers because of the price cap there and current fuel costs. "We don't have an offer that can save people enough money, and obviously we only do business that's profitable," said Harry Warren, president of the Washington Gas subsidiary.

The District's Public Service Commission is also expected to cap regulated electricity rates below current levels when it sets rules next week for a four-year transition period toward full competition.

"We don't think low rates will be a problem" for competitors, said PSC Chairman Angel M. Cartegena.

This year's high prices for oil and natural gas also have discouraged electrical generators from stepping up competition, said Wayne Harbaugh, Constellation Energy's electricity pricing manager. "That's probably holding us back a little," he said.

Harbaugh and Mayberry predict that as prices of electrical generation drop, competition will pick up. "I am very optimistic this will be good for consumers," Mayberry said.

At this point, however, no one is predicting just when that competition will emerge.

A Different Path

When local officials say that the Washington region won't follow California's path, they point to a unique chain reaction of bad luck, misjudgments and opportunism that marked that state's electricity restructuring.

* California's strict environmental regulations and not-in-my-back-yard resistance to development effectively barred construction of new electrical plants in California for the past decade, industry officials complain. Meanwhile, the demand for electricity kept rising as Internet usage grew.

With electricity capacity strained, California and other western states were vulnerable to price shocks during a long, hot, dry summer.

No such shortages of generating capacity seem in store for the Washington region, industry experts say.

"We think we're in pretty good shape the next few years," said Steven Herling, general manager of the PJM Interconnection, a power-sharing pool serving the mid-Atlantic states. Similar assurances come from David Koogler, director of Dominion Resource's Project Current Choice.

* California's elaborate regulatory system required distribution companies to purchase electricity from the state-chartered California Power Exchange (PX), and most of the state's power demands were expected to be filled by purchases a day ahead through an auction system, with suppliers offering electricity at competitive rates.

But with price controls on Power Exchange transactions, generating companies reduced normal offers of electricity on day-ahead sales, according to regulators who have studied the summer's price shocks.

That forced distributors to make last-minute purchases of electricity on the same day that the power was needed. But these same-day purchases were not price-controlled. The demand was intense and generating companies responded by pushing prices up dramatically, regulators say now.

Also, there were unprecedented sales of power by California generators to buyers outside of the state's borders during the summer. To cover shortages, California distributors wound up buying unregulated out-of-state electricity supplies, also at sharply marked-up prices. In the San Diego area, where price caps on retail sales had been lifted, the higher electricity prices flowed straight through to consumers, boosting average monthly summer electricity bills threefold.

In the Washington region, there is nothing resembling the complex California pricing system, officials here note. Unlike in California, distributors here have lined up long-term supply contracts at fixed rates--a solid insurance policy against unexpected price spikes.

Lessons to Be Learned

Local energy regulators expect to be studying California's electricity calamity for a long time, searching for lessons.

Separate investigations by the Federal Energy Regulatory Commission and California regulators have not found proof of allegations that particular companies conspired to drive up prices.

"There's no evidence that's readily apparent that laws were broken," agrees Michael Shames, executive director of the Utility Consumers' Action Network.

"The rules were set up. They created this opportunity, and the companies have taken advantage of it," racking up huge profit gains, he said.

The generators' conduct falls into a gray area, FERC Chairman James J. Hoecker says in an interview.

The California rate structure, coupled with tight capacity, gave a lot of suppliers market power to get dramatically higher prices. "Some may call that gaming. . . . Some would call it maximizing profits, taking advantage of an opportunity," Hoecker said.

"Where there's smoke, there's sometimes fire. We have to look more closely at behavior in this market," he said, adding: "The allegations of a conspiracy to rip off the consumers in California, I think some of those claims are overblown."

Now, as California struggles with the aftershocks of the crisis, the conflict between electric suppliers and lawmakers and regulators seems even sharper.

"You had a big clash between what would be economically sound and what was considered politically necessary," says Steven J. Kean, chief of staff at the Houston-based energy company Enron Corp.

"The political piece is 'Let's cap prices.' Business's response is 'I don't have to put turbines in the state.' "

Duke Energy, Enron's Charlotte-based competitor, is going forward with $2 billion in electric-plant construction and upgrading in California--evidence that with privatization, different companies will react differently to the same market conditions. "We do have a long-term commitment to the state," said Bill Hall, head of Duke Energy's California operations.

Hall's boss, Duke Energy Chairman Richard B. Priory, said that the uncertainty about how California will be regulating prices and profits could undermine that commitment: "We're very, very concerned about how things are proceeding."

http://www.washingtonpost.com/ac2/wp-dyn/A11466-2000Dec1?language=printer

-- Martin Thompson (mthom1927@aol.com), December 03, 2000