12/21 17:43 California Power Shortage Turns Deregulation Dream to Disaster By Daniel Taub

San Francisco, Dec. 21 (Bloomberg) -- In 1996, California Governor Pete Wilson praised an agreement by utilities, consumer groups and regulators to deregulate the state's power market, saying that within seven years electricity prices would fall by 20 percent and no longer be the highest in the U.S.

The utilities now demand that the California Public Utilities Commission allow them to raise rates to stave off bankruptcy. Consumer advocates warn the public may get handed an $8.1 billion electricity bill. The state this month declared power emergencies, averting blackouts with last-minute supplies of electricity.

What happened?

``Deregulation doesn't work when there's a power shortage,'' said David Freeman, general manager of the Los Angeles Department of Water and Power. ``Prices go through the ceiling. That's what's happening, and the experiment is turning out to be a gigantic failure.''

Unlike similar plans in Texas and other states that let consumers and businesses choose their electricity provider, California neglected to include provisions to encourage construction of new power plants. The state's strict land use laws and environmental rules prevented any plant from being brought on line in the last decade.

California's economy boomed in the last four years, helped by growth at Intel Corp. and other computer-related companies in Silicon Valley, and demand in the state's $23 billion annual electricity market soared. Power prices this month have surged to as high as $3,000 a megawatt hour from about $32 last year.

Cash Crunch

PG&E Corp. and Edison International, the state's two biggest utility owners, say the high costs are bleeding them of cash. The two companies have borrowed billions of dollars to pay for electricity, and have petitioned the state PUC to let them pass along that cost to consumers. The commission today scheduled hearings on the matter for Wednesday and Thursday.

Regulators say Edison is threatening to lay off workers unless they get rate increases, and PG&E said it may cut its dividend. Edison shares fell 16 percent and PG&E's stock dropped 13 percent today.

``What we've got in California is crazy,'' said Douglas Christopher, a utility analyst at Crowell, Weedon & Co.

Electricity prices are rising partly because companies that generate power for sale to utilities rely on natural gas, the cleanest burning fossil fuel, to fuel power plants. Natural gas futures prices have more than tripled in the past year to more than $9 per million British thermal units on the New York Mercantile Exchange, the highest in the 10-year history of the contract.

Prices in California surged as high as $56 this winter as cold weather increased both heating and power generation demand.

``It seems so ridiculous now that the entire deregulation experiment was predicated on cheap natural gas,'' said Nettie Hoge, executive director of the San Francisco-based Utility Reform Network, a consumer group.

Compromise

The state's deregulation law was a compromise supported by utilities, consumer groups, politicians and businesses as a way to bring down power prices that were 50 percent higher than the national average.

``Everyone helped make this Frankenstein,'' said Hoge.

The legislation gave consumers an average 10 percent rate cut during the first five years, whether they decided to switch electricity providers. Savings were forecast to at least double by the time deregulation was fully instituted in 2003, analysts said.

Companies could shop for a power provider, and business groups forecast that corporate rates would drop more than 10 percent. New competitors for a share of the state's market could buy power plants from utilities, who were required to sell. The entrants into the market immediately lured lucrative business customers, and made plans to sign up homeowners and small businesses when mandatory rate cuts ended.

Utilities would use proceeds from plants sales to pay off part of an estimated $23 billion in debt, and could refinance much of the rest at consumer expense. They could buy most of their power on the open market, where a surplus of generation would keep prices low.

Plants Sold

The law pressured PG&E's Pacific Gas & Electric Co. and Edison's Southern California Edison to sell most of their plants to reduce debt and give new competitors electricity to sell. Because PG&E and Edison still had debt from building power plants, the rate reduction remains in effect, and that has left them unable to pass on power purchase costs.

``It is time to break decisively from this failed policy,'' John Bryson, chairman, president and chief executive of Edison International said last week. ``We need to reform, and, where necessary, re-regulate California's electric system.''

Now the same groups that supported the law are rushing to find quick solutions to its failure, and to affix blame.

California Governor Gray Davis is calling for price caps and wants federal regulators to force power sellers to pay refunds to utilities, saying they manipulated the market to drive up prices.

Supply Debate

Power producers point out that California laws created the power-plant shortage, and that forcing refunds or imposing price caps will only prevent developers from building new plants.

``New supply needs to be added,'' said Jim Donnell, president and chief executive of Duke Energy North America, which supplies power in the state. ``If the market was re-regulated, who would add it?''

In other states, deregulation rules encouraged utilities to lock in long-term contracts with power producers, bringing increased plant construction. Some states gave any utility the right to buy power at reduced rates from the purchaser of its plant.

California's law favored generators at the expense of power buyers during times of shortages, Hoge said.

``We're sitting ducks for all kinds of manipulation,'' Hoge said. ``Generators didn't know then what a bonanza they had'' when the law was passed, she said.

California split the functions of electricity trading and grid management. The state formed the California Power Exchange to make prices transparent to everyone. The California Independent System Operator was created to make sure all users received electricity.

Utilities were forced to buy power on the exchange for daily or hourly use rather than entering into advance contracts. Prices would be based on producers' estimates of available supply.

That system allowed producers to hold back power until demand surged, driving up prices, Governor Davis has alleged.

Pennsylvania's System

California's system differs from regional power pools developed in the Northeast U.S. and in Canada, consumer advocates said. In those states, power is distributed based on expected demand, not on the available supply on any given day.

The Federal Energy Regulatory Commission approved California's system in 1997, ignoring warnings from California consumer groups that the system would encourage abuse, Hoge said.

Power generating companies said the fault lies with California laws that don't allow them to build plants.

``We can solve it in 36 to 40 months,'' said Harvey Padewer, president of energy services at Duke Energy Corp., which owns power plants in California. ``Just allow us to permit a plant quickly.'' Duke is reviewing whether to stay in California's power market because of the state's rules, he said.

Utilities could also have limited electricity costs if state regulators had allowed them to buy electricity outside the power exchange, Padawer and other power company executives said.

Enron's Offer

Enron Corp., the world's largest energy trader and a specialist in energy price risk management, was one of several companies to offer San Diego's utility a contract to provide all the city's residential power for five years at a cost of $55 a megawatt hour, much less than the $400 or $500 the utility has been paying on the spot market this winter.

San Diego Gas & Electric turned them down, saying it didn't have the flexibility under California PUC rules to enter into a forward contract. Instead, customers would have to keep paying far- higher daily market rates.

``California is now paying the price for that,'' said Steven Kean, executive vice president and chief of staff at Enron. ``There are substantial restrictions on the utilities' power to hedge.''

Even before this year's shortages, deregulation did little for average consumers, said Douglas Heller of the Foundation for Taxpayer & Consumer rights. Utilities had required ``transition fees'' that protected them until 2003 from competitors who might undercut their prices, Heller said. The fees erased most of the savings from switching, he said.

``The promises of 20 percent rate cuts were promises,'' Heller said. ``But there was clearly no way to back that up.''

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-- Martin Thompson (mthom1927@aol.com), December 22, 2000