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Sunday January 14, 12:21 am Eastern Time

TheStandard.com

Power Hungry in California

By Kevin Roderick and Eric Young

The Clinton administration jumped into California's energy deregulation mess Friday, calling for a summit of state and utility officials next week in Washington to try to find a solution to the crisis that has the state's major power companies warning of possible bankruptcy.

The White House news slowed a plunge in utilities stocks. Did not, however, prevent Pacific Gas and Electric, one of the state's top two energy utilities, from formally alerting the SEC that it might be forced to default on an $850 million credit line if the crisis does not ease within 90 days. PG&E acted shortly after Moody's joined the other rating services in downgrading the company's debt to just above junk status. The lower ratings also apply to Southern California Edison, the state's other biggest power utility.

It wasn't supposed to turn out this way.

Deregulation was going to lower prices on electricity and improve service for California's consumers. Instead, the free-market experiment has driven the state's entire power-supply system to the edge of collapse. Southern California Edison and PG&E, which between them serve two-thirds of the market, are warning they may go bankrupt without huge rate hikes. In the meantime, they're predicting blackouts for power-hungry cities.

The 24 other states that have tried deregulating are hoping to avoid the California nightmare. That doesn't mean they won't get hurt. The Golden State, after all, represents 14.6 percent of the U.S. gross domestic product. If an energy crisis pulls the Western giant into recession, the entire country will stumble.

That's why last month, as the crisis deepened, California Gov. Gray Davis flew to Washington to confer with Federal Reserve Chairman Alan Greenspan and President Clinton. Indeed, fears of a debacle that could ripple through financial markets and shred consumer confidence may have helped propel the Fed to suddenly cut interest rates last week. On Wednesday, Davis ordered a special legislative session to deal with looming power outages. The next day the state's Public Utility Commission approved a temporary rate hike averaging 15 percent for large-business customers – far less than the increases the utilities say they need to fend off insolvency.

Deregulation is undoubtedly at fault. The 1996 California measure, which set off a national wave of electricity deregulation, replaced the old monopoly utilities with a free market that was supposed to benefit consumers. But the plan, which went into effect in April 1998, has given the companies that generate electricity near-monopoly status – without a government-mandated cap on prices.

The utilities used to generate their own power and sell it at predetermined rates. Deregulation forced them to sell their power plants and become middlemen, buying electricity wholesale from generators and power exchanges. The generators can effectively name their price, and those prices have soared since last summer as supplies dwindled. The two big utilities say they are now saddled with an $11 billion shortfall.

Since the summer, power supplies have become less reliable. Southern California in particular has felt the heat. In Fontana, east of Los Angeles, California Steel had to halt production seven times in December. The nearby Claremont Colleges had to cancel night classes and close some libraries during finals week. The state's first-ever Stage 3 emergency on Dec. 7 silenced the giant pumps on the aqueduct that supplies Southern California with water.

Southern California Edison and PG&E say they will run out of cash soon. They requested rate hikes of 30 percent and 26 percent, respectively, but the PUC approved increases of less than half those percentages – and only for 90 days. The stock market reacted quickly, sending shares of both companies' parent firms tumbling. On Friday, bond-rating services downgraded the utilities' debt, making it even harder for them to obtain cash to pay their bills.

The deregulation fiasco has consumer groups, Davis and the utilities talking about calling the whole thing off and going back to the old scheme. California's energy problems, however, go deeper than deregulation. The state's population grew by 4.1 million people in the past decade — to 33.9 million – but no major new power generating plants have come online in that time, and none is likely to win approval in the near future. Another problem is that the region's transmission lines are too old and inefficient to carry enough power from other states to meet higher demand.

Furthermore, the need for electricity has soared even faster than the population, propelled by the state's economic boom and the rise of the Internet Economy. Power use in Silicon Valley alone grew by 12 percent in the year ending in August, the Electric Power Research Institute says.

Keeping the lights on is vital to most companies, but an uninterrupted energy flow is especially critical for high-tech firms. Blips as brief as 1/60th of a second can zap computers and other electronic gear, and blackouts can be catastrophic. Many companies are preparing for the worst. Exodus Communications, which runs high-security data centers around the world, is building its own power-generating substation.

While California is bearing the brunt of the crisis, other states are not immune to rising power bills and outages: Natural gas and oil prices are climbing, pushing up rates nationwide. So far this winter, the Pacific Northwest has been the hardest hit. In cold months, the region ships in power from California, and the Northwest returns the favor in the summer when California needs more megawatts to run its air conditioners. But this winter, federal authorities ordered generators in Oregon and Washington to ship power south to prevent blackouts in California. The move tightened supplies at a time when electricity prices had already risen. Tacoma, Wash., levied a 50 percent surcharge on power customers last month.

Next summer is likely to provide another test of the capacity of the nation's power grid. But until then, the rest of the country will likely be spared the worst effects of California's energy crisis – unless the state's woes drag down the shaky U.S. economy. Most of the states that have embarked on energy deregulation have been more aggressive in adding new power supplies, making them less vulnerable than California. A number of the states have also structured deregulation to assure that power generators produce an ample surplus of electricity, even during peak demand periods. In Delaware, Maryland, New Jersey and Pennsylvania, for example, generators are supposed to provide at least 19 percent more juice than will likely be needed on the hottest summer days. Until last month, California had no such requirement.

As with any market-driven shortage, there are some winners. In the Pacific Northwest, aluminum smelters have pocketed millions by shutting down and selling surplus, government-subsidized electricity back to the power grid at inflated rates. The Kaiser smelter in Mead, Wash., purchased power at $22.50 a megawatt hour in December and resold it at $555. But the bigger beneficiaries will be generators commanding unprecedented prices for the juice they produce. Critics call them gougers, but those accusations won't reduce prices. As one power-company spokesman says, it's just "basic supply and demand."

-- (in@energy.news), January 14, 2001