For New York, Energy Lessons Flicker in West

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February 25, 2001 For New York, Energy Lessons Flicker in West

By ALEX BERENSON he following article is based on reporting by Neela Banerjee, Alex Berenson and Richard Pιrez-Peρa and was written by Mr. Berenson.

For New Yorkers, the electricity crisis in California may seem a continent away.

It isn't.

New York's electricity industry has striking similarities to California's. Both have been slow to build new plants and were caught off guard in the last year as demand for electricity jumped. Both depend heavily on natural gas to run their generators, leaving them vulnerable to soaring gas prices. Both states have deregulated their electricity markets, so they no longer control the price of power.

In California, those forces have fed a new kind of power failure: rolling blackouts, huge losses for utilities and businesses hobbled by an unreliable electric supply.

For New York, the immediate prospects are less dire. Although power supplies may be tight in New York City, blackouts are unlikely this summer, barring a bout of unusually hot weather. The state's six utilities are financially healthy, and New York depends much less than California on out-of-state suppliers.

But the way New York deregulated has left ratepayers in New York City and Westchester even more exposed than Californians to price spikes. Consolidated Edison's rates, which have been high for decades, have risen 40 percent since 1999, largely because of costs for natural gas and oil to fuel power plants. Now the nation's highest, those rates are all but certain to rise further as the weather warms and demand for electricity increases. This summer, monthly bills for the average Con Ed customer could easily hit $120, compared with $95 last summer.

New York's problems are likely to worsen over at least the next three years, industry experts say. A lack of major new plants and transmission lines will put the city at increasing risk of shortages and blackouts as demand rises faster than supply. Rates across the state could surge higher, since California's experience shows that deregulation gives power generators leeway to set prices — and, critics say, manipulate the wholesale power markets — when supplies are tight. Last summer, officials say, market manipulation cost New Yorkers at least $100 million.

Those troubles could be costly for the state's economy and officials, who are scrambling to stave off increases and make sure New York City has enough reserve power to handle emergencies like a plant breakdown on a hot day.

"The crunch has come," said Maureen O. Helmer, chairwoman of the state Public Service Commission, which oversees New York's power industry. "The No. 1 priority is keeping the lights on, and we are doing what we have to do to make sure that happens."

The state-owned New York Power Authority is moving to install 11 small generating plants in or near the city by June, though environmental groups have sued to block construction. Last month, the Public Service Commission doubled spending on electricity conservation efforts.

For this summer, those measures should protect the city from shortages, said Con Ed's chairman, Eugene R. McGrath.

"We will have the reserve and the capacity that we think we need," Mr. McGrath said, although if the new generators are not running, that reserve will be less than the state requires to reduce the odds of widespread blackouts on hot days. Isolated blackouts, like the one that hit Washington Heights in 1999, are possible, Con Ed officials say, though those are due to failures of local transmission lines during heat waves, and not the system's larger problems.

The state's generating capacity, 35,000 megawatts, should provide a surplus. Peak statewide electricity demand this summer is expected to be about 30,600 megawatts, though a heat wave could push that figure higher. (One megawatt is enough power to light 1,000 homes.)

But Mr. McGrath cautions that the city and state sorely need to encourage the building of new power plants and transmission lines to meet demand and ensure that suppliers do not get even more control over prices. No major plants have been built in New York State since 1994, and none have been built in the city for decades. Since 1998, more than 60 large plants have been proposed, but the state has approved only 2, and both are upstate, far from where new supply is needed most. Transmission bottlenecks mean that most of New York City's supply must be generated close by.

Although government and generating company officials trade blame for the delays, all agree that the state has moved more quickly since last fall, when California's plight began to draw national attention. Still, no major new plants are likely to be approved for construction in or near New York City before late this year, and then they are likely to face opposition from environmentalists and neighbors. New transmission lines would allow the city to import more power, but those encounter even more resistance because they run through many communities.

In late January, five New York City business and labor groups issued a report warning that 2,000 to 3,000 megawatts of generating capacity — the equivalent of a large nuclear plant — must be built in the city before 2005. Con Ed agrees.

"The state is dealing with the immediate problem," said Kathryn S. Wylde, chief executive of the New York City Partnership and Chamber of Commerce. "We need the same kind of urgency applied to our long- range needs."

The ComparisonsDeregulation Differs

On Opposite Coasts

The word that echoes most often in California's crisis and New York's jitters is "deregulation." But it means different things in each state, and its effects so far have been quite different from its intent.

Like many other states, New York and California deregulated their electricity industries in the mid-1990's in hopes of lowering prices that were already formidable; New York's rates rose 20 percent between 1990 and 1995, driving away manufacturers.

"Back in the mid-90's, the most important thing was to try to get prices down," said Gov. George E. Pataki, who directed New York's deregulation.

To encourage competition in electricity generation, utilities were required to sell their power plants and instead buy electricity from independent generators in new wholesale markets. Rates for consumers and businesses, which had been set by state regulators, would vary with supply and demand rather than being based on the cost of producing power.

Power generators, the thinking went, would build new plants, and new electricity marketing companies would spring up to give consumers a choice of suppliers and rate plans. The new competitors would have to be more efficient than traditional utilities because they could not count on recovering costs from ratepayers. As the cost of producing power dropped, rates would follow.

But in New York, as in California, theory has not become reality. Because no new plants have been built, the existing generators have little incentive to cut wholesale prices. On the retail level, a few companies have tried to compete, but high wholesale prices and the state's regulations have left them unable to offer meaningful savings. So almost all customers still get power from their old utilities, and most people have no idea that they even have the right to choose.

In other industries, high prices often lead to a drop in demand, lowering prices. But electricity is so vital that consumers and businesses will pay almost any price when supplies are tight.

California caps its consumers' rates, and that is why its utilities, unable to pass on runaway wholesale costs, totter near bankruptcy and are relying on the state to buy power for them. New York, however, allows Con Ed to pass on its costs to ratepayers — the most crucial difference in the ways the two states deregulated.

As a result, Californians' rates stayed flat last year, even as prices in the state's wholesale power market quadrupled. Rates there average about 11 cents per kilowatt-hour — half as much as Con Ed's rates last month. (One kilowatt-hour is enough to run a large room air-conditioner for an hour.)

New York's other utilities signed contracts to buy power at fixed prices when they sold their plants in the last three years, so they and their customers are largely protected from spikes in wholesale prices. But the contracts signed by Niagara Mohawk Power, the largest upstate utility, will begin to expire in September, and the company has already asked the state for permission to pass rising costs on to consumers. Otherwise, the company warns, it could face the same squeeze as California's utilities.

Governor Pataki and the Public Service Commission say the state has pushed utilities to lower their prices for distributing power, and rates over all are lower than they would have been under a fully regulated system. They say 70 percent of Con Ed's rate increases in the last year has been due to higher prices for natural gas and oil; even if it had continued to regulate prices, the commission says, it would have had to allow Con Ed to pass those costs to customers.

Independent industry experts largely agree with that estimate. But they warn that this summer could be very different from the last, when cool weather kept demand down. In a normal summer, power supplies are tight statewide, and they say California's crisis shows that when demand catches up to supply, deregulation allows generators to charge extremely high prices for power.

"I don't think last summer was a good basis for comparison," said Ira Freilicher, a lawyer for the New York Independent System Operator, or I.S.O., a nonprofit organization created under deregulation to run the wholesale power market. "Deregulation will exacerbate the price problem if there is a scarcity and we don't get supply."

The MarketSometimes 2 Cents;

Other Times, a Dollar

The crucibles where electricity prices are forged every day are the wholesale markets run by the I.S.O., where utilities and generators buy and sell power. And the way New York's I.S.O. sets prices — the same method California uses — makes price spikes sharper, said Dr. Richard Rosen, an opponent of deregulation and executive vice president of the Tellus Institute, an independent group that studies energy issues.

In New York's two markets — a "day- ahead market" and a spot market that sells power an hour before it is needed — the I.S.O. accepts offers to produce electricity at a particular price. The I.S.O. picks as many plants as it needs to keep the lights on, choosing the lowest bids first. Once all the demand for power has been met, the highest accepted offer sets the price all generators receive.

For example, plant owners might offer their power at prices ranging from 2 cents per kilowatt-hour upward, with most offers bunched between 5 and 10 cents. But a few offers might be as high as $1 per kilowatt- hour. On days when demand is close to overall supply, the I.S.O. has to buy that last bit of power, and under its rules every producer gets $1. Something like that happened a few times last summer, and it could happen more often as demand rises.

The idea behind the bidding system is that when supplies of power are adequate, generators will make bids close to their operating costs, because if they bid too high, their power plants may go untapped. In practice, when supplies are tight, generators can be certain almost any price will be accepted.

The system also encourages generators to bend bidding rules to move prices higher, said Richard Schuler, a member of New York's I.S.O. board. Generators that own several plants may even have a perverse incentive to take some of their supply out of service on hot days, since that can push up prices for the plants they do run. Though generators deny that such practices occur, the New York I.S.O. says it discovered 10 instances last year in which power suppliers manipulated the market. The most serious incident occurred June 26, when a generator withheld power from the market, making wholesale prices soar and costing consumers $100 million.

Given the I.S.O.'s limited enforcement powers — federal regulations prevent it from imposing fines or even publicly naming the generators that break its rules — analysts say manipulation will increase if supplies tighten.

"You've kind of given the generators a get- out-of-jail-free card," said Dr. Frank A. Wolak, chairman of the market surveillance committee of California's I.S.O. "If they continue with the pricing in New York, where they pass through the wholesale pricing, and you guys have a hot summer, wow — I wouldn't want to be at the New York I.S.O."

In theory, Con Ed could protect its customers from short-term price spikes by signing long-term, fixed-price contracts with generating companies, and some consumer advocates fault the utility for not locking up more supply. But Con Ed officials say the terms that generators are offering would lead to even higher rates.

Companies that buy and sell power are already expecting higher prices this summer. Natsource, a local trading company, is offering wholesale power in New York City at 13 cents per kilowatt-hour for July and August. Including Con Ed's transmission charges and other wholesale costs, that translates into a consumer rate of 23 or 24 cents per kilowatt-hour, or a monthly bill of about $120 for the average customer.

Prices may not go that high, especially if the summer is cool. But even at current levels, rates have businesses and consumers worried.

Derek Goins, vice president of operations for Maimonides Medical Center in Brooklyn, said the hospital's electricity bill rose from $2 million in 1999 to $2.8 million last year, even though it used the same amount of power. "I'm frustrated," Mr. Goins said. "It's a piece of equipment you might not be able to buy."

Gene Barrett, a retiree in Queens, said he had adapted to his higher bills. "It's pinching," he said. "What scares me most of all is this summer — is it going to keep going? There will come a point at which it will cut into more than disposable income."

The FutureFacing the Risks

Of Repeating a Crisis

New York's power woes will not go away quickly or quietly. Discussions about how best to proceed are charged with ideology and politics.

Some economists and consumer advocates say controls on wholesale prices are needed to keep generators from overcharging when supplies are tight. In December, the Public Service Commission asked the I.S.O. to cap the wholesale price of power at 15 cents per kilowatt-hour, with limited exceptions.

But the I.S.O. strongly opposes price caps, which it says will lead to supply shortages, push generators to sell electricity to other states and actually raise wholesale prices. It favors a mechanism called a circuit breaker, which would give it more authority to lower generators' bids if it believes there is not enough competition in its markets. Apparently swayed by that argument, the commission has backed away from its proposal.

Deregulation's supporters say that instead of imposing caps, regulators should give the markets time to work. Supply will increase as new plants are built. Industrial customers and businesses will eventually get meters that show electricity use in real time, so they can cut back consumption as prices rise on days of peak demand. Because of the way the I.S.O. sets prices, that could lower rates for everyone. But the Public Service Commission has moved slowly to approve meters, citing complex technical problems.

Governor Pataki says high prices have been decades in the making, and it is unrealistic to expect deregulation to be an immediate fix. "We want to have a vibrant wholesale marketplace that works," he said.

His critics say the state has not worked hard enough to increase supply or reduce demand. In fact, the most aggressive step the state has taken to increase supply — pushing to install the small generators for New York City — has the government intervening in a market it set out to deregulate. Although the plants will ease the city's short- term supply crunch, they put the state in competition with privately owned generators, which may be discouraged from building other new plants.

New York is at "medium to high risk" of repeating California's crisis, said George M. Knapp, a partner at the Coudert Brothers law firm who has studied both states' electric industries. But New York still has a little time, he said, and if it moves quickly to approve new transmission lines and power plants, it may sidestep disaster.

"Otherwise," he said, "you just step back and wait until it's your turn, like California."

http://www.nytimes.com/2001/02/25/nyregion/25POWE.html?printpage=yes

-- Martin Thompson (mthom1927@aol.com), February 25, 2001


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