California in the Dark

By Lawrence Makovich and Daniel Yergin

Friday, March 16, 2001; Page A21

The common diagnosis of California's electric power debacle is wrong. The state is not suffering from deregulation. Rather, it is afflicted by a strange mutant ailment -- partial deregulation and now partial reregulation -- that has produced a flawed market. California designed a market that disconnected customers from prices and, at the same time, made it neither profitable nor possible to build a new power plant. The result is a serious power shortage.

Instead of fixing these flaws, the current policies from Sacramento are moving California down the road to an expensive public power setup and higher prices for consumers and businesses. And the shortage is going to get worse this summer. Under typical weather conditions, the state could face as much as a 10 percent shortfall in electric power during summer peak demand, which will mean severe emergency conditions and periods of blackouts. The effect is likely to be a big shock not only to the economy of California and to the rest of the interconnected West but also to the bruised national economy.

Unlike other states that have successfully deregulated over the past few years, California has made three crucial mistakes since the mid-1990s, when restructuring of the power industry began.

The first is the political unwillingness to allow consumers to see real price signals. The so-called "wholesale price" -- what utilities pay to generating companies -- has been decontrolled, but the price consumers pay to the utilities has not. Consumer prices are remain at 1996 levels, and Gov. Gray Davis has promised to hold to his pledge of no rate increase. Although the price of natural gas, which is used to make a large and rapidly growing share of electricity in California, has increased dramatically, consumers would not know that from their bills. Nor would they know that rain and snowfall levels, on which California critically depends for hydropower, are at low levels. As a result, the utilities have been in the perverse position of selling power to their customers at much lower rates than they are buying power from generators. That is why the utilities are now $13 billion in the hole and teetering on bankruptcy.

Instead of letting customers see higher prices that reflect the realities of supply and demand -- and then act accordingly -- the state is going to use their tax money to advertise conservation. But 25 years of experience demonstrates that promoting conservation without price signals is not very successful. Instead of paying through their bills, Californians will be paying through their taxes for various measures that will enable politicians to say that they prevented electric power rates from going up.

As California drains electricity from its neighbors, residents of those states are seeing their power bills go up by 30 percent or more. We calculate that if rates in California rose by just 20 percent, a third of the shortage could disappear in a matter of months. But instead, the state has embarked on a course of passing higher costs along to consumers in neighboring states and leaving the major bill to be paid by Californians themselves in decades to come.

The second mistake in California is a failure to charge customers for "capacity." Electricity, unlike other commodities, cannot be stored. If there is a shortage of telephone equipment, the result is a busy signal -- frustrating but survivable. But when it comes to electric power, the equivalent of a busy signal is a blackout, and that is unacceptable. Thus, a well-functioning power system needs to pay generators to maintain adequate capacity. That includes a reserve of capacity about 15 percent above expected demand to cope with the unexpected -- whether it's a heat wave, a sudden surge in economic growth or breakdowns in aging power plants. In contrast to other states, California's scheme did not provide any incentive for generating companies to add new capacity and maintain that kind of reserve.

The third mistake is the creation of monumental obstacles to siting and granting permits to new facilities. California is one of the most difficult places on earth to build a new power plant. The environmental permit process, in contrast to other states, is complex, cumbersome and deeply discouraging to would-be investors. Companies will spend three or four years to get approval after approval -- and then find their proposal shot down by yet another local group.

As a result of all this, no major new plants have been built in the state in the past 10 years. Meanwhile, the California economy grew 29 percent over the past five years. In the same time, its electricity consumption increased by 24 percent. The result was inevitable -- a shortage.

California is on the verge of making three more mistakes in dealing with the power crisis. First, the state is signing badly designed long-term contracts for electricity in the midst of a shortage. California cannot simply finance the crisis forever into the future. This summer is likely to generate billions of dollars in additional uncollected wholesale power charges, which now appear likely to be on the state's books, to be paid over an untold number of years.

The second mistake is the plan for a state takeover of the transmission wires to provide a multibillion-dollar cash infusion into the state's three biggest utilities in order to temporarily hold bankruptcy at bay. The prospect of the state -- now the largest power purchaser in the market -- controlling the physical infrastructure necessary for market interactions will have a chilling effect on power investment. As a result, the state could well end up having to assume the role of building new power plants in the future.

Third, a market breakdown this summer would add enormously to the pressure for price caps on wholesale power. But even "temporary" price caps, because of uncertainty over their duration and effect, would slow rather than encourage new investment. Unfortunately, the state's current plans and proposals divert attention from ways of fixing the problem and have California on the path to an expensive and expansive public power authority.

The priority need is, first, to move very quickly to increase supply and reduce demand, and to do so now, while the coming big shock is still a few months away. Second, the flaws in the market should be fixed, taking advantage of the positive lessons of deregulation from other parts of the country. But that won't happen without political will -- and a surge of realism.

Lawrence Makovich, senior director of Cambridge Energy Research Associates, and Daniel Yergin, chairman, are co-authors of "Beyond California's Power Crisis: Impact, Solutions, and Lessons."

© 2001 The Washington Post Company

http://www.washingtonpost.com/ac2/wp-dyn/A12670-2001Mar15?language=printer

-- Cave Man (caves@are.us), March 16, 2001

Answers

Friday March 16, 10:43 am Eastern Time

California utility shares fall on renewed bankruptcy fears

NEW YORK, March 16 (Reuters) - Shares of California's financially troubled utilities fell sharply in early trade Friday as the threat of bankruptcy looms once again as their creditors are seen becoming impatient with lack of a solution.

On Friday, shares of PG&E (NYSE:PCG - news), parent of Pacific Gas and Electric Co., were down 7.5 percent or 97 cents to $11.95, while stocks of Edison International (NYSE:EIX - news), parent company of regulated utility Southern California Edison, were down nearly 7 percent or 94 cents to $12.65.

Coram Energy, classified as a Qualifying Facility (QF) which allows it to sell power to Edison at rates above market levels under a federal ruling, is said to be circulating a involuntary bankruptcy petition against Edison among other five other QFs.

On Wednesday, the U.S. District Court ruled in favor of Caithness Energy's attempt to place a lien on Edison's Mojave power plant, which could allow Caithness to take over these assets. Caithness is also a QF.

California's power woes stem from a 1996 state deregulation law that barred utilities from passing through higher wholesale costs to consumers, pushing Pacific Gas and Electric Co and Socal Edison to the brink of bankruptcy with some $13 billion in unrecovered power costs.

However, some analysts feel that the involuntary bankruptcy petition is just what is needed to get the political solution -- which is seen as slowing in recent days -- back on track.

``Progress toward a solution have effectively stalled in recent days and creditors are losing patience. It is not clear that the political will is sufficient to take the actions necessary to resolve the situation, which ultimately require rate increases,'' said Merrill Lynch analyst Steven Fleishman.

At the hearing before the Senate Energy Committee on Thursday, Energy Secretary Spencer Abraham forcefully reiterated the Bush administration's opposition to price controls in Western region.

http://biz.yahoo.com/rf/010316/n16549872.html

-- Cave Man (caves@are.us), March 16, 2001.