1 year old now, the energy crisis is a saga of wrong turns DAN McSWAIN Staff Writer - North County Times, The Californian How did it happen?

California's energy crisis, a public policy debacle that has already cost the state $50 billion in a year, has unfolded from its early warnings in the outrage of San Diego County consumers into a looming statewide financial and economic catastrophe that has drawn international attention.

The story of how California got here is an epic worthy of the nation's most populous and prosperous state, all by itself the world's sixth-largest economy. It has fear, hubris, greed and more than one tragic flaw.

But it is mostly a story about people who now wish they had done something different.

There is the governor, who underestimated the seriousness of San Diego County's crisis and passed up offers of cheap power last summer. There is the chief executive of San Diego Gas & Electric Co., who says he could have partly protected his customers.

There is the nation's former chief regulator, who wishes his agency had moved faster to crack down ---- both on California's flawed system and on the power sellers who were taking advantage.

"I would call it the year of missed opportunities," said the regulator, James Hoecker, in an interview last week. In January, Hoecker retired as chairman of the Federal Energy Regulatory Commission, called FERC by the industry.

As head of the agency that oversees the nation's power markets, Hoecker was at the center of efforts to stem the state's budding crisis. These days, he gives the occasional speech and has become obsessed with gardening.

Crisis 1 year old

On Tuesday, California's power crisis will be 1 year old.

It began when a surprise heat wave sent the wholesale price of electricity soaring throughout the West on May 22, 2000. Prices have never really come down.

Within 90 days, bills had tripled in San Diego County and parts of Orange County, the first places in the nation to experience deregulation of power costs.

The price shock was sudden and terrifying. People hadn't been told it was coming.

In the resulting political uproar, lawmakers in Sacramento scrambled to enact an emergency rate freeze for 1.2 million customers of SDG&E.

Then the crisis went underground, back into the insular world of power policy. But the meter was still running.

Gov. Gray Davis and fellow Democrats who controlled the state Legislature did little. They bet heavily that help would come from an obscure federal agency that polices electricity markets. The agency was filled with appointees of former President Clinton, also a Democrat. Help never came.

By Christmas, California's three big utilities were going broke, a hundred-year history of engineering achievement and political influence in tatters. In January, the first government-ordered blackouts since World War II rolled through the state.

By Easter, the state Treasury was hemorrhaging $50 million per day buying power to keep the lights on.

By Labor Day, state leaders say, the government may run out of money. Businesses are bracing for blackouts that are predicted to top 20 hours a week through the summer. About half of the state's residents will open bills next month that are 50 percent higher.

Federal help, especially price controls demanded by state officials, seems unlikely from the new Republican administration.

Experts say it will get worse.

Feds slow to react

Hoecker says now that the federal commission should have moved more swiftly to fix markets when problems appeared in June.

The commission waited until August to hold hearings on the matter, released an incomplete study of the market in November, and issued an order in December that arguably made things worse.

"FERC missed opportunities to get on top of investigations as fast as it should have," Hoecker said.

Many analysts say it was the November study that emboldened power companies and set the stage for rare winter price hikes. Average costs increased from 3.2 cents per kilowatt hour in January 2000 to 27.8 cents in January 2001.

The study blamed California's historic rise in summer electricity costs on the state's flawed market and on short supplies. While it said power companies may have had "market power," the ability to control prices, the commission said it lacked the resources and data to punish individual companies.

"That was sort of the beginning of the end," said Frank Wolak, a Stanford University economist who monitors state electricity markets. "That told the generators you have a get out of jail free card."

Many economists believed that low rain and snowfall in the previous winter had dried up supplies of cheap hydropower in the West, handing power companies the ability to raise prices at will. That theory fell apart in December, when prices surpassed the levels seen in summer, even though demand was at a seasonal low ebb.

Again, federal regulators may have encouraged sellers to raise prices at will.

For example, the commission replaced California's cap on prices with a "soft cap" that required power traders to justify their costs. On Dec. 8, the day the soft cap went into effect, electricity prices exploded.

What's more, on the same day, the price of natural gas began to hit all-time highs.

Natural gas is the fuel of choice for key power plants in California. Some of the same trading companies that control the power market also control supplies of natural gas.

State and federal paralysis

For much of the year, federal regulators and California officials have been in a political and policy standoff.

Hoecker and his colleagues faulted the state's deregulation for limiting the ability of utilities to buy long-term contracts that could have locked in low prices. The regulators also said the state moved slowly to build new power plants.

State politicians have responded that power markets are so broken, so badly flawed, that firm federal price caps are the only way to prevent economic devastation in the West.

State Sen. Dede Alpert, D-Coronado, said that in hindsight, state officials may have missed opportunities to limit the damage, counting instead on federal help. Alpert was the author of the emergency rate freeze law for SDG&E customers.

"We thought federal intervention was a very real option, and one of the best options open to us," she said.

Federal regulators, Democrat and Republican, have maintained that price caps would chase off power companies by cutting into their profits, worsening shortages.

Davis and other state officials went on the attack early, with a vehemence that surprised commissioners at what had once been a sleepy regulatory agency. The governor also has routinely ignored commission orders that carry the weight of federal law.

"I do think that I've got a pretty thick skin, but it was very hard for us to get people to sit down in a collaborative environment and get to a collaborative solution," Hoecker said.

Davis missed chances

The governor missed several key chances to respond more quickly. He ignored a request in June to use emergency power to build more power plants made by key authors of the state's deregulation law, state Sen. Steve Peace, D-El Cajon, and Sen. Jim Brulte, R-Rancho Cucamonga.

Davis also rejected calls for an emergency session of the Legislature in July by Assembly Republicans and Sen. Bill Morrow, R-Oceanside. Davis finally called lawmakers into session in January. Of more than 200 bills introduced, five have been signed.

After a slow start, the governor in recent months has done everything the regulators recommended. The state has embarked on a massive program to build power plants, and state power buyers are signing contracts.

Power prices, meanwhile, have continued to rise.

The federal commission, under a Republican chairman, has issued a series of orders designed to fix the market. Analysts say the orders lack vital enforcement provisions. The commission shows no sign of imposing price caps.

Illegal conduct disputed

A key question remains about whether power traders, in orchestrating the highest electricity prices in industry history, have acted illegally.

Economists say shortages, bad market rules, and lack of oversight from federal regulators made it so easy to raise prices that companies didn't have to break the law by colluding or forming illegal agreements.

State officials disagree. After months of accusations, Loretta Lynch, president of the Public Utilities Commission, said last week that she had hard evidence generators shut down plants to withhold supply and boost prices.

It's not clear that withholding power is illegal, or even improper, despite a recent federal order that requires generators to schedule plant shutdowns.

Wolak says it is almost impossible to tell if a power plant is really broken or if operators are faking it. Furthermore, trading and generating companies have a duty to shareholders to exercise market power if regulators allow it.

Under deregulation, "economic withholding" is permitted. Put simply, if a power seller doesn't like a low price, the seller doesn't have to turn on the plant until buyers offer more money.

For most of the last 100 years, electricity has cost from about 2.5 cents to 3.5 cents per kilowatt hour. Utilities tacked on distribution and administration costs, but the average price of the power itself has remained stable.

At the same time, economists say power is the most volatile commodity in the world. It can't be stored in large amounts, and demand must meet supply every second. Even in normal times, electricity has been given away free in the middle of the night and shot past $1 per kilowatt hour by the afternoon.

Shocking prices a year old

On May 22, 2000, an unexpected heat wave hit the West, boosting energy demand from power-hungry air conditioners while federal operators of the region's mighty hydroelectric dams were filling their reservoirs to prepare for summer.

A small cadre of power traders suddenly found that it could charge almost anything it wanted. Buyers for California's 2-year-old power manager, the Independent System Operator, were desperate to keep the lights on and would pay whatever it took to get electricity.

Prices in California shot to 75 cents per kilowatt hour ---- the top price permitted ---- from a trading range of 2 cents to 6 cents per kilowatt hour the day before.

Robert McCullough, an economist in Portland, Ore., recalls the mood in late May.

"A trader called me and said, 'I've just had the most remarkable phone call from the California ISO,'" McCullough said. "'They've got a heat wave and I was hoping to sell some power at 65 bucks (per megawatt hour), but they called and asked me if anyone had any power to sell for $750,'" McCullough said.

In June, a second big heat wave caused blackouts in the San Francisco Bay area. Prices soared and California utilities spent $1 billion in a single week, $3.6 billion in a month. Officials estimated that $2.4 billion was profit to power companies.

By contrast, in 1999, the utilities spent $7 billion all year. By the end of 2000, the utilities spent $27 billion. This year, economists say the bill could top $1 billion a week all summer, costing a devastating $70 billion by year's end.

Did SDG&E do it?

By late June, outrage began to build in San Diego County as consumers opened bills that were up 50 percent, then double, then triple as the summer burned on.

A few small companies were run out of business. Retired people turned off air conditioning during 100-degree inland heat. Poor people went to offices that distribute energy assistance money only to find agencies had run out of funds.

Attention automatically turned to SDG&E, the utility that had earned the contempt of many customers in the 1980s for having some of the highest rates in the nation.

This time, SDG&E didn't do it.

Under the arcane rules of California's partial deregulation in 1996, the utility had sold off most of its power plants, so it wasn't directly making money from the higher prices.

But the utility was guilty of failing to protect its customers with a purchasing strategy called "hedging."

State regulators had given utilities a limited ability to buy long-term contracts, locking in rates to hedge against the ups and downs of the daily market.

But regulators reserved the right to second-guess any contracts.

The result: SDG&E didn't buy any power ahead of the summer, when prices generally go up even in a good year.

"We were wrong," said Stephen Baum, chief executive of Sempra Energy, the parent company of SDG&E. During in October interview, he said: "We should have hedged. I wish to hell we had hedged. We didn't foresee the price spikes, or we would have hedged."

In early May, before prices began to rise, Peace sent a letter asking the utility to buy long-term power for its customers. The letter also predicted harm to consumers.

By November, the utility had begun to buy contracts after a chorus of economists, power companies and the federal regulatory agency said such contracts could help rein in the market. Later, the utility set aside $30 million in anticipation of a state fine for failing to hedge.

State regulators have still not lifted restrictions on the contracts, despite a federal order.

Rivals Southern California Edison and Pacific Gas & Electric did use its limited authority ahead of last summer, saving hundreds of millions of dollars.

The utilities ran out of money anyway. The contracts, however, became important to state power buyers when in February the governor used emergency powers to seize the contracts from power traders who had sought to liquidate them to repay bills owed by utilities. The matter is still under litigation.

Passing on lower prices

Although there were warnings, even the power-trading community didn't realize how high it would be able to push prices.

For example, in April 2000, producers were selling short-term contracts to produce electricity in August for $43. The actual market price in August surpassed the $250 price cap.

Another example: Enron, the world's largest power-trading company, agreed to sell power to the city of Roseville for $49 for five years. That contract was sold during the heat of last summer's power crunch. It was derided by state officials and industry analysts as an expensive deal, because experts predicted that prices would fall by winter.

At about the same time, Davis ignored an offer from Duke Energy Inc., owner of power plants in Chula Vista and Northern California, to sell power for $55 per megawatt hour.

Now those deals look good, at least to state power buyers. When the governor stepped into the market in January, he bypassed the restrictions of state regulators and turned to a strategy of negotiating long-term contracts on terms that have largely been kept secret.

In February, state power buyers announced they had signed five-year contracts for an average cost of $79 per megawatt hour.

Contact staff writer Dan McSwain at (760) 740-3514 or dmcswain@nctimes.com.

5/20/01

http://www.nctimes.com/news/2001/20010520/62221.html

-- and to think Gray Davis once had a future (just@stupid.enough), May 27, 2001

Answers

Davis asks Bush to waive gas additives requirement

-- (Paracelsus@Pb.Au), May 27, 2001.

Excellent.

Have little to offer except that Gray (don't you just love my hair) Davis has been mostly an obstruction to a cure. SDG&E was first able to put the heat on users because they were first and only to recover their dereg costs and thereby allowed to pass on costs. Big D blew them off last fall as gougers. Further, Davis relied on the moribund PUC instead of listening to PG&E & Edison's dire warnings as early as Feb 2000.

Don't mean to really pick on him. He's just a politician and I suppose we shouldn't have expected foresight.

Article states that there are contracts signed for $79 per megawatt average. Doubt that. If so how come the contracts aren't public info?

-- Carlos (riffraff@cybertime.net), May 27, 2001.