Power Tripped

Faulty re-regulation turns out the lights in the Golden State.

Adrian Moore & Michael W. Lynch from the June 2001 issue

(Page 3 of 4)

Did it ever. Times have been great in California over the past few years: The economy has been working at capacity; more people have moved into the state; folks have been buying and air conditioning larger homes; they’ve been surfing the Internet and powering up all sorts of new appliances; golf carts have been filling up the state’s fairways. Everything, in short, has been expanding in California since the restructuring, a situation that creates more and more demand for electricity.

The Ostrich Approach

There may be only one area in which California has not been growing: the number of power plants. It’s difficult to get a permit and a site for a power plant in California, be it in an economically depressed area clamoring for jobs or a high-tech Mecca that demands power. Although no definitive study has been done, it’s generally agreed that a power plant that takes two years to build in a business-friendly state takes at least four years in California. Sunlaw Energy Co. wants to build a $256 million natural-gas-fired plant in South Gate, a blue-collar city in Los Angeles County. The plant is projected to bring in $6 million in annual tax revenue and $1 million in neighborhood improvements -- neither of which has been enough to assuage community activists who are fighting the plant.

In the Bay Area, new economy behemoth Cisco Systems is leading the charge against a proposed Silicon Valley power plant that makes so much economic and environmental sense that even the Sierra Club supports it. "If there’s ever a place that needs a power plant next summer it’s the Silicon Valley," says Beth Emery, who served as the general counsel for the Cal-ISO from November 1997 to November 1999 and is now specializing in energy law in the D.C. office of the law firm Ballard, Spahr, Andrews & Ingersoll. "These people have lost their minds." During last summer’s crisis, activist groups killed a proposal to float an electricity-producing barge in San Francisco Bay -- even as the city faced blackouts. The result of all the obstruction: From 1996 to 1999, electricity demand grew by 12 percent while supply grew by less than 2 percent, according to the California Energy Commission.

That alone would have placed the system under stress. Indeed, the Cal-ISO road-tripped to San Diego in the spring of 1999 to host meetings and to warn anyone who would listen that if nothing was done to get more power on line soon, the lights were going to go out. When the summer turned out to be mild, it looked like a case of Chicken Little. But by last year, a number of shocks, ranging from unusual weather to a shortage of natural gas, combined with the rigid regulatory system, turned the Cal-ISO’s prediction into reality.

"Anything that could go wrong did," says Emery. "High temperatures, lack of adequate resources, inability to get the right regulatory policy through, and then, to top it off, it’s like every decision the governor and the commissioner had made compounded rather than helped solve the problem."

Jerry Taylor and Peter Van Doren of the Cato Institute chronicle the shocks in a forthcoming study. The price of natural gas, which fuels 49 percent of California’s electricity and nearly all of its peak power, shot up in 2000. In 1998-99, natural gas was selling for $2.70 per million British thermal units (Btu). By December 2000, it was selling for $25 per million Btu, and spiking as high as $70. In addition, one of the four pipelines that supply natural gas to Southern California was shut down for much of August due to a break.

Three years of dry winters in the West left California, and other Western states, short of hydropower, with California’s average hourly hydropower output dropping 40 percent from 1999 to 2000.

California’s clean air regulations also boosted the cost of producing power. Since 1994, California has had a trading system for nitrogen oxide (NOx) emissions that forces utilities to purchase pollution credits in order to generate power. In the winter of 1999, the credits were selling for $2 a pound. One year later, they were selling for as high as $40 a pound. (Plants emit between one and two pounds of NOx per megawatt-hour of electricity. In January, regulators waived the permit requirements for generators.)

On the demand side, a hot summer and cold winter boosted demand. Like Spike Lee at the Academy Awards, the Golden State just couldn’t catch a break. The result: On June 29, 2000, electricity was wholesaling on the PX for 43 cents per kilowatt-hour (roughly enough power to run a big-screen TV for a seven-hour Clint Eastwood movie marathon). That was seven times higher than the price had been on equally hot days in June 1999.

In a real market, utilities would have passed on most or all of that increase to customers, as SDG&E did to Dominic Ciolino and others in San Diego County. And customers would have either sucked it up or started using less energy. But with retail prices fixed at roughly 12.5 cents per kilowatt-hour, the state’s utilities had to reach into their pockets to purchase the power at a huge loss. They figured they could do it for the short term. But the short term never ended. The utilities’ losses mounted, approaching $15 billion when PG&E filed for Chapter 11 protection on April 6.

Shades of Gray

Faced with these problems, Davis has worked tirelessly to shift both the cost and the blame for California’s mess. Wedded to retail price controls that were bankrupting the utilities -- his primary goal seems to be that no voter’s electric bill will increase on his watch -- he asked the federal government to put price controls on out-of-state generators and force them to sell power to California. "Never again can we allow out-of-state profiteers to hold California hostage," Davis ranted in his State of the State address. "Never again will we allow out-of-state generators to threaten to turn off our lights with the flip of a switch."

Davis accuses power generators of manipulating the market, shutting down some plants, and withholding power to raise prices, and their profits. His suspicions were bolstered by the research of MIT economist Paul Joskow, who found that power generators were making more money than would be expected if wholesale markets were charging competitive prices. Davis set aside $4 million to fund an investigation by the state attorney general into price manipulation -- never mind that federal and other state agencies were already making their own investigations. In mid-March, the Cal-ISO released a report claiming that, based on the costs of inputs, power generators had overcharged California utilities $5.5 billion for power purchased since May 2000. In the same month, the Federal Energy Regulatory Commission, which oversees wholesale energy markets, ordered wholesale power suppliers to refund $124 million in what it considered overcharges.

Yet it’s far from clear that anyone was manipulating the market, let alone breaking any law. Economists Nguyen T. Quan and Robert Michaels point out that power sellers can make between 450 and 1,000 bidding decisions each day in California’s market. The models used by Joskow and others to measure market manipulation take into account only a handful of bidding choices, and therefore are unable to distinguish between market manipulation and simply good business decisions. The usual accusation is that electricity generators withhold power from the day-ahead market so they can sell it in the hour-ahead market, when utilities are over a barrel to meet customer demand. But research by the University of California at Berkeley’s California Energy Institute found that prices are just as often higher in the day-ahead market, and that companies cannot make higher profits just by withholding power to sell in the hour-ahead market. A Federal Energy Regulatory Commission investigation, which wrapped up in February, concluded that power plant outages were based on legitimate business grounds and not designed to raise prices.