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California's Energy Crisis – Who's to Blame?

By Curtis Lang & Jim Ridgeway on Jun 4, 2000

This article first appeared at OnMoney.com, a division of the online broker Ameritrade.

Do You Believe in Magic?

California's new $10 billion energy bailout plan is being greeted with skepticism by both industry experts and consumer groups. That’s not surprising because the state of California, which has already proven itself to be “the gang that couldn’t deregulate”, has rushed to implement an emergency plan that looks increasingly like a band-aid on a severe gut-shot wound.

Philip Angelides, the California state treasurer, told the New York Times this week that the bond package was “done pretty fast,'' and “we based it on some models, but we're not sure what the future will be like.''

The $10 billion won't be used to buy power, but rather to cover losses California may incur over the next 10 years. The amount of money needed to buy power is greater than the $10 billion authorized, maybe approaching $20 billion over 10 years, experts say.

As they roll out their under-funded, under-modeled energy bailout plan, beleaguered California officials should not look to Washington to help in their hour of need. Energy Secretary Spencer Abraham told a group of western governors at Portland Friday, that the Bush administration, at least for now, is disinclined to step into the energy crisis with government controls.

“I have great concerns about that, and the president has expressed concerns as well,” Abraham explained. “At a time when demand is a very serious challenge for us this summer...anything that puts disincentives in place, that would work against reducing demand, I think has to be looked at very closely.''

In plain English, that means that the Bush administration expects the “magic of the marketplace” to solve California’s energy problems, sure to increase during peak power usage this summer, by raising the cost of electricity to businesses and consumers until it becomes unaffordable to many, and existing supplies can meet newly reduced demand.

It’s a simple, even elegant solution from the Bush administration’s point of view, based upon the contention that the botched deregulation of California’s energy markets can be corrected simply by raising prices to end-users, who have until now been protected from soaring wholesale electricity costs of the past year.

It’s also a politically unacceptable solution – in California if not inside the Beltway. Increasingly restive California consumers expect both state and Federal governments to step in and insure them an electricity market that provides affordable, plentiful electricity – now and throughout the coming long, hot summer.

Angry consumers may ask, what about other Federal agencies? Is the President the only source for relief in all of Washington?

Well, the federal government exercises considerable sway over wholesale electric rates through the Federal Energy Regulatory Agency. FERC can set wholesale interstate rates to make them reasonable and fair. But its members, who are keen supporters of deregulation, have been loathe to intervene.

Consumer group alleges price-fixing

Electric utilities and their out of state energy suppliers are facing a growing barrage of accusations that they have manipulated energy markets to rig prices, and thus triggered the energy crisis, in part, through their own actions.

What’s the evidence for these allegations?

Well first of all, prices are higher this year for electricity in California , but demand has been lower during four of the last six months than during comparable 1999 periods, according to analysis by Public Citizen, the Washington, D.C. based consumer group associated with Ralph Nader. This contradicts the arguments of utility companies and power generators who claim that higher prices are the result of increased demand.

Public Citizen analyzed “hourly load data compiled by the California Independent System Operator (CAISO). CAISO uses this data to find out how much energy must come from various plants to meet California demand and records the highest amounts of demand by hour within the state of California .”

“The data shows that while demand did soar in May, in four out of the past six months -- July, August, October and December - California saw a lower peak demand than during the same months in 1999,” Public Citizen contends.

While power plant producers believe consumers need to pay higher rates to produce the revenue for construction of new power plants “to meet the alleged higher demand. Our analysis reveals their ploy to soak consumers." Public Citizen goes on to say, “With no increase in energy demand, a major contributor to the current crisis is that plants servicing California with 11,000 megawatts of capacity have been taken out of service for a variety of reasons, most undisclosed.”

"Power producers are inappropriately citing increased demand to justify building new plants," states the report, "and they are hoping to speed the process by suspending California's environment-friendly standards."

Suing the Power Producers

On January 18, 2001 the San Francisco city attorney sought an injunction in state Superior Court against energy suppliers and utilities for “unfair, unlawful and deceptive trade practices.'' Defendants include Enron Energy, Dynegy Power Marketing, Duke Energy, L.P. Williams and Morgan Stanley, among others.

The suit claims the energy companies manipulated The Independent System Operator (ISO) into issuing power shortage warnings during the summer of 2000, and then withheld energy supplies from the wholesale market in order to drive up prices, thereby forcing the state agency to buy on the expensive spot market, driving up prices to their own benefit.

One thing is for sure, power producers and utilities have made a mint over the last year in California.

Another consumer group, Public Campaign, published figures purporting to show that after tax profits of California's seveb out of state power producers, which sell on the wholesale market, amounted to more than $4.7 billion. The state's big utilities-PG&E and Southern California Edison -- have received $20 Billion in taxpayer bailouts for so-called “stranded assets'' -- i.e. bad investments, notably nuclear power.

Investigations so far have failed to prove collusion by Enron and others, but the allegations by consumer groups have been bolstered by a study of the situation by Analysis Group/Economics, which was commissioned by a parent of utility Southern California Edison. That study concluded that “power was being withheld inexplicably, at the exact time at which prices were most vulnerable to manipulation,” as Edward Kahn of AG/E told Business Week. Co-author Paul L. Joskow, professor of Economics at MIT, told Business Week that the causes of the debacle are “bad regulation, bad market design, bad luck, and greed.”

Enron dimisses the study as flawed, designed to absolve the utility that paid for it of any share of the blame for the ongoing electricity crisis.

However neutral third parties are also beginning to suspect that the rolling blackouts may not have been entirely unavoidable, and the investigations continue.

Credit Suisse First Boston, the Wall Street investment Bank, which has been advising Senate Speaker Robert Hertzberg on the energy crisis, suggested the state's rolling blackouts were probably “intended to soften up the legislature and the voters to the need for rate increases.'' (View the entire memo at consumerwatchdog.org).  

To deregulate or not to deregulate?

The Bush administration’s knee-jerk deregulatory stance provides ample ideological reason for ignoring the mounting evidence that the “magic of the marketplace” may not be the best medicine for what ails California’s electrical grid.

And don’t expect Bush to probe into the possibility that Enron and other out-of-state power generators manipulated the partially deregulated electricity market.

Enron Corp. CEO Ken Lay is an old friend and backer of George Bush, Sr., and Bush Sr.’s Secretary of State James A. Baker III and Commerce Secretary Robert Mosbacher, Sr., were hired as Enron consultants after the ’92 defeat by Bill Clinton.

Since then, Enron has donated more than $550,000 to Bush Jr., making the energy company Dubya’s biggest donor during his tenure as Governor of Texas.

Enron supplied Dubya’s Presidential campaign with corporate jets and kicked in $250,000 for the Republican convention. For his part, Lay contributed $100,000 to the Bush Jr. inaugural committee. This was only fitting since Lay served as Dubya’s key energy advisor during the 2000 campaign, and is currently a key advisor to the Bush Energy Department.

So for personal, ideological and political reasons it’s important for Bush to stay the course in California, leaving the ratepayers to pay for the mess created by incompetent state regulators, mis-managed utilities, and powerful out-of-state energy generators like Enron.

Section 3: What Works and What Doesn’t

But what about the larger questions? Does deregulation of electricity really work? Is there any good reason for regulation of utilities at all?

Some experts say that the very nature of the electricity industry gives too much power to producers, whether or not there are state-mandated monopolies.

In a deregulated market, when demand rises, companies should seize the opportunity to increase capacity, build new plants, and make more money.

Prices would increase steadily until producers could do so, and as prices increased, demand would fall, creating a continuous, fluctuating state of equilibrium – more or less.

But building power plants takes years, and consumers and businesses tend to want their electricity even if prices go up. This creates the possibility that in situations of temporary scarcity, prices could go up astronomically, and producers could make more money in the short and medium term by limiting the supply and reaping windfall profits.

Because California’s flawed deregulation plan required that utilities sell their power generation plants to outsiders – like Enron – the utilities lost the ability to accurately predict long-term prices for power. In fact, California set up a flawed system that forced the utilities to buy all their power from the California Power Exchange one day at a time. The theory was that this would create the perfectly transparent market with all players forced to participate. Any power left over would be sold the next day to California’s Independent System Operator, insuring that the system would clear day by day.

Elegant economic theory, but in the real world, during a situation of temporary scarcity, power producers could simply neglect to sell power to the Exchange and just wait until the last minute to sell to ISO.

The allegation by consumer groups and others is that utilities, anxious to roll back environmental regulations their aging plants increasingly could not meet, kept plants offline or allowed the repairs on them to take place at a slowdown pace, helping to create the temporary scarcity that has plagued the California electricity market this year.

Public Citizen’s demand analysis, cited above, indicates that demand has not been uniformly higher in 2000-2001 than in 1999, and since 11,000 megawatts of capacity have been offline for long-overdue “repairs” and for other, undisclosed reasons, there is ample room for fear that there is, in fact, no free market for power in California at all, but rather a comfortable oligopoly of utilities and power producers who are manipulating markets and public opinion to suit their own purposes.

These are serious allegations.

Energy producers and middlemen like Enron insist that they are not withholding supplies to drive up prices, but are victims of other circumstances, such as: draconian environmental regulations in California, which stymie the building of new power plants, and make it difficult to keep dirty old plants in operation; the inability of utilities to pass along wholesale price increases to consumers; and a general attitude among Californians that they don’t want new power plants built in their back yards. They hope the Bush administration will help them out by eliminating environmental regulations and using the Presidential bully pulpit to argue in favor of complete deregulation and totally free energy markets. Then they will build more plants and run old, dirty plants currently kept offline to prevent pollution.

But some independent experts say that the current crisis is the perfect demonstration of the need for a regulated market and that increased supplies won’t solve the problem of concentrated market power in the hands of a few energy providers.

“There’s a very good reason this industry has been regulated for 100 years,” Dr. Frank Wolak recently told the New York Times’ Alex Berenson. Wolak is an economics professor at Stanford University and chairman of the market surveillance committee of the California Independent System Operator (ISO). “This is an industry that’s extremely susceptible to market power.”

The bottom line is simply this: whom will markets serve? Markets are man-made creations; they do not spring full-grown from the aethers, like Athena from the body of Zeus. Markets are social creations, designed to serve the needs of entire societies. In this case the key question is this: Will California’s electricity markets be designed to serve the needs of deregulation ideologues, utility companies anxious to offload the costs of a prized but flawed deregulation scheme they highly supported onto ratepayers, and of out-of-state power companies like Enron anxious to maximize market leverage? Or will the market be designed to serve the needs of citizens and businesses in California who need safe, clean, steady supplies of electricity at affordable prices?