Power failure - What went wrong with Californian energy deregulation?
Financial Times, December 27
By Christopher Parkes
Harsh words and angry exchanges can be expected when consumer advocates, power company executives and politicians meet in Sacramento on Wednesday to resolve the energy crisis that has brought California to the brink of blackouts this winter. But the course of action is already clear: 20m consumers who were promised that market deregulation would eventually bring cheaper prices will soon have to accept increases of at least 10 per cent in the cost of electricity.
The action - which will mean abandoning the price freeze agreed in 1996 - has been forced on the state's Public Utilities Commission by the news that financial pressures were threatening thousands of job and even the viability of Pacific Gas and Electric and Edison International, California's leading private-sector distributors. Their debt faced relegation to "junk" status, weakening their ability to raise funds.
In two months the companies have between them accumulated more than $8bn in debt. Under the terms of the state's experiment in partial deregulation, they cannot charge more than $70 a megawatt hour for power that now costs them as much as $1,400 - almost 50 times as much as a year ago.
"We believe that retail rates in California must begin to rise," the utility commissioners said in an interim opinion issued last Thursday. "It is our intent to maintain the utilities' access to capital on reasonable terms."
The price rises, to be discussed at public hearings in Sacramento today and tomorrow and introduced possibly as soon as January 4, have been condemned as a "ratepayers' bailout" by consumer groups. But Wall Street is relieved. "Acerbic rhetoric has finally given way to pragmatic conciliation," says Raymond Niles, an analyst at Salomon Smith Barney.
PG&E and Edison International are seeking price rises of a little under 20 per cent; the state government has hinted that 10 per cent - to start - would be more acceptable politically.
That California's energy deregulation has gone awry is beyond doubt. Gray Davis, the state governor, is due to meet Alan Greenspan, chairman of the Federal Reserve, today to discuss the risks energy shortages posed to California's economy and that of the nation at large. Economists see the crisis as a further sign that, after years of under- investment, the state's infra-structure is in no condition to sustain growth.
But while higher consumer prices may ease the utilities' immediate predicament, long-term remedies will also be needed. Mr Davis, a Democrat struggling with a policy inherited from Republican Pete Wilson and his appointees on the PUC, has suggested it might be necessary to return to a regulated market. Even John Bryson, chairman and chief executive of Edison International - one of the groups that helped formulate the deregulation project - has called for radical action. "We need to reform and, where necessary, re-regulate California's electric system," he said before Christmas.
The proximate causes of the crisis lie in a coincidence of circumstances that have exposed the underlying weakness of both the supposedly "free" market in power and the fragility of the generating systems supplying it. As defenders of energy liberalisation point out, a market in which retail prices are in effect capped while wholesale rates are governed by supply and demand can hardly be called "free".
In the rush to deregulate, few considered the possibility - now a reality - that natural gas prices would rise sharply. But in the past year the cost has risen more than three-fold to the highest levels seen in the 10-year history of the gas futures contract on the New York Mercantile Exchange.
A cold spell in November and December forced a reversal of the normal seasonal trade in power. California, which customarily imports electricity in summer to keep the air conditioning spinning and exports autumn and winter surpluses, remained a net importer.
At the same time, hydroelectric generators in the north of the state as well as in Oregon and Washington have been obliged to reduce production and transmission of their traditionally cheap hydro-electric power this year because dry weather has left their reservoirs unfilled. As a result, California's own oil- and gas-fired power stations worked so much overtime during the summer that the need for maintenance and repairs meant that a third of the state's capacity was shut down for much of this month.
But the underlying causes of the present difficulties go back at least five years. Then, as the state emerged from the deepest recession in its history, little account was taken of the fact that no significant generating capacity had been built since the late 1980s. None has been added since, even though about a third of the state's generating plant is technically obsolete. Since the mid-1990s, however, the Californian economy has grown so vigorously that its gross product is now the sixth biggest in the world - ahead of Italy and closing fast on the UK. Last year, according to Bill Richardson, federal energy secretary, the state's consumption of electricity rose 13 per cent.
California's strong environmental lobby is partly to blame for the lack of additional generating capacity. Even as a heatwave was causing rolling blackouts in the San Francisco Bay area, local authorities this summer refused Duke Energy and Calpine permission to build new power stations. At the same time AES, another generation group, was detected running its plant so hard that it breached air pollution limits. Although it was allowed to continue because power supplies were so tight, the regional air resources board punished the lapse this month with a record $17m fine.
Generators cite such cases as examples of the disincentives to investment in California. They complain that obtaining planning permission for a new power station in the state typically takes up to four years, twice as long as elsewhere in the US.
Out-of-state suppliers in Texas and Arizona, over which Californian officials have no jurisdiction, stand accused of "price gouging" and exploiting the situation - charges now under investigation by state and federal authorities.
With industry and commerce requiring less energy because of the holiday break and the promise of higher prices on the way to relieve generators, California's electricity crisis may be abating. At its worst, blackouts were avoided only because industrial customers voluntarily reduced consumption and householders responded to appeals to switch off their Christmas lights at the evening peak in demand.
But deregulation had the aim of reducing power costs which were up to 50 per cent higher than elsewhere in the US. Cuts of 20 per cent over seven years were promised: instead, prices are to be increased. That is more than a costly embarrassment for a state that prides itself on being a trendsetter. By strengthening the case of proponents of regulation, it could stall market liberalisation efforts in other states and may yet throw the process into reverse at home.
All is not yet lost. The advent of higher retail prices has been welcomed by Wall Street as a sign that rationality is returning to the market. Economists predict a slowdown in regional growth and reduced demand for electricity, providing an opportunity to make further corrections to increase supply.
But there is a more alarming possibility as well. Meteorologists who correctly predicted the havoc wreaked by El Nino in 1998 said a year ago that California and the west were in for a protracted drought to match the one that emptied reservoirs between 1986 and 1992. If that happens, the crisis just past may be only the beginning - and the recriminations in Sacramento today merely a taste of the acrimony to come. |
