Sudden Power Glut Puts State in Costly Bind
Surplus bought under long-term contracts was resold at a $46-million loss
in July. Paradoxically, if trend continues, higher usage could be
encouraged.
JERRY HIRSCH, Times Staff Writer
California may be facing a persistent, escalating glut of electricity as a
result of its buying too much power through long-term contracts, according
to energy experts and a Los Angeles Times analysis.
The surplus, projected to peak in 2004, could pose a costly burden to
ratepayers unless electricity demand rises substantially, according to The
Times' analysis, which reviewed the state's power purchases and projections
for demand over the next several years. Just last month, the state racked up
$46 million in losses after selling surplus power for one-fifth the price it
paid. If that rate is sustained, the deficit could reach as much $500
million in the next year alone.
And if the surplus grows, the state could even find itself in the
paradoxical position of encouraging Californians to use more electricity to
help the state avoid selling large amounts of unused power at a loss.
The specter of a longer-term power surplus belies California officials'
portrayal of the recent electricity glut as only a short-term phenomenon
resulting from a cooler-than-normal summer and strong conservation efforts.
To be sure, factors such as weather, economic growth and power plant
breakdowns could bring the state's bet on energy into balance with demand.
Or the state could pursue other measures, such as buying out the contracts
or forcing utilities to reduce generation.
State officials, such as S. David Freeman, former head of the Los Angeles
Department of Water and Power (who sources say will be formally named to
chair a new state power agency), defend the power purchases. Freeman argues
that purchasing a "healthy surplus" busted the price spike of earlier this
year and will protect against blackouts in coming years.
He said ratepayers have always paid to maintain an electricity surplus.
Before deregulation, however, the cost of that surplus was reflected in what
the utilities paid to keep idle plants operational so they could be fired up
to meet sudden increases in demand. The cost of such standby service was
included in rates.
Yet utilities and others have begun signaling potential problems in the
state's power-purchasing strategy as it becomes apparent that the surplus
could grow in coming years.
Looking forward to 2004, the state has contracts to purchase 43% of the
electricity California's three large private utilities need for their
combined 10 million customers. But according to current trends, the
utilities need the state to supply only about 35%, The Times' analysis
shows. The rest can be handled by the power plants they own and through
their existing contracts with independent generators.
In documents filed with the California Public Utilities Commission last
week, San Diego Gas & Electric said the state might have overestimated what
it needs to purchase for the San Diego service area by more than 25%.
California entered the power business in January, when a surge in
electricity prices and regulatory limits on rates created billions of
dollars in losses for two of the state's biggest utilities, Pacific Gas &
Electric and Southern California Edison. The losses pushed PG&E into
bankruptcy. Edison has avoided seeking protection from its creditors in
Bankruptcy Court, but is technically insolvent.
While it purchased electricity for the two utilities and SDG&E, the state,
through its agent--the Department of Water Resources--started negotiating
longer-term contracts with private suppliers, signing deals that could total
$40 billion in purchases, mostly over the next decade.
Consumers' rates were increased in June by 3 cents per kilowatt hour. A
portion of the increase will fund the contracts, as well as payments on an
expected $12.5-billion bond issue to repay the state for its energy
purchases dating back to January.
Nonetheless, Gov. Gray Davis and his energy officials will face
uncomfortable policy choices if the state has guessed wrong and purchased
too much power without escape clauses in the contracts, as nearly every
energy economist, consultant and power company official who talked to The
Times believes.
One fix would be to encourage consumption to eat up the surplus.
That's what happened during an energy glut in the 1980s, when utilities cut
back conservation incentives and obtained rate changes that encouraged usage
in an effort "to consume their way out of the mess," said Bill Marcus, an
economist with JBS Energy Inc., which consults for the Utility Reform
Network consumer advocacy group.
PG&E has already broached one rate change suggestion that could result in
higher consumption: an increase in the baseline allotment, or amount of
power a household can purchase at the least expensive rate.
Other ways to deal with the surplus could include walking away from a
portion of the most expensive contracts, a move that would probably spark
protracted legal battles; paying generators to cancel contracts; encouraging
suppliers and utilities to close plants or reduce generation; or simply
absorbing the losses.
"We are all on this huge learning curve for electricity markets," said Doug
Larson, executive director of the Western Interstate Energy Board, the
energy arm of the Western Governors' Assn. "We have never gone from a
shortage to a surplus in an environment where market forces set the prices."
In signing the long-term contracts, the Department of Water Resources bet
that demand for power would grow about 2% annually and that an electricity
surplus would develop slowly.
That leaves the state exposed if demand grows less than the agency's
estimate, leaving it with too much juice. The state's financial risk expands
if a power surplus grows more quickly than predicted, depressing spot market
electricity prices and cutting off options for how the state can dump its
extra power.
The state's energy surplus looks to peak in 2004, but could still be
substantial for several years after that.
"Some percentage of the supply will be optional or on standby, but clearly
2004 is when we have the largest supply," said Pete Garris, the Department
of Water Resources' chief energy scheduler.
Complicating the state's strategy are the higher rates consumers are now
paying and a power plant building boom that is expected to push electricity
prices down as thousands of megawatts of new generation in California and
the West come on line over the next several years.
Energy economists say that current higher rates have already induced
consumers to conserve, causing a change in behavior that will probably
continue even with an energy glut. Ratepayers, they say, won't see the
benefit of lower energy prices because they will be locked into paying for
the cost of the state's contracts and its prior purchases.
Even while the state was selling surplus power, customers in the areas
served by its three large utilities used 3.5% less electricity last month
than a year ago, after adjusting for weather, according to the California
Energy Commission. Peak demand--when consumers are using the most
electricity--was off 9.1% after adjusting for a cooler July than a year ago.
Certainly, some of the conservation is transitory, a result of Californians
embracing their civic duty to see the state through its expected shortage.
Also, the economic slowdown has contributed to less usage compared with a
year earlier.
Yet higher electricity prices have prompted businesses and consumers to take
long-lasting measures to reduce power consumption, everything from replacing
household refrigerators with more efficient models to upgrading lighting
systems at businesses, energy economists said.
"Commercial and industrial customers account for two-thirds of the power use
in this state, and almost everything they do to reduce electrical loads are
durable, long-term investments," said Robert Michaels, an energy consultant
and professor of economics at Cal State Fullerton.
Freeman, the chief architect of the governor's energy policy, said locking
in the power surplus was done by design and is a necessity. Reserves of up
to 20% are what is required to ensure a reliable power system, he said.
"This is a very small cost compared to what a blackout does to the economy,"
he said.
Others argue that the state should have simply waited for the power surplus
to build before signing the volume of contracts it has reached with
generators.
Already, nearly 2,000 megawatts of generation capacity will have come on
line in California by the end of this summer, an amount equivalent to about
5% of the current peak demand of about 40,000 megawatts in the territory
served by the three big utilities. Facilities capable of producing more than
3,000 additional megawatts are under construction and slated to begin
operation in the next year, according to the California Energy Commission.
Another 2,500 megawatts is scheduled to come online in 2003. Meanwhile, the
commission is reviewing requests by generators to build plants for an
additional 5,000 megawatts.
In addition, neighboring states such as Arizona are building more plants.
With transmission line upgrades, some of this added electricity could be
available to California.
"A remarkable amount of plants are in the process of being built," said
energy consultant Michaels.
However, not all the new plants will boost megawatt capacity, because some
will replace dated or polluting facilities that will be shuttered.
Nonetheless, developments of the past 18 months have demonstrated that the
often confounding and unpredictable nature of the energy market makes
accurate forecasting exceedingly difficult.
In May, the North American Electric Reliability Council predicted that
California would see 260 hours of blackouts this summer, yet none has
developed. Cool weather--which took many meteorologists by surprise--along
with conservation efforts, a slowing economy and new power plants upended
many of the utility industry group's assumptions.
Just a couple of percentage points of error in either direction can make the
difference between a price-spiking shortage and a depressed market of
surplus power.
PG&E says it doesn't plan to cut back its operations because the Department
of Water Resources might have guessed wrong. In a statement, PG&E said the
state will have to bear the costs of its mistakes.
Officials at Rosemead-based Edison said it's too early to comment on what
might happen.
But Gary Ackerman, executive director of the Western Power Trading Forum, a
group of electricity sellers, said the state agency's best option is to get
generators to agree to let the private utilities take over the contracts,
"where they can be managed in a professional manner."
Because the utilities control an entire "portfolio" of power generation and
sources, they are better equipped than the state to manage surplus power
with limited financial losses, Ackerman said.
But before any of the utilities would accept the contracts, the state would
have to guarantee that they could recover their costs.
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