commentary from this weekend's Barron's FYI
California makes a mockery of markets
By THOMAS G. DONLAN
"CALIFORNIA DREAMING IS becoming a reality." The Mamas and the Papas said it first, but Gov. Gray Davis and the Federal Energy Regulatory Commission are going the dreamy rockers one better. The Davis administration has published evidence that energy companies such as Enron manipulated the state's supposedly deregulated markets and forced utilities and the state to pay too much for electricity and natural gas two years ago. Federal regulators have swallowed most of the state's claims. With shock and horror, officialdom revealed how traders gamed the system to drive spot prices above the just and reasonable levels that should have prevailed during the California electricity crisis.
They engaged in phantom trades at inflated prices, held back supplies, bought and sold at the same price to create a false notion of liquidity in the market. Enron traders in particular used their knowledge of the physical markets managed by another division of Enron to make profits in financial derivatives.
But even the FERC staff acknowledged that "supply-demand imbalance and flawed market design greatly facilitated the ability of certain market participants to engage in manipulation."
The state sort of deregulated in the mid-1990s, but officials never intended that their constituents would have to pay higher power prices. Then economic growth increased demand, while drought was reducing the supply of cheap hydropower. The state had mandated that California power companies rely on spot markets, rather than pay a premium for reliable supplies on long-term contracts, so market prices soared.
For a brief moment of glory, however, FERC refused to indulge the state's fantasies and refused to impose price controls on interstate sales of electricity and the natural gas needed to generate it. In that period of freedom to play a highly sensitive market, traders helped drive prices higher.
Some, working for Enron, Dynegy, Aquila, AEP, CMS and El Paso Merchant Energy, have admitted falsifying natural-gas price information sent to trade publications. A federal grand jury in Texas has indicted an El Paso executive for feeding false information to the trade press, and two Enron executives have pled guilty to similar charges.
(It certainly would be interesting if the grand jury and its U.S. attorney set up shop in Washington, D.C., where feeding false information to the political trade press still is considered a legitimate industry.)
Williams, Reliant, Duke, Mirant, Coral, and Sempra were also viewed with alarm and suspicion, and FERC's staff says that all should be required to prove that they provide complete, honest and accurate information, certified by their chief risk officers, or lose their licenses. FERC also says that California should get refunds -- perhaps $3 billion worth -- from the trading and generating companies.
Said Davis, "I'm pleased that the Federal Energy Regulatory Commission has finally recognized what we've known for a long time in California, which is that California was the victim of market manipulation and illegal gaming." But the governor isn't satisfied: "Now the real question is whether the Federal Energy Regulatory Commission has the grit to issue appropriate remedies. Show me the money. Where is the $9 billion that we've been asking for two years?"
If FERC doesn't satisfy the state's demands, the state will take the case to federal appeals court and possibly the U.S. Supreme Court.
We dare to hope that this is hubris, which will lead to a well-deserved court tragedy for the state. If California submits this mess of its own making to the federal courts, the result should be a judicial wake-up call to the California dreamers, sweeping away the whole clumsy machinery of energy price regulation.
It's time to let high prices restrict demand and let restricted demand force down prices. The things the energy-trading villains did would not have been illegal in free markets, and would not have worked in them. California needs a real market for energy, even if judges must supply it. |
