A Penny Saved Is a Billion Dollars Earned for Energy

The emergence of a creative new “headroom” option gives negotiators for the governor and Legislature the tools they need to resolve the electricity crisis. The only real obstacle is the utilities’ willingness to bargain.

Publicly, Southern California Edison and Pacific Gas & Electric are demanding a $12-billion bailout to pay off the wholesale electricity costs incurred since the crisis began. This claim has all the credibility of Pinocchio on steroids. Recent revelations that they sold power to themselves at inflated rates and funneled utility tax refunds to their parent companies will likely cut that price tag in half or more.

But that is precisely what is so critical in the current negotiations: All parties must first agree on a price tag. Once they do that, the political challenge will be to provide the utilities relief without raising electricity rates or taxes or appearing to agree to a utility “bailout.”

In fact, there are three ways to meet this challenge. Option 1--buying the transmission grid--is now commonly accepted as the linchpin of any solution. The state would buy the grid at fair market value with revenue bonds so it’s a “buyout,” not a “bailout.”

The state would then lease the grid back to the utilities to operate and pay off the bonds with revenues from transmission rates. In other words, the state would do what it currently does: operate the grid. And the utilities would do what they currently do: maintain the transmission wires. But the transaction would generate a bundle of cash while helping to resolve a whole slew of other electricity issues.

The big problem with the grid option is that it may not generate quite enough cash to consummate a deal. That means an added sweetener may have to be found.

With Option 2, the utilities would exchange stock warrants for some added cash. These warrants might be issued with a face value of, say, $15 per share. Then, when the utilities stock rises to, say, $20 per share, the state could cash the warrants in and recover its money. But the actual number of warrants that can be issued are constrained by Wall Street’s fears over stock dilution. As a result, the warrants may generate only a small fraction of the cash that the state actually turns over to the utilities. By any definition, that’s a bailout and therefore politically unacceptable.

Accordingly, negotiators may have to find a final sweetener to either supplement or replace the stock warrant deal. That’s where a creative new “headroom option” may come to the rescue.

Retail electricity rates are frozen at about 7 cents per kilowatt-hour. At the same time, the power generated by California’s own utilities is substantially cheaper. Indeed, approximately 60% of the power consumed by Edison and PG&E; customers is produced at rates of 5 cents or below. This cheap “native load” is available because the utilities retained most of their low-cost hydro, coal and gas-fired plants after deregulation as well as some long-term contracts for power.

Here is where the headroom option kicks in. Currently, the governor’s office is negotiating with independent wholesale generators for the remaining 40% of the needed power. If the governor can lock in an average price of 7 cents or less, the utilities’ native load can be blended with the wholesale generator load, and the average cost of all power could be as low as 6 cents.

If retail rates are capped at about 7 cents and the average cost of power is 6 cents or less, the state will have headroom of at least a penny to deal--where headroom is the savings increment between existing retail rates and the lower cost of the power. While this penny might not seem like much, it could easily generate enough additional cash--$1 billion or more--to consummate a deal and do so without raising our taxes or rates.

A happy end to this crisis is in sight, but only if the utilities don’t get greedy. Their decision will determine whether the state’s energy crisis gets resolved or whether the federal bankruptcy courts will soon be called on to fix a mess that could have been readily solved.