We’re Paying the Price for Bad Energy Decisions of Years Past

Last Thursday, the California Public Utilities Commission, as expected, approved temporary rate increases for customers of Pacific Gas & Electric, and Southern California Edison. Neither utilities, Wall Street nor consumer groups were pleased. A special session of the Legislature will now tackle California’s electricity crisis. Can lawmakers fix the problem?

Deregulation of California’s electricity market failed because policies adopted 25 years ago left the state without adequate generating capacity. For years, California imported 25% of its electric energy from neighboring states. When those states started growing faster than California and needed energy for themselves, it was too late for California to offset the loss by building up its energy infrastructure. Lacking sufficient generating capacity, California could not create a competitive wholesale electricity market when the Legislature enacted deregulation in 1996.

Deregulation obligated investor-owned utilities to sell their power plants to independent companies, creating a buyers’ market for generators. These companies, able to buy existing plants at below-construction costs, lack an incentive to build new capacity.

The Legislature failed to recognize how easily market power can be closely concentrated. To achieve market control, a generating company need own only a significant fraction of the 10% of total capacity that represents the “reserve margin”--the difference between reliable power and a blackout at peak demand. A truly competitive electricity market requires more generating capacity, in more hands, than does a regulated, vertically integrated utility industry.

Finally, when deregulation separated generation from distribution, no organization with operational capability has an “obligation to serve” and to assure reliability. Before deregulation, vertically integrated utilities were responsible. Now, no one is required to build new plants or even operate the ones they own.

Electricity deregulation, by the way, appears to be working in Pennsylvania, which has excess generating capacity and exports power to neighboring states.

One must look to the policies of the 1970s to see why California is short of generating capacity today.

In 1974, the Legislature created a second commission to regulate electric utilities. The state Energy Commission licensed new power plants and developed energy-efficiency standards to dampen electricity demand. Efficiency and conservation are not irrational concepts when applied with due respect to the facts on the ground, and when planning forecasts reflect the truism that it is always better to have a little too much than not quite enough. But there was another agenda.

In the late 1970s and early 1980s, state government demonized nuclear energy. During this period, the Legislature enacted a moratorium on construction of nuclear power plants in California and passed another law making it easier for the state’s municipal utilities to invest in the Palo Verde nuclear plant in Arizona. California’s policy was to rely on out-of-state power, a legacy that haunts us to day. (The Los Angeles Department of Water and Power, a municipal utility, is holding on to all its generating capacity, including its share of the Arizona nuclear plant. With excess capacity, it is profiting by selling excess electricity in the inflated wholesale market.)

Unfortunately, California’s current electricity shortage may worsen this summer. Northwest reservoirs, depleted by unusual winter power sales to California and below-average rainfall, may not have excess capacity to feed our summer demand.

Furthermore, most of California’s generating capacity burns natural gas, and more such plants have been proposed. But the price of natural gas has quadrupled in the past 12 months and is now about $10 per thousand cubic feet, which is equivalent to oil at $58 a barrel, twice the current price. By contrast, Pennsylvania’s generators are fueled by coal and nuclear power, thus insulating ratepayers from volatile oil and natural-gas prices.

Thus, there is no quick fix to restore reliability or low prices. The divested power plants have been sold and cannot be recalled and “re-regulated” by the state. A takeover of the electric utility industry by state government would make matters worse. Within state government, only the Department of Water Resources has relevant experience for such an eventuality, and that is limited to the operation of hydroelectric facilities.

The state and the investor-owned utilities want the Federal Energy Regulatory Commission to cap the cost of power in the wholesale market. This and other measures, such as the commission’s recent decision to allow distribution utilities to hedge their bets with long-term contracts for electricity purchases, should be pursued. But these fixes will not solve California’s basic problem: lack of adequate generating capacity.

Here are some longer-term remedies:

* California’s energy history suggests that the Legislature should return all regulatory functions, including power-plant licensing, to the state Public Utilities Commission. Just as there is no industry operational responsibility for reliability, so have government responsibilities become blurred. It is ironic that deregulation has brought a proliferation of regulatory agencies. Where once there was the PUC, there is now the PUC, the Energy Commission, the Independent System Operator, the Power Exchange, the Electricity Oversight Board and the governor’s “green team.”

From 1960-1970, California’s population increased 26%, air conditioning came to the Central Valley and the semi-desert south, and electricity use more than doubled--a far greater increase than in the decade from 1990-2000. Under regulation by the PUC, this unprecedented increase in demand was met with adequate supply.

* Further power-plant divestiture by California’s regulated utilities should be suspended. Fortunately, there are signs that the PUC has a de facto hold on further divestiture. The regulated utilities should be allowed to construct new power plants of their own so the independent generators will be forced to compete. Electricity-distribution companies should not be totally dependent on generators who have no obligation to serve. Both utilities and independents should be able to propose to the PUC plants of their own choosing, including nuclear.

* The PUC should accelerate the use of time-of-day metering and pricing so that ratepayers will have an economic incentive to shift electricity use to off-peak hours.

* The Energy Commission’s power-plant-siting function should be returned to the PUC. Its other activities--conservation regulations and grants, energy research, support for renewables and data compilation--should be placed in a new department of state government. The Legislature should increase funding for research and development of advanced generation and energy storage technologies. Last year, an independent evaluation panel, in a report to the Legislature, questioned the wisdom of combining research and regulatory functions within one agency.

When asked recently about the state’s energy crisis, former Gov. Jerry Brown said that a fundamental rule has been ignored: “If it ain’t broke, don’t fix it.” The Legislature ignored this rule in 1974 and again in 1996. As it tries to restore reliable and economical electricity service to California, it should take great care to apply another rule: First, do no harm.