Energy Landscape Is Forever Altered

California’s immediate electricity crisis seems to have passed. But like a hurricane that resculpts a tropical island, the crisis has radically altered how 27 million Californians get their electricity and what they pay for it.

Not all the state’s energy problems have disappeared; a siege of very hot weather, for example, could still bring shortages. But the degree of change in the short-term energy picture since the blackout days of early spring is hard to overstate.

A megawatt-hour that once cost hundreds, sometimes thousands, of dollars now regularly sells for less than $80.

There hasn’t been a forced outage since May 8.

Predictions that California would suffer 260 hours of blackouts this summer now seem ludicrous.

The state government, which was spending an average of $65 million a day to buy power in May, now pays an average of less than $30 million a day. Basking in unexpectedly cool summer weather, the government has so much power on hand that on some days it has had to sell surplus electricity at a loss.

That sudden shift, from crisis to calm, obscures an equally dramatic change in California’s long-term approach to how electricity gets bought and sold.

Just three years ago, the state had embarked on a broad deregulation scheme designed to put most decisions about electricity into the private marketplace.

Now, the state government itself has become the biggest buyer of power in the West.

The state’s two largest utilities, already stripped by deregulation of much of their ability to generate electricity, are, at least temporarily, also out of the power-buying business. Financially wounded, maybe crippled, their role has been sharply curtailed, perhaps for years.

Utility rates paid by millions of customers have been raised, and the state’s utility watchdog, which used to control rates, is poised to yield much of its authority to an unlikely agency: the Department of Water Resources, whose principal job until January was running reservoirs and canals.

And consumers seem almost certain to be saddled with billions of dollars in debt and contracts to buy power that practically guarantee high electricity rates for years to come.

The two sets of changes, the short-term and the long, are interconnected. Both stem from the state’s dramatic entry into the market seven months ago.

On Jan. 17, blackouts darkened much of the state. Power plant owners refused to sell electricity to Pacific Gas & Electric and Southern California Edison, the state’s two biggest utilities, which had been nearly drained of cash by eight months of soaring wholesale power prices while being prevented by the state from raising rates for consumers.

Four private energy companies were warning that they would take the two utilities into Bankruptcy Court the next day if the state did not begin to pick up the bill for electricity.

Faced with the options of rationing power, shocking California’s economy with a tripling of electricity rates or opening the state’s checkbook, a grim-faced Gov. Gray Davis signed an emergency decree to allow the Department of Water Resources to use its budget to buy electricity that would then be sold to consumers.

That act, later broadened and formalized by the Legislature, opened the door for taxpayer money--$8 billion and counting--to be used to buy electricity.

“It’s our obligation to provide power to the homes and businesses that drive California,” Davis said at the time. “I’m disappointed the utilities can’t do it. We have no choice but to step in, and we will do it.”

The involvement of the state in buying power changed the political calculations involved in setting electricity rates. For months, the private utilities had complained that California’s rates, which were frozen as part of the state’s deregulation law, were lower than the cost of buying power. But raising rates to help the utilities was politically unpalatable; the Public Utilities Commission in January gave them just a fraction of what they sought by raising rates for PG&E; and Edison residential customers by 9%.

After the state began buying power, though, it was California’s treasury that was at risk. Pressure built quickly for more rate hikes. In March, the PUC approved the largest increase in its history, boosting the rates of some customers by more than 40%.

Those increases showed up in bills last month. The higher costs and conservation efforts have reduced demand. Cooler-than-expected weather lowered demand even more. Californians used 12% less electricity last month than in June 2000, after adjusting for weather and economic growth, according to the California Energy Commission.

Seven months after the state began buying power, January’s sense of urgency has dissipated. Buyer’s remorse is setting in. Grumbling grows louder about how deeply the state has inserted itself into the electricity business.

It was a “huge mistake” to let the Department of Water Resources become the buyer of most of the electricity used by California, said Bill Booth, an attorney for the California Large Energy Consumers Assn., a group of heavy industry manufacturers that pushed hard for deregulation in the early 1990s.

“I would hope that the state as an entity chooses to get out of that role sooner rather than later,” Booth said. “The state has shown zero capability of doing that well,” he said, voicing a criticism also made by Republican lawmakers.

Davis and his advisors argue that they had little choice but to jump in and buy power on behalf of the utilities. And they insist that their intervention has stabilized the market.

Long-Term Contracts Called ‘Insurance’

After the state government began buying electricity, officials moved quickly to get the state out of the exorbitant spot market by locking up $43-billion worth of long-term power contracts, some lasting more than a decade. Lawmakers and consumer advocates are growing increasingly critical of those contracts, some of which are now more expensive than the falling prices in the spot market.

But Davis administration officials insist that spot market prices are falling only because the state is now buying 40% of its power under contract, rather than bidding up prices by seeking all of its electricity in the market.

“Insurance is insurance, and it costs a little bit, but it’s a damned good thing to have,” said S. David Freeman, the governor’s top energy advisor and the former general manager of the Los Angeles Department of Water and Power.

“The people in this ballgame that will criticize long-term contracts will criticize anything with stability in it because God forbid that it may turn out to cost a tiny bit more than what the spot market is in the future,” Freeman added. “That kind of thinking leads you to be in the spot market.”

The shift out of the spot market is not the only factor that has stabilized the situation, however, and some accuse the governor of taking undue credit.

The change is “clearly explained by the fundamentals of supply, which has increased, and demand, which has decreased because people are conserving,” said Gary Ackerman, executive director of the Western Power Trading Forum, a group of electricity sellers.

The price of natural gas, the fuel used to run most of California’s power plants, has fallen by half since early January. There is widespread disagreement about why--mirroring the argument over why gas prices spiked in the first place.

When prices rose, electricity companies accused gas pipeline companies of gouging. The gas firms said power generators bid up the price knowing they could recoup the cost by selling expensive megawatts.

Another factor in lowering wholesale electricity prices is that the state’s overall power supplies are more abundant because many power plants that were shut down this spring are running again.

At times last winter, more than 10,000 megawatts of capacity were offline. Recent plant shutdowns have totaled closer to 4,000 megawatts. Three new power plants have opened this summer, adding 1,415 megawatts to the state’s capacity.

Statewide demand for electricity has been peaking at a little more than 30,000 megawatts in recent days.

Again, the reasons for the additional supply are disputed. Generating companies say their plants were shut down earlier this year for repairs and maintenance.

State officials and consumer advocates have alleged that some of the plants were taken offline to manipulate prices. Today, with less power being bought on the spot market, there are fewer incentives for such manipulation.

A federal wholesale electricity price cap that took effect in June also has also dampened prices, experts say.

The Federal Energy Regulatory Commission imposed the cap, now at $92 per megawatt-hour, after resisting the pleas of California politicians for nearly a year.

“They just did a complete 180,” said Severin Borenstein, director of the University of California Energy Institute in Berkeley, “and if they had done it earlier, we would have saved a lot of money.”

The agency that manages most of the state’s transmission grid has found that bids by power sellers dropped after June 21, when the price limit took effect. But assessing how much of the change resulted from the cap and how much from other factors “is difficult,” said Anjali Sheffrin, director of market analysis at the California Independent System Operator.

The changes in the market--and the debate between the administration and its critics--involve who pays for risk.

Little Incentive for Firms to Trim Costs

Before deregulation in 1998, California’s electricity industry was designed above all to avoid the risk of shortages. Utilities built a cushion of supply, and regulators guaranteed that they could pass on the cost to their customers.

Critics said that such regulation left the utilities with little incentive to trim costs, meaning that ratepayers paid higher bills.

Deregulation was supposed to shift the risk of owning power generation to private companies and those who bought their stock. Proponents said consumers would benefit as private firms risked their own money to build power plants and competed with one another to sell electricity.

But in practice, competition in California brought price spikes and supply shortages.

“The reason why economists have preached that competition is better than regulation,” said Ken Rose, executive director of the National Regulatory Research Institute at Ohio State University in Columbus, “is that the investor putting his own dollars on the line will be more careful with those dollars. The downside of that is if there’s any ability of the suppliers to control prices, then they’ll exploit that advantage, which is what you’d expect them to do.

“You can’t make risk go away,” he said.

Now Californians face a different risk: that a new, largely untested 96-person, $2-million-per-month bureaucracy designed to buy power could run amok.

There’s no easy way to disband the power-buying operation until the utilities get back on their feet financially. That could take years. In April, PG&E; filed for bankruptcy to fend off creditors. Edison’s finances have started to improve somewhat, but the company is still seeking help from the Legislature, where no rescue plan seems to be gaining momentum.

In the meantime, the Department of Water Resources has little oversight as it goes about its newly assigned job of buying electricity.

The Public Utilities Commission for 80 years has dictated the rates utilities could charge. But under new rules proposed earlier this month, the PUC will essentially become a rubber stamp, adjusting rates for customers of PG&E;, Edison and San Diego Gas & Electric Co. to match whatever amount of money the Department of Water Resources says is needed.

Even PUC officials say such a drastic loss of control is necessary to allow the state to sell $13.4 billion in bonds. Those bonds are designed to repay the state’s taxpayers for past power costs. They will be backed by the money that customers pay PG&E;, Edison and SDG&E; each month.

That is just one of the ways in which the drastic actions taken to prevent an energy meltdown have hemmed in policymakers trying to envision the future shape of the state’s electricity industry.

“There is certainly a lot less room for designing the future than many people would like,” said state Sen. Debra Bowen (D-Marina del Rey).

For example, competition--the dream of deregulators--appears dead for at least several years.

That’s because of the need to pay for the long-term contracts and reimburse the state’s general fund for the billions already spent.

The owners of steel mills, cement plants and grocery stores blanch at the cost of the contracts. They are chafing to break from the utilities and cut their own deals for electricity with private companies such as Enron Corp. Such one-on-one deals were banned by the Legislature when it put the state into the power-buying business.

“Ultimately, we think our own companies buying power for themselves is the best solution,” said Jack Stewart, president of the California Manufacturers and Technology Assn.

But that move would again shift the risks inherent in the electricity business. Allowing big firms to walk away from the utilities would mean that someone else--renters, homeowners and small business owners--would have to bear the cost of maintaining a cushion of extra supply for the state. Many lawmakers are reluctant to allow that.

“Any kind of meaningful competition in California has been postponed until 2004, 2005, at which time some of the long-term contracts start ending,” said Michael Shames, executive director of the Utility Consumers’ Action Network in San Diego.

Ultimately, Davis said in an interview, “the long-term solution to this problem depends on having more power than we need.”

Generators base their prices “on how much power they know you do or do not have,” Davis said. To protect consumers from being gouged, he said, the state’s goal should be to always have at least 15% more power than it needs.

Private companies will never take on the risk of building the last few power plants necessary to ensure a surplus, said Davis, so the state must.

To that end, Davis backed a law that takes effect next month creating a Public Power Authority. The agency will be able to sell $5 billion in revenue bonds to build, buy and own power plants and to finance energy efficiency and conservation programs.

Ironically, the governor said, this new agency, as the “builder of last resort,” could clear the way for the competition that the state’s deregulation plan so miserably failed to achieve.

“We’ve never really had a chance to test deregulation in an ideal world, because we’ve never had more power than we need,” the governor said. “My overriding goal is to keep the lights on and provide Californians with the power they need. . . . A byproduct of our efforts will be to put the state in a position where deregulation works.”

In the hybrid system Davis envisages, the state government will act like a giant public power agency and control nearly as much electricity as private companies. That role for California government would have been inconceivable just two years ago, said Ohio State University’s Rose, who tracks the way each state regulates the electricity industry.

“I don’t know of any other state headed toward that,” he said. “But no other state has had the crisis of California.”

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