Can Energy Watchdog Show Bite?
The warning that California’s deregulated energy market could be manipulated came in a technocrat’s research paper, not a confidential corporate memo.
Steven Stoft--then an economist for the Federal Energy Regulatory Commission--used mathematical equations to make his case. But his 1998 paper summed up the vulnerability in plain English:
“Generators can significantly increase their profitability by causing ... congestion and then bidding to alleviate it,” Stoft wrote. His paper was publicly circulated shortly before the state’s new power market was to open that April Fools’ Day.
Stoft’s warning went unheeded. Now that Enron Corp. memos have revealed that its traders were using such schemes to exploit the California market, FERC is facing renewed questions about its own role in the power debacle and whether it can shape up as an effective watchdog.
The answer may determine whether California succeeds in its efforts to recoup $9 billion for alleged electricity overcharges and change the terms on $42 billion in contracts for future electricity.
FERC came under withering political attack at the height of California’s energy crisis for refusing to impose price controls on wholesale power in the West. The Bush administration cast blame for the power shortages on California’s policies that it said had blocked power plant construction.
But FERC, operating under a new chairman, is gradually gaining a reputation as a different kind of agency, though it’s unclear whether it can be a tough cop on the energy beat.
FERC is pushing an aggressive investigation of the very price manipulation by energy traders that its leadership dismissed against the advice of the agency’s staff two years ago.
In August, President Bush named Patrick H. Wood III, a Texas utilities commission chairman when Bush was governor, to lead FERC amid controversy over the agency’s handling of the energy markets.
Wood, 39, is a policy whiz with small-business roots in east Texas and a Harvard law degree. His stated goal is to restore respectability to electricity deregulation, and his track record shows he doesn’t mind stepping on corporate toes if he thinks it will help.
It was Wood’s decision to post the Enron memos on the Internet, FERC staffers said.
Wood on May 8 approved FERC’s order requiring all sellers of electricity in the California market to state under oath whether they engaged in the manipulative tactics described in the documents.
That action sent a shudder through the industry, conjuring visions of tobacco executives lined up before hostile congressional committees.
Steve Maviglio, press secretary for Gov. Gray Davis, said a sea change has come over FERC since Wood took over.
“It’s shocking, considering that most observers would have thought that anybody appointed by Bush would be ... more hostile,” Maviglio said. “Wood is far more pragmatic. The governor gets a sense every time he talks to him that he’s a can-do kind of guy.”
A market monitoring and enforcement division created by Wood is in its infancy, although a director has been hired. The office would bring together about 80 economists, lawyers, engineers, auditors, policy analysts and former traders to watch the markets for emerging trouble spots.
Congress has yet to act on legislation that would broaden FERC’s powers by increasing fines for violations of the Federal Power Act from $5,000 to $1 million and increasing prison terms from two years to five.
Even so, stepped-up enforcement by the regulator may not provide enough of a deterrent when a slick move can net millions for traders. The answer is to design future energy markets with price limits and rules that resist tampering, a leading consumer advocate said.
“The key to an honest market is that people have to recognize that their chances of succeeding in a manipulation are very, very small,” said Mark Cooper, an energy policy analyst with the Consumer Federation of America. “Once you are in the realm of ‘I know I can beat this market; the question is can I beat the cop?’ then order has broken down.”
Although California officials applaud the changes at FERC, the industry has voiced concerns.
Craig Goodman, president of the National Energy Marketers Assn., which represents traders, said FERC has let politics set policy.
“There’s a lot of political heat on FERC,” Goodman said. “California regulations were so flawed that it [provided an incentive] for the behavior at issue.”
Mark Stultz, a spokesman for the Electric Power Supply Assn., said high prices are not an indicator of misbehavior.
“You need something more than high prices before you go putting out subpoenas for documents of every market participant,” Stultz said. “Does the existence of high prices ... equate to probable cause for bad behavior? The answer is no.”
Yet to many observers, the Enron memos seem to have provided just that. They do constitute probable cause, said former FERC commissioner Matthew Holden Jr., now a professor of politics at the University of Virginia.
“The total collapse of Enron has caused people on all sides of the political spectrum to believe that there was massive misbehavior,” Holden said.
As California braced for blackouts last summer, Enron was at the peak of its power as the most successful of a new breed of energy-trading companies called marketers.
The fleet-footed middlemen often had better information technology, sharper long-term weather forecasts and a more comprehensive grasp of the market than regulators--and in the case of Enron, according to the memos, market manipulation strategies that its traders dubbed Death Star, Fat Boy and Get Shorty.
Stoft, the economist who warned of weaknesses in California’s market design, also predicted that Enron and other traders had the potential to distort the course of electricity deregulation.
In a 1997 paper, Stoft called them “the most crucial, yet most overlooked group of players” in deregulation.
Critics said lawmakers and regulators at all levels of government failed to recognize that marketers were more than facilitators, that they had their own economic interests and would pursue them zealously.
In May 2001, when blackouts rolled across the state, Vice President Dick Cheney took the lead in casting the blame squarely on California.
“What’s happened in California,” he said, “is they’ve taken the route of saying, ‘Well, we can conserve our way out of the problem.... We don’t have to produce any more power. So they haven’t built any electric power plants in the last 10 years in California, and today they’ve got rolling blackouts.”
Stoft, now a senior researcher at the University of California Energy Institute in Berkeley, said he believes that FERC officials must have suspected that traders were taking advantage of loopholes in California’s byzantine market rules during the height of the crisis.
Two current FERC staffers confirmed that, saying the Enron memos released last week disclosed nothing really startling.
“For most of us, this was not a surprise,” said one senior staffer, who asked not to be identified. “If you had asked me before we got those memos whether Enron was doing this, I would have said, ‘Probably.’”
Said Stoft: “The California market monitors were writing to FERC and complaining. But [FERC] did not want to look. I don’t want to blame it all on FERC, though. It was California that invented these stupid markets.”
Whether the Enron strategies violated any laws remains unclear.
FERC, which functions like a national utilities commission, had the statutory authority to intervene in California to guarantee “just and reasonable” rates.
But during 2000 and the first half of 2001, the agency’s governing board was reluctant to act, partly because of strong free- market beliefs.
California officials and members of the state’s congressional delegation clamored for relief.
Within FERC, Commissioner William L. Massey complained that the agency was abandoning its legal duty to consumers. But Curtis L. Hebert Jr., President Bush’s first appointee as chairman, maintained that the solution was in California’s own hands, saying the state needed to approve new power plants and stop shielding consumers from higher electric bills.
There were legitimate explanations for soaring prices as well, such as California’s dependence on out-of-state power, a boost in demand from the strong economy and a long stretch of atypical weather in the West.
With rolling blackouts in California and growing political pressure in Washington, Hebert agreed in June to wholesale price limits on electricity throughout the West. Prices stabilized, and the blackouts ceased. Conservation by Californians and new power plants coming online also helped turn the market around.
But by August, Hebert had left FERC.
