Power Deregulation: A Tale of Two States

Men’s Fitness magazine has voted Houston the fattest city in the country for three years running. So after the incriminating issue hit newsstands last year, it was little wonder that the 24 Hour Fitness on Richmond Avenue saw a crush of new customers working out on dozens of power-hungry treadmills, elliptical machines and stair climbers.

Electricity use spiked -- but the health club’s monthly bill actually dropped, by 10%.

“We probably saw anywhere from 2 to 3 cents a kilowatt-hour decrease,” said Mike Morris, director of purchasing for San Ramon, Calif.-based 24 Hour Fitness USA Inc. “For a company like us, that adds up.”

Texas is walking slowly and relatively smoothly into its second year of electricity deregulation, with lower bills and many apparently satisfied customers. That’s in stark contrast to California, where deregulation is synonymous with rolling blackouts, soaring power costs and market-rigging by energy companies.

The average residential electricity bill in Texas dropped by more than 9% in the fourth quarter of 2002 from the same quarter the previous year. By the end of last December, nearly 7.4% of residential customers, or about 361,000 households, had taken advantage of deregulation and changed electricity providers. Among businesses and other institutions, more than 10% had switched.

In California, squalls from what some call the “perfect storm” of deregulation persist. On March 26, federal officials are scheduled to release the results of their investigation into the causes of the California energy crisis of 2000-01, which sent prices soaring and left millions temporarily without power in the wake of deregulation.

The factors that conspired to derail deregulation in California included a low power supply, providers’ inability to pass along price hikes to consumers and what state regulators said was rampant market manipulation by energy companies.

Texans said they took note of California’s troubles and crafted their plan to avoid similar pitfalls. The Lone Star state also was helped by its relatively plentiful supply of electricity.

Morris remembers electricity bills for 24 Hour Fitness’ California gyms doubling in a year. “In Texas, we did not experience the same kind of spike that we experienced in California,” he said.

The so-far-so-good experience in Texas has given cautious hope to a small group of deregulation advocates in California.

“Texas shows that if it’s done right, it can work,” said Mitch Wilk, former president of the California Public Utilities Commission.

Under deregulation, utility monopolies are eliminated and the market is thrown open to providers, which are allowed to compete for customers. As in California, Texas businesses and households typically get their power from either a municipal utility or a utility company that operates for profit.

But industry experts point to several factors that appear to play into the different outcomes for deregulation in Texas and California:

* Price regulation: California’s plan opened the doors for competition, but rates paid by most residential and small-business customers remained frozen. As a result, utilities could not raise their prices as they were hit with soaring wholesale costs for power in California’s electricity markets.

Pacific Gas & Electric Co. ultimately sought bankruptcy protection, which Southern California Edison narrowly avoided.

“You, in essence, had a plan that was bound to fail when prices went up,” Wilk said. “The assumption was that prices would only go down.”

In Texas, electricity companies can go before state regulators twice a year to seek rate hikes, and they are guaranteed a response in a relatively speedy 45 days.

* Divestiture: California regulators, eager to prevent a dominant power plant owner from dictating prices, ordered the major investor-owned utilities to divest themselves of half their natural-gas-fired power plants in 1998. The utilities, lured by lucrative offers, sold them all. That put the utilities at the mercy of power companies that are being investigated by federal regulators for allegedly rigging the market to raise prices.

In Texas, a utility is required to sell off power facilities if its power generation company has a market share of more than 20%, but no company has been big enough to force a divestiture. Texas deregulation law required utilities to divide their generation, transmission and retail services into independent companies so that profits in one area can’t be used to subsidize services in another and unfairly gain market share.

* Power purchases: Utilities in California were forced to buy power primarily through the centralized market, the California Power Exchange, on the hour or day before it was needed. That created a volatile spot market and made conditions ripe for market manipulation.

The Texas deregulation plan allows utilities to make medium- and long-term contracts.

“The most important distinction in terms of keeping the perfect storm from happening in Texas is the companies’ ability to contract outside of a spot market,” said Lynne Kiesling, a senior lecturer in economics at Northwestern University.

Self-Sufficiency Issues

Aside from disparities between the Texas and California plans, there were key differences in energy self-sufficiency.

California failed to build a new power plant from 1994 to 1998, even though its economy and population were growing. During that time, five plants were built in Texas. What’s more, many observers say California was too dependent on hydroelectric power -- and paid the price when the Pacific Northwest was slammed with back-to-back dry winters.

“Hydropower is such a variable supply feed,” said Mark Cory, a director of El Paso Corp. Finance Center at Rice University in Houston. “We rely on coal, some nuclear and a lot of natural gas. Coal and natural gas you can really rely on year to year. You certainly don’t expect tremendous variation.”

Texas looks to hydroelectric power for only 1% to 2% of its output. Although more than 50% of its power comes from natural gas, state officials say the availability of power produced by coal and nuclear energy helps cushion rising natural gas prices.

California relies on out-of-state sources for 20% of its power. Texas gets virtually none of its power from out of state.

Another key difference was the way deregulation was launched. When the barriers were lifted in Texas in January 2002, the Texas Public Utility Commission mandated that private companies drop prices by 6% to ensure that residential customers received an immediate discount from their “incumbent” provider. Regulators then set a maximum price per kilowatt-hour in several large metropolitan areas around the state, calling it a “price to beat” and encouraging utilities to discount their rates below that number.

To make sure customers were savvy to the competition, the Legislature gave $12 million to the PUC for a public education campaign to spread the word on area rates and providers.

“We really urged them to shop around and try to find someone who could beat the price that they were paying, even though they were paying 6% less than they had been before deregulation,” said Theresa Gage, the PUC’s director of governmental relations.

According to the PUC, the competitive atmosphere created by deregulation saved both businesses and households between 8% and 18% in 2002 compared with the previous year. Those lower prices meant a savings of $160 per household last year, or about $13 a month. (Regulators say they have not yet calculated average business savings.)

Service Complaints

There have been some problems. Carol Biedrzycki, executive director of Texas Ratepayers’ Organization to Save Energy, said there is widespread dissatisfaction with incorrect billing and delays in getting service connections.

“Customer complaints have skyrocketed,” she said.

The PUC’s Terry Hadley confirmed a fourfold increase in complaints during the last year, from 2,100 to 8,500, but chalks it up mostly to confusion among customers, many of whom are dealing with new utility companies for the first time.

“It mirrors what we saw with telecommunications in the long-distance market,” he said. “With more providers, you have more complaints.”

In addition to consumer complaints, there also have been a few signs of the type of market manipulation that is now believed to have been rampant in California. Texas PUC officials say they are investigating the alleged manipulation of prices by power companies on the wholesale electricity market on Feb. 24 and 25. On those days, marketers and schedulers allegedly bid small amounts of power at exorbitant prices, driving the price per megawatt-hour to 18 times the average price of the previous week. The actions boosted costs paid by power buyers by $17 million.

The PUC’s Gage said that the alleged market gaming was an aberration, and that the fact that regulators spotted it shows that controls are working.

“We knew it was happening on those days and we monitored it,” she said.

Deregulation advocates say Texas represents the wave of the future, though it may take years to arrive.

So far, there hasn’t been “a real compulsion for people to switch” to a new electricity provider that might charge less per kilowatt-hour, according to Rice University’s Cory.

“If you ask your average consumer what they’re paying in terms of cents per kilowatt, most people won’t know,” he said.

Commercial customers -- with their higher bills -- have changed providers at a greater rate than households.

The 50-store Fiesta Mart Inc. grocery chain made the switch and cut its bills by about 30%, company spokesman Bernie Murphy said, adding: “That’s a lot of money.”

Pitching for California

Success stories are fueling some discussion of bringing deregulation back to California. Last month, a group of scholars from UC Berkeley and Stanford, joined by Wilk and other former regulators, signed a manifesto asking California policymakers to take a second look at deregulation.

“With the benefit of hindsight, let’s look at why California failed and put together a recipe for success,” said Tom Campbell, a former state representative and now dean of the Haas Business School at UC Berkeley.

But politically, key lawmakers and even deregulation supporters, including the California Manufacturers & Technology Assn., acknowledge that California’s experience argues against a return engagement soon.

“No one is seriously talking about deregulation in California,” said state Sen. Debra Bowen (D-Marina del Rey), chairwoman of the Senate Energy Committee.

Michael Peevey, California’s new PUC president, agreed.

“I just don’t think there’s an appetite for it. Not for now,” he said, adding, “Two years from now, it’s a different matter.”