Copyright 2001 The San Diego Union-Tribune The San
Diego Union-Tribune
January 28, 2001, Sunday
SECTION: OPINION;Pg. G-1
LENGTH:
1414 words
HEADLINE: Blackouts are now rolling
through California; why not the heads of state regulators?
BYLINE: Thomas W. Hazlett; Hazlett is a resident scholar at the
American Enterprise Institute.
BODY: 'California's deregulation scheme," railed Gov. Gray Davis this month,
"is a colossal and dangerous failure."
A failure,
certainly. But the governor confuses deregulation with perestroika, a top-down
restructuring by commissars in Sacramento who, as Davis' words indicate, remain
clueless about California energy markets.
An act passed
unanimously by the Legislature in 1996 left controls on retail electricity rates
in California while wholesale prices were free to float. This led logically and
inexorably to what elliptical policy analysts call an "incomplete success," and
what we know as a "crisis."
When the wholesale rate is
below the retail rate, policy wonks debate efficiency in stuffy academic
conferences. But when the price lines cross, investors go primal.
Two of California's big three utilities say they have lost
in excess of $12 billion since last June buying wholesale and selling retail. At
first, this red ink comes out of shareholder wealth. Share prices have tumbled
for PG&E, Southern California Edison (owned by Edison International), and --
to a lesser extent -- San Diego Gas & Electric (owned by Sempra Energy).
Debt financing is next; too bad we can't seem to harness
the energy being generated by creditors fleeing the scene. Public bond markets
are closing, bank windows shutting, and energy wholesalers demanding cash on
delivery. Now, California has seen power outages -- the next source of capital.
Think of blackouts as energy conservation for customers and a savings plan for
utilities: when selling at a loss, lack of sales is a windfall.
How did we get here?
Under the old rules,
monopoly power franchises were issued. Scale and scope economies -- one provider
per region, top-to-bottom integration of generation and distribution -- were
exploited, ratepayers protected by price controls. Customers' bills were
adjusted such that shareholders kept up with the Dow Joneses. The system hid
lots of inefficiencies. But plants got built, power grids operated, and
electricity delivered.
In 1978, things slowly began to
change. That's when PURPA (the Public Utility Regulatory Policy Act) was
enacted by Congress, mandating that utilities purchase power generated by
independent producers. The basic idea was excellent -- let new competitors into
the market, allowing entrepreneurship, cost savings, and windmill operators a
chance to flourish. But PURPA went beyond opening the market, rigging
prices for independent power at above-market levels. These high-priced contracts
accumulated over several years, as did utility investments in power plants that
became, in many cases, white elephants.
One weakness of
traditional utility regulation is the "heads we win, tails we win" payoff
enjoyed by investors. By the mid-1990s, many utilities in California and
elsewhere had burdened themselves with relatively high-cost power, some forced
upon them by PURPA, some voluntarily assumed on advice from Rosy
Scenario. Demand for this power proved weak. Yet investors still recouped
outlays since regulated rates reflected such outlays (which were approved by
regulators). But pressure developed to give ratepayers a break.
By 1998, electricity rates in the Golden State averaged 23 percent
above Arizona's, 55 percent above Nevada's, and 84 above Oregon's. It seemed a
no-brainer to seize these bargain prices for California's customers, shaking
free of the utilities' high-cost commitments. While local distribution of power
would continue to be provided by a monopoly at cost, electricity would be
supplied by competitors.
Two critical elements shaped
this market restructuring. First, retail rates were to remain capped until March
31, 2002 or later. Given the generous spread between retail and wholesale
prices, the utilities stood to profit handsomely during the transition.
Ironically, this was the bargain utilities lobbied for, seeing this interim
margin as compensation for the high-cost contracts and facilities being phased
out of the "rate base." But before that could happen, a surprisingly robust
economy and various acts of God sent wholesale energy prices -- set in a market
regulated not by California's Utility Commission but by the Federal Energy
Regulatory Commission (FERC) -- surging. The generous retail price floor turned
into an onerous price cap.
The restructuring plan was a
shambles, due in no small part to the key policy change promulgated in the
electricity reform: vertical disintegration of the utilities. To energize the
competitive wholesale electricity market, regulators told the firms to divest
much of their plants and long-term contracts. These generation sources were
pushed into a wholesale exchange where the utilities (along with other big
energy users or distributors) would buy power. The impact of restructuring was
to hoist the spot electricity market to economic supremacy.
A problem there. People build homes and factories assuming that
affordable power will flow day after day, year after year. With oodles of fixed
investment and California lifestyles relying on energy inputs, it is difficult
to adjust purchases to reflect continuous changes in market conditions. As is
stashing some megawatts away for a scorching, maximum air-conditioner day.
The natural inclination is to purchase energy long-term,
assuring supply and avoiding the severe price spikes known to haunt electricity
markets. Yet, the largest buyers of electricity were chased out of long-term
planning. Instead of having ample reliable sources of power generation to buffer
demand swings (and to bargain down wholesale suppliers), the utilities were
naked to market swings.
This truly risky scheme was
compounded by tightness on the supply side. Environmental rules and
not-in-my-back-yard politics make permitting for a new power generation station
just about your least favorite way to spend a decade. Even transmission
facilities, which could help lower wholesale prices by bringing additional
competitive sources to California's wholesale market, are stymied. Currently,
San Diego Gas & Electric is pleading for approval of "Valley-Rainbow," an
electric transmission line routed through Riverside County. Locals oppose the
project as benefiting San Diegans, despite the fact that improved access to the
Western power grid would benefit citizens statewide.
The solution? Experts are sticking their fingers in sockets to avoid
answering this question. Every direction lies a mine field. New generation
plants are a great idea, but multiyear construction projects won't help much in
2001. Allowing private utilities to get back into generation through ownership
or contract is also logical, but buying plants or energy in today's market would
incur the huge expense that triggered the crisis. Years for build-out again
needed.
What about Gov. Gray Davis' helping tidbits? He
offers such gems as stopping electricity exports (California is a net importer),
putting $1 billion in state funds on the table (the utilities are losing $40
million a day), or threatening to seize power generation facilities (perhaps
doing for new energy supplies in California what Castro's nationalization did
for casino investment in Havana).
Such policy panic may
well compound the uncertainties of restructuring, smashing power generation
investment incentives.
Severin Borenstein, a noted
energy economist at Berkeley's business school, is unimpressed with the
political menu. While he believes that FERC should apply (or threaten)
short-term wholesale price caps to allow economic long-term contracts to be
executed, restoring solvency, the ultimate solutions lie with increased supplies
and accurate pricing signals for consumers. Conservation awareness will
experience an epiphany the instant that hot summer day power rates reflect hot
summer day scarcity.
He wisely cautions against
over-reaction. "The difficulties with the outcomes so far should not be
interpreted as a failure of restructuring, but as part of the lurching process
toward an electric power industry that is still likely to serve consumers better
than the approaches of the past." While states attempting to rationalize
electricity policy should heed the mistakes of California's disjointed effort,
they should not forget the inefficiencies of investment shielded from
competitive forces. California's own leaders, who now propose state-funded
facilities to generate energy, already have.
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