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There have been a lot of articles about the California Power Crisis lately, and
many of them probably cause us a bit of head shaking and scratching.
As far as I know, nobody here has attempted to "connect the dots" and put together a coherent account of the crisis: Its roots in the faux deregulation of 1996, its slow buildup late last year, and the explosion we are facing today. I have no fancy credentials, but I have a talent for writing and an eye towards reducing complex issues to their simplest essentials. I hope you'll enjoy my presentation. If you have questions, comments or suggestions for improvements, please drop me an email. PerspectiveWe're Californians. We have the best climate in the US, the strongest high technology industry, the most beautiful women. We may also have the stupidest government, but hey: That's par for the course.Last summer, electricity cost me less than $200 a month. Now it might cost $300, and this includes full-time air conditioning in an area that regularly gets 110ºF heat. In contrast, a friend of mine living in Pittsburgh pays $400 a month for the whole heating season to keep his house from being a gigantic icicle; might I add that the heating season is months long than our cooling season, and that doesn't include his use of electricity at all? No, our situation isn't so bad. But it's bothersome and dangerous and nobody likes sitting around with the lights out and the air conditioner not humming. So, let us proceed ... What was California's deregulation?A complex, confusing, ineffective mess. Here's what it boils down to:
Truthfully, the parties involved should have realized that nobody was going to build new plants, due to draconian environmental regulations and NIMBY (Not In My Back Yard) lobbies. At the time, though, everyone expected demand to decrease. Curiously, these issues were all covered, with what seems in hindsight like uncanny accuracy, in Arthur Hailey's book Overload, so nobody can say they weren't warned - and by an early 1980s potboiler at that. To be specific, there were 21 post-deregulation proposals for new power plant construction; not one was accepted. This is, of course, the biggest difference between California's deregulation effort and those of other states - supply was artificially constrained. For example, Texas deregulated their power markets at about the same time; plenty of new power plants were built and deregulation is counted as a resounding success. What's the source of today's disaster?The trigger appears to have been the recent doubling of natural gas prices. Most of California's power is generated using natural gas, so the total cost of generating power went up, about 10% all told.Another factor has been the shortage of cheap hydroelectric power in the northwest due to droughts. Normally much of that power would be imported into California; not this year. Despite this, the crisis still could have been resolved with minimal pain. The right resolution would have been to allow a rate increase proportionate to the added cost of generating power, about 10%, and permission to negotiate long-term agreements with the power generating companies. This would have given us secure power for the long term at minimal extra cost. At the time, Davis thought this was a tempest in a teapot and didn't want to be known as the governor who raised rates, even though it's doubtful the public would much care. As a result, he stood firm and did not allow the increases. Instead, he told the utilities to find the money. Now, let us suppose you rent or mortgage doubled and your income did not increase. You might be able to continue living as you had for a few months, feeding off of your savings. But eventually, you would find yourself unable to pay. For some reason I cannot fathom, which most likely has to do with political calculation, Davis didn't quite get this point. But the result was that the utilities, understandably, ran out of cash and could not pay their bills. So, why did the cost of electricity go from $20 to $200 a megawatt?Dog Gone was kind enough to explain several reasons for this.
What good came out of the deregulation?Because wholesale prices were able to increase with the market, we got power from people we would have never expected to - Arizona and British Columbia all did their little bit to help. And these sales came spontaneously, through the power exchange. In short, the setup worked to get supply where there was none previously.Unfortunately, this was not enough to overcome the inherent lack of supply. However, it is not clear that the supply situation would have been any better in a regulated environment; rules cannot generate power out of thin air. So, given this, what did Davis do? What should he have done?Well, to begin with, he ran a whole ton of expensive, sophisticated advertising designed to convince us California rubes to use less power.His next step was bluster: He threatened the power generators with a takeover of their plants via eminent domain. When no generator would sell our utilities another watt, he stepped in and had the central water supply agency buy the power on the state's behalf, rapidly running through the state's entire budget surplus for the year. Then he proposed to issue bonds to pay for the remainder of the year's power, and floated a 10% rate increase. The idea was that the rate increase would pay off the bonds over time. Finally, he put together some incentives for power generators to build in the state; thanks to his earlier bluster, the response was understandably under whelming; who the heck wants to invest in a state that has promised to confiscate what you build? What should he have done? Let retail electricity prices float with the market. The generators would start cranking again, because they would know that they could get paid. Rates would go through the roof for a while and then settle down as more power came on line. In the end, it looks like the worst of both worlds: We are getting the debt, and electricity rates probably not much different then if he'd just let them increase proportionately to utility costs. What does the left resent?The left believes that a total state takeover of the power system is a good idea. After all, Los Angeles' DWP has sailed through the crisis with no tiresome blackouts or need to raise rates. But this, of course, was a feature of the deregulation plan discussed above; the DWP was not obligated to sell off its power plants, so it didn't have to buy that much power. What power it did buy was through long-term contracts, at highly favourable prices. In fact, it was able to sell power at insane profits, some of which was purchased from generators, This is a strange business, folks.One of the left's biggest arguments is that billions of dollars were sent from the operating subsidiary of the utilities to the parent company (which, in the case of PG&E, did not declare bankruptcy). These billions, of course, were from the sale of power plants. The left wants to send this money straight into the eternal sink of day by day power purchasing. This is just like forcing me to use my savings to pay my suddenly inflated rent bill; it's not going to do anybody any good after a couple of months. Again, the only way to deal with this problem is to increase income or bring present expenditures into line (possibly by getting a cheaper house), not pay current expenses out of savings or capital. Anyone who's seen their tax bill will realize that just because the word on the bill is "public" doesn't mean there isn't plenty of greed involved. The LADWP has been selling a great deal of power on the spot market and charging a king's ransom for it. Just because it's public doesn't mean it doesn't want a higher budget and fancier offices. Sorry, LA Weekly. The power linesDavis wants the power transmission structure - the power lines, transformers, and so on - associated with the utilities. He has seized on this as a way to get something of value back from the utilities for dumping so much money into power purchases on their behalf.This is a rather odd policy, though, since the power lines still need to be managed, and the state is unlikely to be effective in this role. Since taking over the power lines will not add a single watt to the power system itself, this does not seem like a wise use of state money. How are the utilities to blame?The utilities should have insisted on an escalator clause added to the promised 10% rate decrease. I think it's fair to say that was a serious blunder.But does it deserve a death sentence? This seems doubtful to the extreme. How are the power generators to blame?For the most part, they are not. External circumstances, such as high natural gas costs, low levels of hydropower, and the need for power plant maintenance even during peak demand times has caused this crisis.They have contributed to it by "gaming" the spot markets - that is by placing increasingly high prices in the spot market to find out the actual market price. With the severe power shortage, almost every bid was accepted - and remember, the highest accepted bid from any company was what the power consortium had to pay all companies - a sure recipe for disaster. Needless to say, it would be impossible to successfully "game" the power markets if there was not already a severe shortage and high market prices. The power generators were taking advantage of high market prices, in the same way you would if your employer offered to double your salary. Would you take it or say "Oh, no, I have enough, no thanks"? What about the smaller power generators?California law provided for special rates to be paid to small-scale power generators, most of which used environmentally sensitive fuels such as natural gas, wind power and the like. The rates were kept artificially high so these companies could stay in business despite woeful inefficiencies.Rates for these companies were fixed separately from the power exchange, and they were not paid through it. As a result, the utilities have simply defaulted on these bills, making it impossible for many of the small generators to continue operating, especially those relying on natural gas. These companies are responsible for a shocking 20% of the power currently generated in California. If they are not paid, this factor alone will ensure a long, dark summer. Davis has proposed paying them about half what they were being paid previously going forward (but not paying their previous bills, thus keeping them in a tenuous condition). Unfortunately, most of them have costs significantly higher than that, so this is unlikely to help a very bad situation. Gray Davis does not appear to have any sympathy for the plight of these companies, but their situation goes a long way towards explaining why he has not seen many takers for his new power plant initiatives. How is the State of California to blame?
Is the power crisis only a California problem?No. Other states are also facing similar problems, albeit with more grace than California. This Los Angeles Times article gives details.The main problems that make California special are the tough regulatory environment, the massive size and diversity of the state, and its importance in the overall economy. So, what of the future?Blackouts, lots of them. At the very best, we will find some way to pay for all available power, but the supply is still on a knife edge, with regular Stage III alerts, meaning less than a 1.5% surplus of supply over demand.The biggest problem is summer. California is known for its warm, pleasant weather, but naturally the price of this is intense heat in summer in many parts of the state, and the consequential heavy use of air conditioning. Without the discipline imposed by higher rates, people will run their air conditioners extensively in an effort to keep comfy. This is going to tax our energy resources to the limit and beyond. The most likely short-term outcome is rolling blackouts for the entire summer, possibly returning in December when the anti-pollution power plant run limits are hit. And in the long term? Some new power plants will come online in 2002, so the crisis is likely to ease at that point, but it will most likely be a few years until things return to normal. -- Bob Huang
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