Electricity in California

How did things go so wrong?

Robert J. Michaels

Professor of Economics

California State University, Fullerton

rmichaels@fullerton.edu

Orange County Business Council

Jan. 11, 2001

The good [but expensive] old days

1960s -- production costs and rates falling1970s -- energy crises, environmentalism,

and Jerry Brown1980s -- passing through uneconomic plant

and contract costs1990s -- California rates 150% of national

average 1993: PUC staff issues the “Yellow Book,” blames regulation for problems

The promise of a new system

1970s: cost-cutting transactions by utilities And deferral of in-state construction

1980s: Independent power arises, wants freedom to trade Small, fuel-efficient, clean gas-fired plants 1992 federal legislation and transmission rights Large customers want rights Utilities claim “stranded costs” as obstacle

Changing Nature of Industry Cost Characteristics

$/MW

1930

1950

1970

19801990

MW50 200 400 600 800 1,000

Source: Williams Company and TR Casten, “Whither Electric Generation? A Different View”Energy Daily, September 7, 2000.

1999 California Power Sources

Coal 19.8 % 1990 SW imports 12.0%Hydroelectric 23.5 % 1999 “ “ 8.5%Gas 31.0 %

Nuclear 16.2 % 1990 NW imports 12.6%

Biomass 2.0 % 1999 “ “ 9.5%

Geothermal 4.9 %

Solar 0.4 % 1990 Ca non-utility 20.2%

Wind 1.5 % 1999 “ “ 34.7%

April 20, 1994: The Blue Book

Proposes comprehensive “direct access”

Utilities to open lines to user transactions

Phase-in to recover stranded costsSCE proposes compulsory “Poolco” Two years of conflicts and lobbying

September 1996 -- A.B. 1890

Freezes retail rates, 10% cut for small usersUtilities required to use short-term PX

All power sells day-ahead at highest bid Utilities must divest some (not all) powerplants

Stranded costs recovered as difference between rates and PX prices, 2002 deadline

ISO to operate system, real-time markets No precedents for PX and ISO markets Switch from state to federal (FERC) regulation

Markets begin --1998 to May 2000

California energy prices fluctuate predictably Move with short-term prices elsewhere in west Allegations of market power Prices in $30 - $80 / MW range at most times

Rules make entry of new sellers hard PX sells 80% of power in state Municipal utilities largely untouched by changes

SDG&E freeze ends mid-1999 Required to pass through PX prices afterwards

2000 -- the endless summer

Short-term prices rise all over the westCal utilities’ energy costs above frozen rates

FERC cuts allowable ISO and PX prices Duration of losses threatens insolvency

Non-Cal utilities buy only small amounts of power in short-term markets

Cal utilities can only buy short-term, can’t hedge It’s what they wanted in 1996

Why, and why now?

Summer weather, NW water situationRising fuel and emission permit costsCalif demand far higher than expectedCalif in-state supply falling shortWest-wide market equalizes pricesDid producers act monopolistically?

2001 -- Critical Times

Utilities at limits of ability to borrow Up to $ 1 million / hour in new debt What might bankruptcy mean?

FERC will not force producer refunds Blames California for own situation Has overriding interest in region, not state Found no evidence of monopolization Low likelihood of winning them in court

Utility solvency requires large rate hikes

The State-of-the-State Speech

Proposals for state takeovers only conceal risks and losses

Proposals to keep power in-state probably illegal

Political uncertainty discourages new plants

No acknowledgement of hard choices that must be made immediately