Electricity in California How did things go so wrong?

1. Electricity in CaliforniaHow 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

2. The good [but expensive] old days • 1960s -- production costs and rates falling • 1970s -- energy crises, environmentalism, and Jerry Brown • 1980s -- passing through uneconomic plant and contract costs • 1990s -- California rates 150% of national average • 1993: PUC staff issues the “Yellow Book,” • blames regulation for problems

4. 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

5. Changing Nature of Industry Cost Characteristics $/MW 1930 1950 1970 1990 1980 MW 50 200 400 600 800 1,000 Source: Williams Company and TR Casten, “Whither Electric Generation? A Different View” Energy Daily, September 7, 2000.

6. 1999 California Power Sources

8. April 20, 1994: The Blue Book • Proposes comprehensive “direct access” • Utilities to open lines to user transactions • Phase-in to recover stranded costs • SCE proposes compulsory “Poolco” • Two years of conflicts and lobbying

9. September 1996 -- A.B. 1890 • Freezes retail rates, 10% cut for small users • Utilities 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

10. 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

11. 2000 -- the endless summer • Short-term prices rise all over the west • Cal 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

12. Why, and why now? • Summer weather, NW water situation • Rising fuel and emission permit costs • Calif demand far higher than expected • Calif in-state supply falling short • West-wide market equalizes prices • Did producers act monopolistically?

13. 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

14. 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