Power Problems in California
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RAY SUAREZ: We take a further look at the world of power in California and the nation beyond with Severin Borenstein, director of the University of California Energy Institute and professor of business administration and public policy at the University of California Berkeley’s Haas School of Business; Paul Patterson, an electric power analyst at Credit Suisse, First Boston; and Tyson Slocum, senior researcher at Public Citizen’s Critical Mass Program, which specializes in energy issues that affect consumers.
Mr. Borenstein, we just heard that consumer advocates and the industry weren’t happy with today’s solution to increased electricity rates. Do you think it buys time? What do you think of the solution?
SEVERIN BORENSTEIN: Well, it buys a little bit of time. It probably doesn’t really buy enough time to really figure out the long run problem here. The critical issue here is that the utilities have to earn enough revenue to cover their costs going forward. They’ve lost a lot of money already since June when prices got out of control. But to keep them out of bankruptcy we do have to make sure they get enough money going forward, and we can then go back later on and fight out who is going to pay for the losses from the last six months.
RAY SUAREZ: And, Paul Patterson, what do you make of this solution?
PAUL PATTERSON: I don’t think it’s enough. Clearly what the utilities requested and needed wasn’t met. The rate freeze has not ended, and the real critical issue here is getting lenders to feel comfortable enough to continue to loan money to them. And the commission’s actions alone don’t seem like that will be good enough.
RAY SUAREZ: So what do you suggest being done in the short term, because high-demand summer is not that far away?
PAUL PATTERSON: Well, I think what has to happen is that there has to be a reasonable plan that between the legislature, the Governor and perhaps the CPUC to come up with a method and a plan which basically guarantees the utilities the ability to recover their purchase power expenses. They’re not responsible for these expenses. This is the wholesale market that’s acting, and it’s simply a situation whereby they’re trying to simply collect money that they’re buying power for on behalf of consumers.
RAY SUAREZ: Well, Tyson Slocum, those caps were put in place as part of the transition period from a regulated to an unregulated utility market. What happened, why did they have to be raised today?
TYSON SLOCUM: Public Citizen feels those rates should not have been raised, and we feel that deregulation is a failure because true competition can never occur in the utility industry. What’s going on in California right now is total market control and price manipulation by a few large energy producers. They can charge whatever price they want on the wholesale market because no one is there to stop them, not the government, and definitely not any other energy competitors because there is no competition. And that is what’s bearing out in California right now. And what’s going on in California is going to happen all across the United States unless we put the brakes on deregulation.
RAY SUAREZ: So, what, just undo the legislation that created this deregulation plan in the first place, go back to where California was before this started?
TYSON SLOCUM: Absolutely. Remember that the deregulation law was heavily supported by Southern California Edison and PG&E, the two major players in California. They essentially wrote the law. They gave millions of dollars in campaign contributions to the governor and to the California legislature. There wasn’t one single vote in opposition to the deregulation law in either the House or Senate. That shows their kind of influence in the political process.
Why did they do it? For two main reasons: Southern California Edison and PG&E got a huge consumer funded bailout. Consumers overpaid their electric bills by over $18 billion to pay for the utility’s bad investments in the past. The so-called stranded costs. And the second aspect is that southern California and PG&E were restricted by regulation by venturing into other businesses where they saw profit. With deregulation the door was wide open. But what happened was they were simply outfoxed by outside corporations like Enron and Duke Energy that are bigger, smarter, and frankly, meaner.
RAY SUAREZ: So, Paul Patterson, what do you make of that diagnosis?
PAUL PATTERSON: I don’t think it really gets to what the heart of the problem is. The heart of the problem is that electricity, one has to remember that you really can’t store electricity on an economic basis – that the demand for electricity is essentially relatively inelastic. And as a result, and finally if you don’t allow enough power plants to get built, which is what the state of California did, it’s very difficult to get sighting and permitting, there’s a large alliance on natural gas-fired plants, and as a consequence there wasn’t enough supply. And in an environment like that where there’s no inventory, where there’s very little in the form of imports that can come from international sources, what have you, you’re in a very localized market, if you don’t have enough supply, and you have an increase in demand, which we did, and no new plants being built, you do have the potential, which we’ve obviously seen happen here in the wholesale market, of prices getting extremely high. That’s unfortunate, but that really isn’t necessarily the fault of the people who are in the power supply business.
One of the other problems that you have is that the price of power is essentially frozen at the customer level. Customers are not seeing these high prices. If you were to buy a cup of coffee and it normally costs a dollar but you walked into the store the next day and it costs $20, you might decide not to buy coffee, you might decide to do something else. Well, it’s very difficult, (a), to find a substitute for electricity, but also if you don’t see that price, if you do not see the fact that the cup of coffee is costing that much, your demand is not reduced. And there isn’t as much efforts to conserve. So it’s that dynamic of the market. The market wasn’t deregulated in the right way. And, as a consequence, that’s why you have the problem. Also, it’s important to remember that the utilities were really forbidden from actually signing up long-term contracts. There wasn’t a problem in the market until relatively recently. And that’s what’s caused the problem. It’s really a demand-supply issue in a very, very critical commodity that doesn’t have any form of inventory. That’s what I think the problem is.
RAY SUAREZ: Severin Borenstein, is Paul Patterson right, or are there some consumers who are being exposed to suddenly doubling and tripling bills in specific areas of the state?
SEVERIN BORENSTEIN: Well, no the consumers to this point are still being protected at the retail level. So that really is true, that the prices are frozen. But I would have to disagree that all of this is just supply and demand. The reality is that when you get into a situation with very tight supply and there’s very little price responsiveness on the demand side, the sellers are put in a position where they can push prices up much higher than even a competitive market would give you in these tight markets, and we’ve seen that happen. And we’ve done research that shows prices are above competitive levels. But I think to get back to what the short run problem is in California and what the strategy is here, I think what’s really going on is the Public Utilities Commission is playing a game of chicken with the federal government because the state of California and the P UC have really hoped that the federal –.
RAY SUAREZ: That’s the Public Utilities Commission?
SEVERIN BORENSTEIN: Yeah, thank you. That the Federal Energy Regulatory Commission would grant some sort of relief by up imposing price caps, and the wholesale market to keep prices from going completely out of control, the Federal Energy Regulatory Commission has backed away from that and in fact has lifted the price caps that were in place. And that’s been — the result of that has been astronomical prices. The state is hoping that the FERC is going to step in -
RAY SUAREZ: FERC being?
SEVERIN BORENSTEIN: The Federal Energy Regulatory Commission is going to step in before the utilities go bankrupt, and I think what we’re seeing right now is a showdown, because I think realistically it is possible that the utilities will go into bankruptcy, and once they do go into bankruptcy it’s important to recognize that at that point, there is no more shareholder equity to drain in order to pay these bills. The only way that the utilities are able to continue to buy power is if they have some guarantee. That guarantee is going to have to either come from the state or from the federal government, or from a rate increase that assures lenders and sellers that the bills will get paid. I think that’s where we’re going. If we go into bankruptcy, we’re going to either see a giant price increase very quickly, or we’re going to see the state or, frankly, from California, our preference, the federal government, bail this out.
RAY SUAREZ: Tyson Slocum, one utility executive today said we can’t go on selling something that we buy for 27 cents, for 7 cents. I mean, you can see the sort of self-inevitability of that statement.
TYSON SLOCUM: He probably should have thought about that when they wrote the law. I think the big shining star here is the City of Los Angeles and the 30 other California communities that have publicly owned and publicly controlled power. They’re paying significantly lower rates than electricity provided by privately owned corporations. How is that possible? The only explanation is that there’s massive market manipulation going on by the very few players who control California’s market.
RAY SUAREZ: So what should the two dozen other states who are looking at deregulation now be considering in looking at the California example?
TYSON SLOCUM: They have got to put the brakes on moving ahead and wait and see what’s going to happen in California, definitely no more deregulation, and take a look at public power. I mean that’s really right now the smart thing to do.
RAY SUAREZ: Paul Patterson, what should people be learning from California and the 22 other states looking into deregulation?
PAUL PATTERSON: A couple things. First of all they have to be thoughtful. They have to make sure that there is adequate supply. There’s no question that if there isn’t adequate supply, Severin said you have, or marketers have the ability of — it’s a seller’s market and prices can be high. That will in turn actually create a demand for new generation and new generation will get built. But you have to have, as in the state of Texas, for instance, adequate regulation to allow people to site generation, to build generation, to have it hooked up to generation. These are critical issues. If you simply deregulate the market and don’t allow supply response to take place, you’re going to have a very dysfunctional market, which is what we’re seeing.
Also I’d like to step back here on the price caps. The price caps they had, they had a $250 megawatt hour price cap. The reason why that price cap went away was essentially the price of gas got so high in California that even the most efficient gas plant wouldn’t be able to produce electricity underneath that price cap at an economic price.
RAY SUAREZ: Well, this story is going to go on, because California is facing further decisions, and so is the rest of the country. Panel, thank you.
TYSON SLOCUM: Thank you.
PAUL PATTERSON: Thank you.