Wholesale Electricity Price Limits
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RAY SUAREZ: While Californians braced for another round of rolling blackouts, a little-known federal agency met in Washington to consider ways to alleviate the state’s chronic energy crisis.
CURT HEBERT, Federal Energy Regulatory Commission: All right. Let’s call this meeting to order.
RAY SUAREZ: The Federal Energy Regulatory Commission, called the FERC, was created in 1977 as an independent agency within the Department of Energy. It regulates the transmission and selling of wholesale electricity and other interstate power sales. The agency has the authority to limit how much companies can charge for wholesale power in California. During the recent energy crisis in that state, Governor Gray Davis and others have pleaded with the Commission to set price caps. They’ve also complained of possible price gouging by energy companies. Much of California’s energy comes from major power companies outside the state. But despite these pleas, FERC’s regulators have said they would not go beyond emergency limits on prices.
Today the five-member commission, including two new Bush appointees, struck a compromise. They expanded current price limits in California beyond emergency periods to 24 hours a day, seven days a week, and they extended those limits to ten other western states. Early this morning — prior to the meeting — President Bush said he would continue to oppose price controls, but was open to a possible new approach.
PRESIDENT GEORGE W. BUSH: They’re not talking about firm price controls, they’re talking about a mechanism, as I understand it, a mechanism to mitigate any severe price spike that may occur, which is completely different from price controls. Price controls do not increase supply, nor reduce demand, and that’s precisely what is needed in the state of California.
RAY SUAREZ: For his part, after the FERC announcement, California Governor Gray Davis reacted to the new order.
GOV. GRAY DAVIS: For nearly a year I have been founding on the Federal Energy Regulatory Commission to do its job and enforce reasonable electricity prices. Today the FERC has finally taken a step in the right direction but there is much more they should do.
CURT HEBERT: It is sweet to have a five vote, it is sweet to have five commissioners, God love your heart, good luck to California, good luck to the West.
RAY SUAREZ: Today’s order will be effective through September 2002, keeping limits on prices for two summer seasons.
RAY SUAREZ: And joining me now is the chairman of the Federal Energy Regulatory Commission, Curt Hebert. Mr. Hebert, a Republican, was first named to the commission in 1997 by President Clinton. President Bush named him commission chairman in January.
Well, sir, maybe we can begin by you explaining to electricity ratepayers in California and now several other Western states what they might expect as a result of the commission’s action this afternoon.
CURT HEBERT: Well, actually what we’ve done, Ray, is we issued an order today, and I think the important thing to understand is that it’s an order that came out of the commission 5-0, five votes for it. So we’re all moving in one direction together. We had issued an order, back April 26, that went into effect on May 29th, and under that order what we did was, we mitigated prices during certain periods, reserve periods, and we define them as emergencies. And during those periods, what we saw in the very first day that they went into an emergency is that prices dropped from around $300 to, when our mitigation plan went into effect, to around $109.
So it dramatically brought the prices down. Average prices remained to be low in emergency and non-emergency periods. We had also gone out to try to get comment as to what direction we should go in looking at the Western market as a whole. We’d specifically just looked at California. So in those comment periods what we did was, we understood by looking at the comments, that in fact we did need to improve upon it, and the way we could best improve upon it is in fact to go West-wide with this. We have a reserve situation where they’re within 7 percent of reserves where we mitigate the prices, and then we’ve got a little different scenario once… outside the reserves, but we still mitigate prices.
We set a standard at which we think they should fall below, but we don’t set a cap. What we do is, we set using market inputs. We’ve got the nox costs, we’ve got the gas costs, we’ve got adders for credit to solve one of the big questions as to how about people wanting to do business in California? How do we take care of that need and give them the certainty that their bills will be paid if they come in and do business? So at the end of the day, what we did today was we put a better mechanism than we already had in place that has already brought prices down, but will do so while using market mechanisms, but at the same time attracting investment to bring much-needed supply into California and the West, and at the same time improve upon their infrastructure and transmission grid.
RAY SUAREZ: If you’re an electricity generator or a marketer, and you’re no longer able to raise prices at will when you feel demand is high and reserves are low, why is this not a cap? Wouldn’t this look like a cap if you’re a generator in Oklahoma or Washington state or Texas?
CURT HEBERT: Well, it’s not a cap, and several points need to be made about that. One, if you look at the states in the West, we went out to Boise, Idaho, we heard from all the state commissioners. They made it very clear to us, eight states there, that they didn’t want caps, they didn’t want cost-based rates. They wanted to use market mechanisms. That’s what they thought was best. I have to believe those state commissioners know better than some people in Washington, D.C., how to take care of their needs. That’s exactly what we did.
We use those market mechanisms. But we didn’t set a price at which we say the lights are going to go out. We didn’t set a price at which we say you can no longer deliver electricity. We’re going to allow them, if things get so tight in a reserve or a non-reserve period, to come in and justify beyond, if they need to, to make certain that that electricity is delivered. The position we found ourselves in at the commission, actually in December of last year, which we had set caps in place in California… I dissented from all of those. I’ve opposed the caps: They don’t work; they flaw the market; they create an artificial market; and in the end they harm consumers.
We had caps at $750. They were lowered to $500, and they were lowered to $250. Empirical evidence that the Federal Energy Regulatory Commission that was brought before us showed us that in fact average prices rose. And so many people want to talk about this single price spike. Consumers don’t pay single price spikes The market looks at that for signals to bring in adequate supply, to build out infrastructure. What we’re worried about and, more importantly, what consumers are worried about are average prices. So this will bring down average prices whereas a cap won’t. It will bring average prices up. And this will bring in needed supply, which is so desperately needed in California and the West.
RAY SUAREZ: Well, if you’re a homemaker running a refrigerator in Fresno or somebody who runs a convenience store in San Luis Obispo, is the FERC standing in between you and the power generator now to at least create some expectation that there won’t be sudden rises in price in the coming months?
CURT HEBERT: Well, we are injecting ourselves during periods that we think are tight, where there could be some manipulation of the marketplace; in other words, some misconduct, some ability for them to come in and manipulate prices. And what we do is, we intervene at a level that we think indicates what a market would otherwise bring to that consumer. That’s in fact why it’s not a cap. A cap would be some arbitrary figure that would not in fact pick a market input or use market inputs to deliver a price at which they should have energy delivered. And if they need to go above that price to keep the lights on, to make sure we’ve got adequate supply when you do have increasing demand, then we want that to happen, and we want them to come in and cost-justify that.
RAY SUAREZ: But for a long time, energy utilities were among the most regulated businesses in American life. Regulators like yourself tried to set a price at which both the owners got a profit and the consumer got a steady and predictable supply. You’re saying that even that model was flawed from the get- go?
CURT HEBERT: Well, I think when it was used, what we find, and this is what… you know, we energy nerds, we attorneys and economists and engineers and accountants that do this, we talk about these things all the time. The general public doesn’t understand exactly how it works. But what is important for them to understand is that regulation is a substitute for the market. And market, the market, is a substitute for regulation. What we’ve tried to do is move beyond regulation, understanding that Americans love choices.
Americans believe that they are smarter than anyone else in choosing their product. They may want a higher-price, qualitative product or they may want a less-qualitative product that’s a little cheaper price. We’re going to try to give them opportunities. Now, we do need to keep quality high when it comes to electricity but we need to allow them to use those opportunities and have the choices when and where necessary. Cost-based rates did not allow that opportunity. The other thing that cost-based rates did in many areas — actually when I was back in Mississippi as a commissioner there and as a chairman there, we found from time to time what utilities would do, is they would is they would gold plate.
In other words, they would build systems, quite frankly, that weren’t necessary to provide reasonable services and reliable services to consumer, but they would do that because they would get a return on that investment. So this is an opportunity to give them a choice. We’re driving efficiency here through this plan. And I think this is the one thing, Ray, that I think most Americans should be excited about and the people in California and the West as well. This is a plan that drives at efficiency. This is a plan that takes the least efficient unit and lets it set a market-clearing price. And the profits are derived between those that come under that and the least efficient price itself.
In other words, there’s no way to understand what market price is going to clear at on any given day. So they drive efficiency. Understand that the more efficient they are, the more profit they get. The same time, we’ve got some dirty units out there in California. We’ve got units that are 2,000 and 3,000… I’m sorry, 20,000 and 30,000 heat-rate systems. Now we’ve got new technologies that bring us down to a 7,500 heat-rate system. We’ve got technologies that on compressed situations can bring it down to 4,500, much cleaner systems.
And this is the green part of it, that not only drives the efficiency to keep costs down, which in the end consumers love, but at the same time what it does is it learns from a very strict principle that we all believe in: The best way to protect the environment is never to make it dirty in the first place. Let’s get the cleaner units online; let’s take those dirtier units off; let’s drive the efficiency. This will work. It will bring down prices. It’ll bring necessary supplies in to protect, in the long term, the people of California and the West and the rest of America if we use these principles.
RAY SUAREZ: Earlier in the program, California Governor Gray Davis said your move wasn’t enough, but it was a step in the right direction. Earlier in the month, he said that the price caps were just a temporary measure until California gets some new generating capacity online. Why weren’t they even a temporary answer, in your view?
CURT HEBERT: Well, I’m not really understanding if you say earlier in this program that the governor said that our step wasn’t enough. We haven’t even issued the order yet. We’re fine-tuning the order. It will be issued later tonight. The press release is just going out. If you haven’t read the order, and the order is, I think, 55 pages — it may be 56 by the time we finish with it — I’m not sure how, unless you’re being intellectually dishonest, you could say in fact the plan isn’t enough or isn’t working.
RAY SUAREZ: Well, I think he wanted a straight-ahead price cap, and I think you’ve been very clear that he is not going to get it.
CURT HEBERT: Well, the consumers don’t want straight-ahead price caps. We learned that when we went to Boise, Idaho. We had eight states say, we don’t want price caps, we don’t want cost-based rates. You have found that the people in California now understand that through their conservation efforts — and let me tell you, people in California are doing a magnificent job, and I appreciate them coming forward — they also understood, because we put the price-mitigation plan on the table.
We’d asked California to file for a regional transmission organization — the only state that had not filed one. They had not filed one, and said they weren’t, and then we put it in the mitigation plan, said they had to file it if they wanted the mitigation plan to continue, and they did file it. Now we hate to ever put anyone under duress at the FERC, but I will commend those leaders that finally said we think the regional transmission organization is important. But at the same time, if you look at the evidence, the evidence is clear.
Price caps haven’t worked anywhere. Didn’t work in the Nixon or the Carter or the Clinton administration. But what we’ve done since January 22, since January 20, when President Bush took this office forward, what we have done has been very positive. We have issued refunds — that was not done in the previous administration — $130 million worth. We have brought prices down. Empirical evidence is there. And for those that want to say well, the circumstances are different, we don’t know what the demand was, we don’t know what the supply was.
We don’t know what the temperatures were — let me tell you — the examples I was giving you where the prices come down, they came down on a record-breaking temperature day of 101 degrees in California. So these are real models that are working. The people of California will understand this works. And I will tell you I’m not here to get elected governor; I’m not here to get elected for anything. I’m here to call balls and strikes. My fellow commissioners who join me in this effort today are here to call balls and strikes and provide answers to the American people, the people of California and the people of the West. And that’s, in fact, what we did, and that’s what we care about.
RAY SUAREZ: Chairman Curt Hebert, thanks for being with us, sir.
CURT HEBERT: Thank you. My honor.