California Price Caps on Energy

MARGARET WARNER:

For more on the debate over price caps we're joined by David Freeman, chief energy adviser to California Governor Gray Davis and former head of the Los Angeles Department of Water and Power; and Craig Roach, an energy economist and partner at Boston Pacific, a consulting and investment firm that advises power companies. Welcome, gentlemen.

David Freeman, the crux of the dispute between the governor and the president is, of course, over whether to impose the price caps of wholesale power. How would the caps work and what justifies the case?

S. DAVID FREEMAN:

Well, the law justifies them. I happened to have worked for the old Federal Power Commission under the same statute that was passed by Sam Rayburn in '35, which requires as a matter of duty that the wholesale price be just and reasonable. And the FERC is just simply not carrying out their duty.

This is a matter of an agency not doing what the law requires them to do, and, as a result, we're paying 50-60 billion dollars this year for electricity that cost $7 billion two years ago. The issue is pretty straight forward.

We're not talking about cabbages or carrots where the marketplace, the law of supply and demand are okay. We're talking about the oxygen of life in a high energy civilization, and we're talking about depriving people of funds to pay for groceries and clothes and necessities of life.

I mean, to say that the caps are not going to affect supply and demand is to leave out the key element in the equation — the people who are being overcharged at a rate that's unheard of in the 100 year history of the electric power business.

MARGARET WARNER:

Craig Roach, do you think the FERC can make a case that the rates are just and reasonable, and, if not, why not impose price caps?

CRAIG ROACH:

I think they can make a case, as the president did in the opening clip, that price caps are going to make matters worse. I don't think we've taken the people out of our concern, out of the issue, out of the equation. We have a shortage in California. We just don't have enough power plant capacity to supply all the need. In a shortage we want suppliers to supply more. We want consumers to consume less. And that price signal is what orchestrates all those actions, and at this point somehow artificially lowering that price is just not going to do what we need to do; it's going to work in the opposite direction.

MARGARET WARNER:

What about that point, Mr. Freeman, because the president makes it too, that it's actually counter productive to impose price caps because it ultimately discourages exploration and production and, therefore, restrains the need — restrains the ability of the producers or the willingness of producers to produce more power?

S. DAVID FREEMAN:

Well, in the first place we're building power plants in California. We'll have this problem behind us in a couple of years if we have any money left. I think the law is very clear. We have had price caps based upon costs at a reasonable profit in this country for almost a hundred years, and the power system has grown from teakettles to one of the best in the world.

It all depends on what level the cap is; if it reflects all of their costs and a good profit, people have built power plants on that basis from time immemorial. It is outrageous to just say in the abstract that any cap is going to discourage power plants from being built. They don't need to make obscene profits that go from $200 million to $600 million in one year for the energy companies in order to build power plants.

We have contracts long term for power plants to provide electricity at our existing rates. There is a shortage, the gentleman is correct, and they're taking advantage of the shortage and disobeying the law, which is on the books, that requires that prices be just and reasonable. And the very same FERC has found the existing prices are not just and reasonable.

CRAIG ROACH:

I think let's clarify one thing. There is a price cap right now. I don't believe that California state government likes the level of the price caps.

MARGARET WARNER:

You're talking about, excuse me, the price cap that the FERC did say would go into effect during an emergency state.

CRAIG ROACH:

That's right. And there have been price caps all along ever since deregulation, but, you're right; in April of this year, FERC did impose a price cap. Anytime reserves fall below a safe level, they trigger that price cap. In fact, I understand that today that price cap is being imposed; there's a stage one emergency.

And FERC is acting on principle; they're saying, look, if there is a shortage, what we're going to do is we're going to go in, we're going to calculate the price of electricity that will prevail in a fully competitive market, and if any supplier charges over that, we're going to come and scrutinize that price and essentially seek refunds.

MARGARET WARNER:

All right. And how much —

S. DAVID FREEMAN:

Let's be quite honest about this, though.

MARGARET WARNER:

Go ahead.

S. DAVID FREEMAN:

They've set a price at the highest cost that anybody has, and it doesn't apply to out-of-state producers of electricity and applies only when we're in a stage one emergency. This is Swiss cheese; this is not a cap.

MARGARET WARNER:

All right. Let's go back, though, to the bigger dispute between the governor and the president, which has to do with the governor's desire for wholesale widespread price caps, not just in emergencies. What about the point Mr. Freeman's made a couple of times now that the law says FERC is supposed to keep the prices just and reasonable? Do you think the prices are just and reasonable, or do you think the governor has a point, Mr. Roach, when he says that these producers are engaging in price gouging?

CRAIG ROACH:

I don't think there's any evidence of price gouging. Let's call it anti-competitive behavior. There have been several investigations at the federal and state level. One of the classic anti-competitive behaviors is to withhold supplies, and FERC, and I believe the state have gone in to investigate times when power plants weren't available.

There's been no evidence of anti-competitive behavior, price gouging, and in that sense the prices are just and reasonable. But the real issue here is: How do we solve this problem, and, again, I think price caps are just going to be counter productive. And it's not just in the abstract.

The New York Times had an article just a little while ago about San Diego and their consumption, San Diego residents and their consumption of electricity. Last year, they were the only ones that actually saw these price hikes, and they reduced their consumption according to the Times about 9 percent. And now that there's been a reduction, there's not a new price cap in San Diego, they've gone back to pre-crisis levels. Prices orchestrate action; they work. They do what the marketplace is supposed to do in a shortage.

MARGARET WARNER:

All right. What about that point, Mr. Freeman — because we've had some environmentalists make that point, that actually prices, if they go up, will get people to conserve.

S. DAVID FREEMAN:

Well, let me first of all, I'll point out that the gentleman did not answer your last question on whether or not this is mandatory. But we have the highest prices for electricity of anyone in the United States of America, except Hawaii now. They're making last year's argument today. The prices have gone way up in California; and people will see them in the June bill. And we are conserving. Our consumption is 7 percent low last year. We're sending the signals to the consumers. The problem is that they're not going to have any money left to pay their grocery bill at the rate that's being charged by these wholesalers who are — it doesn't really matter whether their behavior is criminal. The prices they're charging are a crime. I mean, they're ten times what we've negotiated long-term contracts for. No one, including FERC, thinks they're just and reasonable. In fact, FERC is now just the opposite — in plain English — in their opinion; they just refuse to enforce the law.

MARGARET WARNER:

Mr. Roach, what's the alternative to price caps? Is California just supposed to tough it out until what — a year and a half from now — Mr. Freeman said they thought they'd have enough extra plants?

CRAIG ROACH:

No. I think Mr. Freeman's already pursued and mentioned in his discussion one of the major issues. Look, there are two problems in California that have caused this crisis. One is just not enough power plants; the state has to be aggressive in bringing on power plants. Permitters, regulators, environmental regulators —

S. DAVID FREEMAN:

We are.

CRAIG ROACH:

— have to — and I think you've begun to be — but they've got to consider it a victory to bring on a new power plant that is environmentally sound; they've got to have that culture. It's not okay just to delay power plants. The second thing is the rules in California had to the utilities selling at a fixed price and buying at a variable price.

In answer to that, the bilateral contracts that Mr. Freeman mentioned — and I think he's right — they are going to start to solve some of the problem, and the prices in those contracts are superior; they are good prices, and some of the same people being charged with gouging are probably offering those prices.

MARGARET WARNER:

Before we end, let me take —

S. DAVID FREEMAN:

They're gouging because they sold to me at a tenth of what they're charging today.

MARGARET WARNER:

All right. Mr. Freeman, let me ask you this before we leave. Is this price cap debate, do you think, going to be tied up elsewhere in the country this summer, or other states have faced energy shortages, or is it very particular in California, just briefly?

S. DAVID FREEMAN:

Well, I understand that Governor Pataki is considering action that he could take against price gouging; I heard that this afternoon.

MARGARET WARNER:

Mr. Roach, do you think that's going to be — will you have this debate elsewhere?

CRAIG ROACH:

I think there are some areas — New York City, for example, perhaps New England — but we ought to look for states that are doing it right. Texas happens to be one; Texas similar size in electric terms, they've built a lot of power plants; they probably won't have anything like this.

S. DAVID FREEMAN:

They've built some price caps into their structure.

MARGARET WARNER:

All right. Mr. Freeman, Mr. Roach, thanks very much.

S. DAVID FREEMAN:

You're very welcome.