California power woes a warning for Ontario

Peter Gorrie
Toronto Star
January 6, 2001

Mindy Spatt’s message to Ontario is clear: “Don’t do anything we did.” Spatt, a consumer advocate, is speaking from her office in San Francisco. She’s talking about electricity, something everyone uses and takes for granted – until it isn’t there. And increasingly in California, it isn’t there. And when it is, it’s at a shockingly high price.

“We made a huge mistake,” she says.

The group she works for, the Utility Reform Network, blames deregulation of the state’s energy system.

In March, 1998, California did what Ontario hopes to do this year – it ended a longstanding monopoly system and opened the generation and sale of electricity to competition.

The free market was supposed to increase the supply of power and cut prices for home and business consumers. But it has done just the opposite. The state – with a huge and booming economy based on high-tech industries that need lots of reliable power – has suffered one major blackout and its system teeters on the brink of collapse.

While most of the companies that generate electricity are making money hand over fist, the two main utilities, which distribute the power to two-thirds of the state, say they’re in danger of going bankrupt because they are not allowed to raise prices. One announced an additional 1,450 layoffs yesterday – after 400 jobs were eliminated last month – to help offset its share of the $11.9 billion (U.S.) power firms are estimated to have lost. Also yesterday, fears about bank loans to the two largest firms, helped send U.S. stock markets downward.

Things got so bad that Gov. Gray Davis shut off the lights on the official state Christmas tree after they’d been on for only 35 minutes. In San Diego, where there is no limit to the increase that can be passed to the consumer, hydro prices have shot up more than 300 per cent. Elsewhere, where the state government still has some say, the cost is going up by as much as 15 per cent, still far short of the increase requested by the utilities to keep afloat.

“The fuse has been lit. When people get their bills, it’s going to detonate,” said Harvey Rosenfield, president of the Foundation for Consumers and Taxpayers Rights, yesterday.

The Ontario government and energy experts here are keeping an eye on California, and to a lesser extent Alberta, which is going through its own deregulation crisis. The Queen’s Park view is that we’ll do just fine when the “open market” finally arrives. Others are less sanguine.

“The experience in those unhappy jurisdictions is rich with lessons for us,” says Tom Adams, of Toronto-based Energy Probe. “I’m afraid we’re not learning them.”

“All reports are that the whole thing (in California) is a mess,” says Andy Frame, an energy consultant who was a senior adviser to Ontario Hydro for 17 years. “If we keep charging ahead, we’ll get into the same kind of mess.”

Ontario consumers are already seeing evidence of the open market. Brochures from some of the 40 electricity retailers that plan to enter the competitive fray are landing in mailboxes, offering power at “guaranteed low rates,” usually for a year.

But that’s only the public face. Behind the scenes, technical experts, lawyers, researchers and officials are trying to solve problems in a massive and complex system that, if it works well, will be invisible to most of us, but if it fails, well . . . .

California, like Ontario and most other parts of North America, used to have monopolies that generated and distributed electricity. Ontario Hydro was government-owned and covered the entire province; California was served by several private companies, each with its own fiefdom. But they operated in much the same way. They aimed to provide a secure electricity supply. The prices they charged were strictly regulated by government boards, based on the actual cost of producing and distributing power. Like Hydro, California’s utilities ran into financial trouble, largely because of delays and cost over-runs on nuclear plants, but also because they got flabby.

The conservative wave of the mid-1990s turned the lights out on the monopolies. The free market, the argument went, would create a better, more efficient system.

In California, the big utilities were required to sell off at least half of their power plants to other companies. They then had to buy power from the new generators – bidding for it on a daily market – and sell it to business and residential consumers.

The price the generators could charge was capped, but at such a high rate that the cap didn’t seem to matter. The price utilities could charge to consumers was also capped, at a much lower rate.

At first, the system seemed to work well. The generators and utilities made decent profits, and rates for consumers were reasonable. But the system contained a major flaw. Virtually no new power plants had been built in a decade. And the transmission system was becoming stretched to the breaking point. Meanwhile, the California economy was leaping ahead – it is now the world’s sixth-largest – and the population was growing by 600,000 a year.

Last spring, demand started outstripping supply and the generators started raising their prices. Before long, the utilities were paying far more for power than they were allowed to charge for it. The two biggest – Pacific Gas and Electric Co,, and Southern California Edison – claim that they each owe about $6 billion.

“I’ve got a fourth-grade grandson that can do the math on this,” says Bob Glynn Jr., head of Pacific Gas’ parent company, PG&E Corp. “If you’re buying at 27 cents and selling at 7, you’re going to run out of money.”

To date, the utilities have managed by getting lines of credit from banks and floating bond issues, but as the price gap widens, they’re warning they might need to seek bankruptcy protection.

Their finances are so precarious that out-of-state suppliers, including B.C. Hydro, have stopped selling power to them despite the fabulous profits to be made.

And yesterday, after utilities were granted only 7 to 15 per cent in price increases, half the amount they had sought, credit agencies downgraded them, stopping just short of cutting their ratings to junk levels. Predictably, their shares nosedived.

California’s rules allow for the caps on consumer prices to be removed once utilities have paid off debts they’d run up over the years. The only one to do so, to date, is San Diego Gas and Electric. Once its shackles were removed, rates shot up more than 300 per cent for homeowners and businesses.

“We’ve put the generation in the hands of private companies and there’s been hell to pay,” Spatt says. “Prices are absolutely insane.”

Amid the growing chaos, last month the federal government invoked a law requiring California’s neighbours to send in all their surplus power. That emergency measure was extended yesterday.

There are increasing calls for a return to regulation.

And, in a sign of just how taut nerves are, Gov. Davis and the head of the state’s regulatory agency no longer speak to each other.

All this threatens a rude awakening from California’s economic dreaming. In just one example of the potential impact, computer giant Hewlett Packard says a 20-minute power interruption at one of its microchip plants can cost an entire day’s production, worth $30 million (U.S.).

It’s not a situation that attracts new investment.

Meanwhile, every available generating plant is being used to boost the supply – even some that had been mothballed for not meeting pollution laws. Even so, there is no end in sight for the supply crisis. Many of California’s generating plants are old and need to be shut down and overhauled. Even if new plants and transmission lines are built, it would take years to get them approved and in operation. President Bill Clinton has invited Davis and power company executives to a White House meeting on Tuesday to try to find a solution to the crisis.

Alberta also opened its electricity market with too little supply to meet demand, with a predictable result. With a fat budget surplus, Premier Ralph Klein was able to quickly announce $20 a month rebates for frantic residential consumers. Here, Ontario Hydro has been broken into five pieces. The biggest, Ontario Power Generation, or OPG, still produces about 85 per cent of the province’s power. Another, called Hydro 1, operates the wires, transformers and the rest of the transmission system. The other three are small operations that carry out regulatory or financial duties of the former Hydro.

When the open market begins, possibly as soon as this year, other generators will be allowed to produce power in competition with OPG. And the retailers will buy power and resell it to consumers, also in open competition. The distribution system, which carries the power from generating plants to homes and businesses, will continue to be regulated.

The system isn’t entirely run on free-market principles. OPG is considered too big for competition to work, and has been ordered to shrink. Within 42 months after the market opens, it must sell some of its non-nuclear generating plants. Until then, its revenue will be capped at about the same rates it charges now. Within 10 years, it must have sold enough generating capacity to reduce itself to 35 per cent of the province’s total production.

Other generators and retailers will be allowed to charge what the market bears. The theory is that competition will keep prices in check. Just in case, a group called the Independent Electricity Market Operator, or IMO – one of the remnants of Ontario Hydro – will try to ensure there’s fair competition when generators sell to retailers. And the Ontario Energy Board will keep an eye on the retailers who sell to consumers.

The board and IMO are still writing the complicated rules for how the market will work and have just begun testing computer software to handle the transactions. Neither group is saying when they’ll be ready; the province won’t launch the market until they are.

Provincial officials say we have a huge advantage over California and Alberta.

Supply here is well ahead of demand, says Shane Pospisil, of the ministry of energy, science and technology.

Ontario continues to closely follow California and Alberta but, so far, “there’s nothing . . . that’s caused Ontario to change its plans. A lot of what they’re experiencing is the result of the difference between them and us, especially the fundamental demand/supply imbalance.”

The IMO concluded in a recent report that Ontario will have plenty of power for at least the next 10 years, without taking into account the restart of parts of the Pickering and Bruce nuclear plants and large new supplies expected to come on stream.

About $3 billion worth of generation projects are proposed, including two by American giant Sithe Energy on the west side of the GTA and one by TransAlta Utilities in Sarnia.

Additional connections with Quebec’s power grid will allow Ontario to import more electricity.

As well, Pospisil says, only 4 per cent of Ontario’s power is generated using natural gas, guarantees the projects will be built. “There’s a lot of talk and there’s little action.” Problems like gas price hikes, a delay in the market opening, or confusion over regulations could scuttle any of them.

Sithe Energy, for example, is developing projects all over the northeastern United States. It has more on the books than it will have the turbines and other equipment to build, so its projects are, in effect, in competition with each other. “We don’t know if we’ll get the investment,” Adams says.

Ontario Hydro’s first responsibility was to ensure a secure power supply, says Frame, the energy consultant, but, “under the new system, no one has the responsibility to meet demand. If more supply is needed, who’s got the responsibility of building new plants? Under our legislation, no one has.”

Those who back deregulation assume that if the market is there, supply will be built, he says. “That’s not working in California.”

Most of the new plants will be fuelled by natural gas, raising the threat of rate hikes if gas prices keep rising. While some in Ontario debate whether price caps will be needed, there are no plans for them, says Kevin Dove, a spokesperson for the IMO. “The market will determine prices . . . We believe that by ensuring the maximum amount of choice in the marketplace and the maximum supply of power, that will be the best protection for consumers.”

Much of southern Ontario’s air pollution comes from coal-fired generating stations in the Ohio River valley.

Canada has been urging the United States to impose controls on those plants, but Ontario consumers could soon be buying power from them.

The rules won’t deal with environmental concerns, Dove says. “We need to know supply is reliable, not (just) where it comes from.”

 

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