California Daze

November 13, 2001

California’s continuing electricity nightmare

By Tom Adams, Energy Probe

I had the occasion last month to meet with some of the responsible agencies involved in California’s electricity reforms and some of the State’s key decision makers. These players include Kellan Fluckinger a senior advisor to Gray Davis and the California Power Authority, several people at the California Energy Commission, a representative of the California Independent System Operator, two representatives of the Electric Power Research Institute, and a prominent utility reform advisor to the environmental NGO community. As a result, I anticipate continuing instability in California’s electricity system. The ongoing problems in California’s power system suggest a general observation about the difficulty of achieving successful electricity reform.

What principles?

Durable economical principles are noticeably lacking from the plans of the major California government organizations now defining the state’s electricity future. The following concepts are widely accepted as true and constitute some of the main ideas guiding the sector.

    · Government should make the major decisions for the power system, including directly controlling the physical dispatch of the system. Since the governor’s office took over the California Independent System Operator by replacing its board, the organization is no longer independent. (The successful liberalized power markets around the world all have some level of independent governance regarding rules for system dispatch.)
    · Customers should not be charged market-based marginal cost prices, but instead should be charged fair (meaning politically determined) prices.
    · California’s crisis is caused by greedy generators and the Federal Energy Regulatory Commission (FERC). The FERC must exercise regulatory control of much of California’s electricity sector. (Why these culpits haven’t caused the same crisis in Pennsylvania Jersey Maryland Interconnection is never explained. Notice how this desire contrasts with the traditional state views of state rights.)
    · Greedy generators should have their property confiscated through abrogation of contracts, windfall profits taxes, and/or default on payment of arrears now owing to generators.
    · Assets of local distribution and transmission companies, and potentially also generators, driven into bankruptcy by chaotic government and regulatory actions should be taken over by the state.
    · The quality of life in California is positively correlated with the number of wind turbines installed and program spending for conservation. Further, many people believe that subsidies to conservation and renewable energy production recovered from customers constitutes internalization of otherwise externalized environmental costs of conventional power provision. (Environmental NGOs have played virtually no role in designing the market rules. Now they find that delivering firm power for a defined period, as required by the rules, from intermittent generators like wind turbines, is an inherent problem without an open spot market to cover imbalances between forecast and actual production.)

Regulation’s logical limits

A fundamental regulatory confusion is developing in California. There is enthusiastic support in many quarters for a return to regulation of power investments and prices by the California Public Utilities Commission (CPUC). At the same time, there is widespread support for nationalization of power supplies, either directly by government building or taking over assets, or indirectly through government contracting for power. Recognition of the logical problems inherent in one state agency regulating another appears to be absent.

At the height of the power crisis, a state organ called the Department of Water Resources (DWR), at the insistence of Governor Gray Davis, signed a number of long term power purchase contracts that together sum to a large portion of the state’s supply needs. With falling market prices, these contracts now represent a significant net liability to DWR. The CPUC appears to have authority to control the recovery through rates of the DWR’s costs associated with those contracts.

There was widespread approval for the decision of the CPUC in early October that apparently moves toward denying the rate impacts of the DWR contracts, which may result in abrogation of the contracts. Ratepayer groups appear to believe that any short-term harm that might be imposed on generators is good by definition. Environmental groups see the abrogation of the contracts – most of which are based on gas-fired generation – as an opportunity to replace that supply with wind power.

The DWR has taken the lead not only in power procurement but also in advocating elimination of customer choice, explicitly on the grounds that it wants to ensure that customers cannot escape having to pay for above-market power costs locked in by its contracts.

Ontario Hydro of California

California’s drift toward nationalization of substantial portions of its power sector is very similar to what happened in Ontario during the first two decades of the twentieth century. The nationalization of California’s power sector might lead to some early apparent policy successes, and fuel opposition to power sector liberalization developing elsewhere in the world.

The two largest investor-owned power distributors in the state, Southern California Edison and Pacific Gas & Electric, are being driven into bankruptcy by a complex series of factors including chaotic government and regulatory actions, internal management errors, and major financial and technical deficiencies in the original restructuring plan. Assets of those firms may end up in state control. Mr. Fluckinger expressed to me the view that the State should control enough peaking generation to be able to manage prices within a “reasonable level.” The bond issuing authority and contracting capacity of DWR and the CPA are more than sufficient to achieve substantial price control.

Nationalization of the power sector through confiscation and bond issuance parallels the Ontario Hydro model from the period 1906-1922. The Ontario experience demonstrates that nationalization of a poorly functioning private market through confiscation and bonds can appear to be a superior form of organization for the power sector. It took a long time for the Ontario public power system to collapse under self-inflicted wounds perpetuated by an overall lack of accountability. If Ontario’s experience holds in California, even after the nationalized electricity sector has converted massive taxpayer-backed subsidies, not into net assets, but into even greater net liabilities, there will be true believers who will complain that the government electricity company would have succeeded if it had only received greater subsidies.

Implications of complexity

Electricity system restructuring is irreducibly complex. The physical function of modern electricity grids requires that each electrical component is connected to, and can affect, all other components. Grid engineering allows a very narrow range of operational flexibility. High fixed and variable costs make the system vulnerable to financial disruption. The societal costs of unreliable power are extremely high and rising. The power sector is vulnerable to political influence not only because it has so many points of connection with public interest priorities, but because regulatory mechanisms, which are difficult to shield from political influence, are needed.

The interconnected engineering, financial and regulatory minimum requirements for operable electricity systems imposes demands on the policy environment. Randomness, confusion, bias, illogicality, and distraction in the policy environment can have severe consequences on electricity supply reliability.

Despite the availability of vast intellectual resources, the design and implementation of California’s electricity restructuring has so far come up far short of a workable system. California’s experience with electricity restructuring illustrates the challenge of complexity.

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