Thomas Walkom
The Star
March 31, 2001

SAN DIEGO – As Ontarians prepare for the brave new world of the competitive electricity market, they might reflect on the fate of Arthur Edelman.

Edelman is a 75-year-old retired carpenter, a big, plainspoken man. On his right arm is a tattoo, a memento from his wartime service in the U.S. Navy.

Edelman also has a bad heart. To walk even a few paces in his tiny, two-room apartment is an effort. To get around his seniors’ complex, he uses a battery-powered, motorized scooter.

Every evening, he plugs in his scooter to recharge the batteries. Until last summer, that presented no problem.

But in June, Edelman and 3 million other San Diegans became the first North Americans in decades to experience the full fury of a deregulated electricity market.

As Californians turned on their air conditioners, electricity rates charged by San Diego Gas and Electric, the local private utility, began to climb. By August, Edelman’s monthly power bill had tripled to $125 (U.S.)

Even after an alarmed state legislature acted to temporarily reregulate San Diego’s rates (albeit at higher levels than had prevailed before the summer) he was still scrambling.

Living on a pension of only $1,040 a month, he had no choice.

“I keep the lights off; I try not to run any appliances,” he says.

Nonetheless, he hasn’t been able to pay his full electricity bill for almost a year. He is hundreds of dollars in arrears. Recently, he was warned that his power will be cut off if he doesn’t pay up.

What will he do if he can no longer power his scooter? “What can I do?’ he shrugs. “I can’t walk. I need it to do everything.”

Told that Ontario is preparing to enter the world of deregulated and privatized electricity, Edelman just shakes his head.

“Oh boy,” he says. “You guys are in for a glaring shock.”

Premier Mike Harris insists that the worst aspects of the California deregulation nightmare – such as the rolling blackouts that periodically sweep the state – won’t happen here.

But even he now acknowledges that electricity rates will jump when Ontario finally opens up its power system to competition later this year.

“I have no doubt that prices will be going up,” he told a business group earlier this month.

(In fact, as The Star revealed this week, even before deregulation begins, the price of basic power is set to rise by 8 per cent.)

Rising power rates weren’t part of the government’s story three years ago when it decided to break up Ontario Hydro, privatize parts of it, and replace the decades-old system of electricity regulation with one based on competition and market pricing.

Then, the Premier said he was “quite confident” his government’s moves would lead to lower electricity prices for all. Energy Minister Jim Wilson was even bolder.

“Competition is our best guarantee for the lowest possible prices in Ontario,” he said, after introducing his Electricity Competition Bill in the Legislature.

At the time, few seemed to doubt him. The major interest groups, the so-called stakeholders, were in agreement.

Big industrial users figured they could get cheaper rates. Private energy firms hoped to gobble up some of Hydro’s lucrative generating plants.

Smaller municipalities looked to make a cash windfall by selling off their utilities. Larger municipalities, like Toronto, hoped their wholly owned electrical utilities would become profitable cash cows.

To many environmentalists, deregulation would encourage so-called green power, such as solar or wind generation. Anti-nuclear groups, including Toronto-based Energy Probe, assumed that privatization would kill Ontario’s three big atomic generating plants.

Hydro’s top managers figured privatization was their chance to make it in the big leagues, with hefty private-sector salaries to match.

Even Ontario Hydro’s main union, the Powerworkers, came on side after the utility promised that workers wouldn’t lose their jobs under the government’s scheme.

In 1999, as Hydro was split up in preparation for what the government called “market opening,” togetherness was the order of the day.

Powerworkers president John Murphy was hired by Ontario Power Generation, one of Hydro’s successor firms, as an executive vice-president. Energy Probe chief Tom Adams was appointed to the board of the Independent Market Operator, another Hydro successor firm.

(Adams, who in recent months has become openly skeptical about the government’s market-opening scheme, was not reappointed this year).

Even the opposition parties weren’t overly perturbed. During the 1999 election campaign, the issue of privatizing and deregulating electricity almost never came up.

To most Ontarians, it just didn’t seem that important.

In fact, the decision to take apart Hydro is probably the most far-reaching economic move the Harris government has yet made, one that overturns almost a century of industrial policy in the province.

Since 1906, public power has been the cornerstone of the provincial economy.

Created largely at the behest of manufacturers who wanted cheap power, Ontario Hydro – particularly under its first chairman, Adam Beck – literally electrified the province.

Cheap electricity drove the manufacturing industries of the south as well as the mines and pulp mills of the north. By the 1950s, the words Ontario and Hydro were synonymous.

Hydro’s secret, the utility insisted, was that it provided power at cost. The private monopolies it replaced had charged whatever the market could bear. But Hydro based its rates on the real cost of producing electricity.

As long as those costs were steady or falling, Hydro was golden. But when the construction of pricey nuclear plants sent costs spiralling upward, the crown utility began to lose political support.

Wilson’s Electricity Competition Act was the result, striking right at the heart of the way power is produced and sold in this province.

First, it removes Hydro’s effective monopoly. Once “market opening” occurs (that date, twice postponed, is now expected for the fall), other private firms will be allowed to compete in the generation and sale of electricity. In fact, Hydro is required to divest two-thirds of its generating capacity within 10 years.

More important, the price that consumers pay for power after market opening will no longer be based on the real cost of producing that power.

Instead, price will be determined by supply and demand.

If consumer demands for electricity are high, those selling power will make superprofits.

Conversely, if consumer demands are low, sellers could find themselves bankrupt.

Economic theory predicts that in the long run these ups and downs should even out – that price spikes, for instance, will encourage new generating plants to come on line, which will automatically bring rates back down.

But as California has demonstrated, in the world of electricity, economic theory does not always work.

It’s easy to mock California’s experiment with electricity deregulation.

The original scheme was rammed through the legislature by Steve Peace, a Democratic state senator best known for his role as co-star in the 1978 horror film Attack of the Killer Tomatoes.

Deregulation has become such a disaster that the state is on near-constant blackout alert. Last night, California was yet again put on notice to expect rolling blackouts as energy reserves dropped perilously low. Two of California’s three big private utilities are on the verge of bankruptcy; the California Power Exchange, the jewel in the crown of the deregulated system, has closed its doors.

Lights have already been doused on the expressways. Starting this month, businesses which keep their outdoor lights blazing all night will face hefty fines.

The very state government that decided to get out of the electricity business is now back in it with a vengeance – buying power, reregulating rates and, if negotiations with the private utilities succeed, taking over three-quarters of California’s transmission and distribution system.

The cost to electricity users and taxpayers from this fiasco is estimated at $17 billion and climbing.

“We will not let a California happen in Ontario,” Harris vowed earlier this year.

Yet just 10 months ago, this same California was a model for deregulation, one lauded across the continent.

Alberta based its fledgling system of electricity deregulation on California. In Ontario, Wilson singled out California as an example for all.

California’s experience, he told reporters in 1998, showed definitively that a free market in electricity would lead to lower rates.

Until 1998, California, like most U.S. states, had provided power through a system of regulated utilities, each acting as the sole provider of electricity to a defined area.

While some were municipally owned, three-quarters of the state’s power was provided by a trio of private firms, Pacific Gas and Electric in the north, Southern California Edison in the centre, San Diego Gas and Electric in the south.

In all cases, rates, profits and expansion plans were subject to regulation by government agencies.

But in the mid-’90s, California decided to turn all of that on its head. Competition had already been introduced to air travel, telephones and natural gas.

Why not electricity? Surely, supporters of deregulation argued, electricity was a commodity like any other.

As well, there were more practical reasons. California’s electricity prices were high compared to elsewhere in the U.S. Partly, this was because consumers were still paying for high-priced nuclear plants built by the state’s utilities.

Partly it was because the utilities were required, as a conservation measure, to buy a portion of their power from higher-priced alternative generators that did not use fossil fuels.

As in Ontario, those lobbying hardest for an end to regulation were the large manufacturers who used the most power – particularly cement makers. Bypassing the big utilities, these firms figured, could substantially cut their power costs.

The U.S. federal government’s 1992 decision to open up the wholesale, interstate electricity market to competition put the game in motion. In 1996, the state’s then Republican administration decided to finish the job.

Platoons of economists trooped to the state capital in Sacramento to advise on setting up a competitive market. Behind the scenes, bagmen and lobbyists greased the wheels.

The final bill, passed unanimously by the California legislature in 1996, was not only a tribute to theoretical economics. It was also the result of intense bargaining between the utilities, large manufacturers, environmental and consumer groups.

And it was remarkably similar to the scheme the Ontario government plans for this province.

At the centre is a commodity exchange for electricity. The hourly spot price set by this exchange acts as the fulcrum for the entire system.

Ontario’s proposed version of this exchange is the Independent Market Operator, a crown corporation charged with operating both the physical system and the financial trading floor.

California split those functions between two bodies. The Independent System Operator runs the physical system, making sure power goes where it is supposed to go. The California Power Exchange – until it was unceremoniously shut down last month – acted as the trading floor.

There are other differences. For instance, California initially discouraged long-term contracts, a characteristic which ultimately proved costly to the state. Ontario says it won’t do that.

But in the end, both schemes were driven by the same philosophy. Generators would compete with each other to sell electricity into the market. Utilities and other retailers would compete to buy.

These retailers, in turn, would compete with one another for the attention of final consumers who would be able to choose from a wide array of electricity providers.

Competition would rule; prices would reflect supply and demand.

To appease California’s utilities, $28 billion of their debts – most of which were incurred from building nuclear plants – were billed directly to consumers as so-called stranded costs. These were to be paid off over time through a hidden charge on electricity bills.

To appease consumer groups, rates were frozen for up to four years, after which the private utilities could charge whatever the market would bear.

But if a utility paid off its stranded costs before 2002 – as San Diego Gas and Electric did – it could start charging the full market rate early.

That was the little wrinkle that sent Arthur Edelman’s rates soaring last summer.

These days, critics say the state’s decision to freeze rates caused all of California’s subsequent problems. If the utilities had been allowed to pass on costs to consumers, the argument goes, they wouldn’t be facing bankruptcy. If they weren’t facing bankruptcy, they could pay their bills. If they paid their bills, the generators would supply them with more power and the state wouldn’t have to endure blackouts.

But in 1996, the rate structure demanded by the state appeared more than generous to the utilities. True, legislators had insisted on an additional 10 per cent rate cut for residential consumers. But it was largely phony, financed by yet another hidden charge on consumer power bills.

“The 10 per cent cut was fictitious,” says Laura Krannawitter, an adviser to one of the Republican members of the state’s Public Utilities Commission. “It was a way to sell deregulation to a skeptical public.”

The fiction worked. The California public bought deregulation, voting down a last-ditch plebiscite aimed at derailing it.

Initially, the big utilities prospered. According to an audit done for the Public Utilities Commission, Pacific Gas and Electric made so much money in the first years of deregulation that it was able to pay at least $4 billion to its parent holding company. That enabled the parent to indulge in generous dividend payouts and foreign acquisitions.

At the behest of the state and at considerable profit to themselves, the private utilities also sold off about half of their generating capacity to other firms.

Later this would be seen to have been a critical mistake. California’s utilities are now in the unenviable position of having to buy power at 30 cents a kilowatt hour from plants they once owned, so they can sell at the government-mandated rate of about 7 cents a kilowatt hour to consumers.

But when the market opened in 1998, neither the utilities nor the state worried about this. California’s plan, like Ontario’s, was contingent on forcing the generating industry to open up to new players. The more players competing, the more prices would fall. That was the theory.

Only two imperfections marred this otherwise faultless leap into market-based electricity. First, retail competition never materialized. Some businesses found alternate suppliers. Some consumers dedicated to environmental goals bought power – at higher prices – from so-called green generators.

But 98 per cent of California’s customers, both residential and business, stayed with their existing utilities.

Partly this was because retail competitors found California a hard slog. The four-year rate cap was high enough to give the incumbent utilities a good profit but low enough to discourage competitors.

According to one estimate from the American Public Power Association, the cost of persuading just one customer to switch to a new supplier can be as high as $600.

What’s more, consumers weren’t interested in switching. Why should they? Rates were stable; the lights worked. Who wants to spend all their time comparing kilowatt-hour prices just to save a few cents a month?

The second flaw would turn out to be more serious. The state’s economy was booming. Electricity use, thanks to the rapid expansion of the Silicon Valley high-tech industry, was skyrocketing.

Big energy firms from outside the state had gobbled up existing utilities, often paying premiums of two or three times book value for the privilege.

But they weren’t lining up to build new plants. In fact, as they waited patiently for prices to rise, the private generators had every incentive not to add to capacity.

The reason, as University of California economist Severin Borenstein has pointed out, is that the economics of electricity are ruthless. If demand skyrockets and supplies are limited, those who control those supplies can make a killing.

Which is exactly what happened. According to figures assembled by the state’s Electricity Oversight Board, generating firms saw their profits rise last year by anywhere from 47 per cent to an astounding 1,800 per cent.

This week, the California Independent System Operator reported that generating firms have overcharged Californians by a whopping $5.5 billion (U.S.) during the last 10 months.

Nora Whitcotton sits in the gloom of her tiny two-room apartment in El Cajon, just outside of San Diego. “Is it all right if I don’t turn on the light,” she asks her visitor. “I try to save on the electricity bill however I can.”

Whitcotton illustrates what an economist would call the inelastic nature of demand for electricity. She is 63, suffers from a host of lung diseases and lives on a social security cheque of $732 a month.

For Whitcotton, sitting in the gloom and hooked up to her oxygen machine, electricity is a matter of life and death. If the price of power goes up, she can’t just turn off her electrically-operated machine – not if she wants to keep breathing.

“Without it, I wouldn’t survive,” she says.

Ever since she described her situation to a local public interest group, Whitcotton has been inundated with media.

“Nightline (an ABC television news show) came to interview me,” she says. “Goodness, there were so many of them; they had to move all of my furniture out so they could fit in.”

Today, it’s The Star. A few weeks ago, it was a Japanese newspaper. “I did turn down CNN though,” she says. “I wouldn’t let them come.”

With all of her media guests, Whitcotton is thorough and polite. She has two years’ worth of electricity bills at hand to prove that she’s not exaggerating when she says her rates tripled last summer. For someone who lives on $732 a month, an increase of $129 on her power bill – like the one she experienced last August – is sobering.

But isn’t she all right now? Didn’t the new rate cap the state imposed on San Diego Gas and Electric solve her problem?

Not exactly, replies Whitcotton. And she directs the reporter’s attention to her latest bill. There she has been charged $95 for electricity priced at market rates. Thanks to the rate cap, she only has to pay $46 of that immediately. But the remaining $49 hasn’t been forgiven. It is being charged to her as a debt which she will have to begin repaying in two years.

Like the 10 per cent rate cut the California legislature enacted in 1996, Whitcotton’s new rate cap is essentially fictitious.

Still, she is asked, isn’t there an upside? According to the theory of electricity deregulation, consumers like Whitcotton are supposed to alter their behaviour when rates rise. That’s the whole point.

Ontario’s Market Design Committee, the government-appointed body charged with establishing the rules for electricity deregulation in this province, put the theory quite succinctly in its final report.

Rising electricity rates, the report noted, give consumers “a reason to think about conservation and a benchmark against which they can judge some of the supply options that competitive retailers in their area may offer.”

So why didn’t Whitcotton think about conservation? She laughs. “I pay $135 a month for medical bills. My rent is $192. That leaves about $400 for food, utilities and everything else. . . .

“At $400 a month, I don’t eat out. I don’t go to the movies. I eat a lot of potatoes and use powdered milk. Life is pretty simple. In the summer it gets hot in here, but I try not to turn on the air conditioner. I keep the lights off as much as possible. This (she pats her oxygen machine) uses 500 watts of power.

“I don’t understand what else I’m supposed to do.”

And what about taking advantage of the “supply options that some of the competitive retailers in (her) area may offer?” She laughs again.

“There aren’t any.”