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Energy Energy firms bet prices would rise with deregulation

There were many causes of California’s energy crisis, but whatever the solution, it’s not going to come without pain for local ratepayers.

That seemed to be the consensus from an energy forum held Feb. 12 in San Diego. The forum, sponsored by Burlington, Mass.-based energy consultants Xenergy Inc., brought together heads of the utility industry, utility experts, consumer advocates, and state and federal regulators.

Arthur O’Donnell, associate publisher of the magazine California Energy Markets, said California had been “set up from the beginning for possible failure.” The first mistake was that when the utility restructuring began, the state placed too high a priority on allowing the utilities to recover their “stranded costs,” or bad investments made before deregulation began, O’Donnell said.

Then, as the utilities began unloading their power plants , as mandated under deregulation , the plants sold for two or even three times their book value. That should have set off major alarm bells, he said.

“Nobody quite questioned the fact that maybe this was a bad omen,” O’Donnell said. “Somebody was making a bet that prices were going to go up.”

Still, the state and the utilities both turned their backs on power forecasting. As recently as 1997, reports from state agencies declared the state would have a power surplus all the way through to 2005. In 1999, the California Energy Commission did release a report saying that unless new plants were built, the state would be facing a shortage , but that wouldn’t happen until 2003, he said.


Out Of State Expansion

At the same time, natural gas costs soared. Also, California faced a drying up of energy imports. Population expansion in other states , 40 percent in Nevada and Arizona , meant more power was needed elsewhere, with less available for California, O’Donnell said.

Once the crisis began over the summer, it was compounded by state inaction. All along, the state was hoping that the Federal Energy Regulatory Commission would institute regional price caps and refunds, and remained positioned all the way until mid-December, when the FERC ultimately refused, he said.

In fact, San Diego Gas & Electric Co. put out a request for proposals to enter into “forward contracts” back in July. They received nine bids to buy power in bulk , which would have lowered prices for consumers, O’Donnell said.

However, SDG & E; had to put the bids before the California Public Utilities Commission for approval. If the utility had signed the contracts and prices fell, that could come back and haunt them later. So SDG & E; was seeking reassurances from the commission, he said.

“The utilities were concerned that they were going to get dinged on a reasonableness review, so they wanted pre-approval on those contracts. The Public Utilities Commission was unwilling to give that kind of reasonable pre-approval, and so the contracts lapsed. And meanwhile, the prices went higher and higher,” O’Donnell said.


Waiting For A Miracle

And yet the state is still hoping for a miracle. O’Donnell faulted Gov. Gray Davis’ proposals for assuming, even at this late date, that California can get out of its mess without raising rates.

“Many of the people in the industry are coming to the conclusion that that cannot be done. There will be a pass-through of costs at various levels, in various forms, and if it’s not the ratepayers paying for it, it will be the taxpayers paying for it,” he said.

Those thoughts were echoed by Stephen Baum, CEO of Sempra Energy Corp., parent company of SDG & E.; Deregulation was based on a long list of wrong assumptions. The market that resulted , which would have worked during times of energy surplus , quickly turned into a “nightmare” when supplies dried up, he said.

“Worse, the generators and marketers learned to take advantage , legally, in my view , in the flaws in the construction of the market,” Baum said. “A marginal price regime has become whatever the market will bear.”

The situation is exacerbated by the retail price caps customers face throughout California. Although electricity prices have soared, ratepayers are shielded from the basic reality of price spikes and thus have no incentive to reduce demand, he said.


Competition Dead

High prices, meanwhile, have killed competition in California. No customer currently under a price cap would switch to a different energy service provider and lose that protection, Baum said.

Baum noted SDG & E; had paid off its stranded costs in July 1999, and thus was granted the authority to pass on its own costs for electricity. Prices spiked about a year later , once generators and marketers figured out how to play the new rules to their advantages.

Once San Diegans saw prices shoot through the roof, it led to a “French Revolution”-type response. That led to calls for legislators to approve Assembly Bill 265, imposing a retail price cap on SDG & E; even as its costs remained high.

It’s important to note, however, that AB-265 is in effect “a loan with a huge balance.” Buried in the bill itself is language promising that SDG & E; will be able to recover its costs , so far at $500 billion, plus interest , in two to three years, Baum said.

As for the rest of the state, Baum noted Southern California Edison and Pacific Gas & Electric are in dire economic straits. The state must do everything in its power to restore those utilities to credit worthiness , and that includes higher rates, he said.


Make Ratepayers Pay

“The state should immediately set a predictable rate regime that includes rate increases , and I know the politicians don’t want to hear this , but that includes rate increases commensurate with the actual future costs of electricity and natural gas,” he said.

Although this is a bitter pill, there is something worse even for businesses than higher rates, and that’s unpredictability. Higher rates can also send a signal to consumers to motivate them to change their energy use, thus reducing the imbalance between supply and demand, Baum said.

Other solutions include building more power plants to address the imbalance of supply and demand, and new rate structures that protect the poor while encouraging ratepayers to implement additional conservation measures, he said.

Baum added California can’t expect regulatory relief to take control of prices on the wholesale market. That hadn’t happened when Bill Clinton was president, and is even less likely now that President George W. Bush is in office, he said.

Curt Hebert Jr., FERC chairman, said California cannot rely on a federal bailout and needs to solve its own energy problems. Nor are power price caps in the spot market the long-term answer, he said.

The problem is one of basic economics, as booming demand did not keep up with supply. This came as California markets , which were never fully deregulated , have never been competitive, he said.

To solve the problem, both he and President Bush are looking to create competitive retail energy markets in the state. To do that, California needs more generation capacity and better price signals for consumers, and reduced reliance on spot markets in favor of purchasing energy on the forward market.


‘Unmitigated Bunk’

The utilities, meanwhile, need help shoring up their credit worthiness. Bankruptcy of the utilities must be “avoided at all costs,” he said.

But Michael Shames, executive director of the Utility Consumers Action Network, disagreed with the cause of the problem and its solution. The state’s failure to allow forward contracting during the summer was not to blame for ever-increasing prices, he said.

“That is absolute, unmitigated bunk. Forward market contracts would not have saved the day,” Shames said. “The line that was being fed to the utilities, to the state policymakers by generators and others, was what happened this summer was an aberration. It would not be duplicated in the winter.”

So even if the state had given the utilities full discretion to enter into forward contracts , something that did not exist in California or anywhere else , the utilities would not have taken advantage of it, since the line from the generators was that the prices for electricity were expected to decline, he said.

As far as solving the problem, additional rate increases are not the answer, Shames said.

“There have been rate increases imposed on customers already. In San Diego, it’s been about a 25 percent increase as a result of AB-265, and the PG & E; and Edison territories have received increases of about 9 percent,” he said. “So there already have been rate increases; I think the politicians have determined that that’s about as far as they can go.”

The expectation is that prices will go down once the crisis subsides, and things will eventually balance out as profits from future years make up for the current shortfall, Shames said.

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