The deregulation debacle

Who's responsible for for California's electricity crisis? Everyone.

Published January 30, 2001 8:30PM (EST)

Californians were promised the world when deregulation of the state's electricity market was signed into law by then-Gov. Pete Wilson in 1996. Everyone from the utility companies and labor unions to environmentalists and state regulators joined hands to hail a proposal that would supposedly lower retail prices, break up power company monopolies, reimburse utilities for billions of dollars lost in past decades and spur the development of "green" energy.

But today, amid daily power emergencies and utilities clamoring that they have been pushed to the brink of bankruptcy, finger-pointing has replaced hand-holding. The lawmakers involved in crafting the bill are blaming federal regulators for not doing their job; the utilities are charging that California's Public Utilities Commission (PUC) is responsible for the mess; the PUC says both the feds and the utilities are at fault. The federal government is blaming the state, while the governor blames the feds and the companies controlling the generation of energy. Consumer groups blame the utilities and the Legislature. And as California crawls toward yet another imperfect and expensive fix-it plan, no clear solution is in sight.

Who is really the culprit? The easy answer is everyone: The state deserves some of the blame for setting up an imperfect marketplace. The consumer groups can be blamed in part for their myopic focus on breaking the utility monopolies, which prevented them from foreseeing the coming power generator cartel. The utilities are on the hook for signing off on a deal that allowed them to be outsmarted by other energy companies, and then forced them to come crawling back to taxpayers for another bailout -- this time from a system that they largely created. The federal government is guilty, at the very least, of inaction, for failing to step in to order rebates from energy producers who have been making out like bandits. And finally, the producers themselves deserve criticism for willfully abusing the deregulated market to push California into daily power emergencies.

Not surprisingly, few players are ready to stand up and accept responsibility. But even if it's impossible to single out any primary villain in the electricity mess, or to figure out a way forward that makes any sense, it is relatively simple to pick some winners and losers out of this sorry bunch.

First up in the winners column are the energy suppliers, the coterie of companies that bought power plants from California utility companies and then sold the power back to those same utilities at exorbitant rates. But don't shed too many tears for the utilities -- because even though their stock prices are declining, the shareholders of those utilities are still also winners: the beneficiaries of substantial payouts as a result of a massive $26 billion utility bailout included in the original deregulation plan. Meanwhile, the parent corporations of the utilities that currently claim to be on the verge of bankruptcy appear to be doing quite nicely, spending billions more on expansion plans.

Who is the big loser? That's easy too: the Californian taxpayer now faced with footing the bill for a second massive bailout of the utility companies, while at the same time enduring rolling blackouts and the high likelihood of spiking retail electricity prices.

So how exactly did this mess happen?

In one of his last acts as President, George Bush set the wheels of energy deregulation in motion nationwide when he approved the Energy Policy Act. It aimed to break utility power monopolies across the country by opening up control over the transmission lines that deliver power, while effectively deregulating the price of wholesale electricity. But the Federal Energy Regulatory Commission left the details of how to deregulate the retail side up to the individual states.

California, then mired in its worst recession since World War II, rushed to get into the deregulation mix. Business leaders chafing at California's high taxes and high energy prices (half again as large as the national average) used the threat of moving out of state to force the government's hand.

"The big electricity users went to Gov. Wilson during the recession and said, 'We're going to move elsewhere.' Doing business in California was just too expensive," says John Nelson, now a spokesperson for Pacific Gas & Electric, who was then spokesperson for Republican Assembly Speaker Curt Pringle. "You had problems with worker compensation laws, and taxes and energy prices were too high. The state went about reforming it all. We lowered taxes and pushed for deregulation."

"The industrials wanted this, big time," says Lenny Goldberg, lobbyist for the Utility Reform Network (TURN). "Federal policy makers were pushing it, but other states didn't do it as quickly as we did. The PUC and the Wilson administration were pushing it forward." The PUC took upon itself the task of setting up California's deregulation structure. Before deregulation, the state's major electric utilities -- PG&E, San Diego Gas & Electric and Southern California Edison -- had a virtual lock on the energy market. Not only did they own most of the power generating plants, they also controlled the transmission and distribution of that energy to retail customers.

The idea behind deregulation was to allow other energy producers into the market, breaking the utilities' monopoly and, so the thinking went, lowering the wholesale price of electricity.

"This whole thing was pinned on the price of wholesale electricity dropping," Goldberg says. "That was the linchpin to the plan."

With growing pressure from industrial groups and consumer advocates to do something about the state's high energy prices, the PUC sprang into action. On Dec. 20, 1995, in a 3-2 decision, the board set up a framework for the deregulation of California's energy market. "Today's decision may be looked to as the foundation for California's emerging market institutions and regulatory reforms," the report states.

The PUC waved a very large carrot in front of the utilities. If the utilities would agree to "voluntarily" sell off at "least 50 percent of their fossil fuel generation assets," the PUC would help the utilities pay off billions of dollars of debt -- so-called "stranded costs" -- accumulated over past decades, mostly as part of nuclear power plant building programs.

AB 1890, the deregulation bill, sailed through the Legislature in 1996 and was signed by Wilson with the support of everyone from environmentalists, who thought the bill would open markets to green power, to the utilities, who signed off on their $27 billion bailout.

"There is not a single person in this state that does not benefit from this," said Assemblyman Steve Kuykendall, R-Palos Verdes, after the bill was passed.

Today, spokespeople for the utilities argue strenuously that the PUC forced the utilities to sell off their power plants, thus setting the stage for the current debacle, but the truth is a bit more complicated.

"The PUC did not require them to divest; they encouraged it," Goldberg says. "The incentive was they would be able to use that money for their stranded costs. They were able to take that money out, and distribute it to shareholders, and buy other assets all over the world.

"They got twice book value for those plants," says Goldberg, "and paid off their shareholders substantially."

In fact, when these plants began fetching top dollar on the open market, the utilities sold more than the goal of the PUC plan. Edison sold roughly two-thirds of its energy generation capacity, while PG&E sold off nearly all of its fossil-fuel run plants. In 1995, according to the California Energy Commission, utilities produced 157,589 megawatts of power, 74 percent of all power generated in the state. While the commission does not have the most recent percentage, estimates now place it closer to 35 percent.

Between 1996 and 2000, the utilities sold power plants with a total book value of $1.8 billion. Those plants fetched a combined $3.1 billion retail. That money was used to reimburse utility shareholders. SEC reports show the plants fetched top dollar -- sometimes up to three times market value -- on the open market. Watchdog groups now say that's money the utilities funneled to their parent corporations. Nelson says that's nonsense. He claims the sell-off of the plants was supposed to help the utilities cover their stranded costs -- that was part of the original deal cut with the PUC.

"Those prices sure did raise some eyebrows at the time," said one commission source. While Nelson says they were "pleased and surprised" at what the plants were fetching on the open market, he said the prices were only 10 to 20 percent higher than projected.

"We only had until 2002 to recover our stranded costs. When we went to the PUC in the aftermath of the law's passage, they made it clear that if we didn't sell the entire portfolio, we would not be able to get recovery of stranded costs," says Tom Higgins, senior vice president for Edison International. In effect, Higgins says, the utilities were forced to sell their plants, or risk losing tens of millions of dollars.

"Were we compelled? Certainly not," says Higgins. "But as a practical matter, we would not have been able to recoup our costs unless we sold."

The PUC plan also established two new entities -- the Power Exchange (PX) and the Independent System Operator. The Power Exchange was envisioned as a clearinghouse, a place where competitive forces would lower the price of power for California electricity consumers. Any electricity generated by the utilities would be sold to the Power Exchange. The exchange would then assess the power supply with the power demand, set a spot market price for the power and then, in essence, broker the reselling of that power back to the utilities.

The ISO was supposed to be a central command station coordinating the scheduling for the delivery of power so that everyone would get the power they needed. In the event that there was not enough power to go around, the ISO was empowered to buy chunks of energy, which would be more expensive than PX power. But that was only supposed to be a last-ditch response. No one envisioned that by the summer of 2000 the Power Exchange would have essentially collapsed, and the ISO would be perpetually buying power at premium prices to keep the lights from going out.

Those costs have been passed on to the utilities that deliver power to California residents. And because the utilities are prohibited by state regulation from passing that cost on to rate payers, the utilities are taking the financial hit.

To say that the Power Exchange hasn't worked out is an understatement. Private firms that bought the plants in the utilities' power plant sell-off cut their own deals with other energy consumers and marketers, or even sold their power out of state rather than sell to the Power Exchange. As a result, the spot market in California began to collapse.

The Federal Electricity Regulatory Commission said as much in a recent decision. In an effort to step in for utilities and try to stop some of the bleeding, the FERC overwrote the state provision that required utilities to sell the power they generated to the PX.

"Essentially, you had a situation where the ISO became the Power Exchange, and the market prices were being set at extremely high levels," said FERC spokeswoman Barbara Connors. "The commission found the marketplace in California was fundamentally flawed, and said as much in their Dec. 15 ruling."

The Power Exchange structure prevented utility companies from signing long-term contracts with power providers -- a fact that is now widely pointed to by observers as one of the biggest mistakes in California's deregulation plan. Again, the assumption was that the wholesale price of energy would fall, and consumers would rejoice when retail prices consequently fell. The PUC prohibited utilities from locking up long-term contracts for energy from producers, out of fear that consumers would not reap the benefits from what the commission thought would be tumbling wholesale prices. But now that the price of wholesale energy has shot up to more than 30 cents per kilowatt hour, the commission's reluctance to allow the utilities to enter into long-term contracts turned out to be the wrong move.

Edison's Higgins says the utilities saw California was headed for a crisis nearly two years ago, and the Public Utilities Commission failed to act. "In March of '99, we and PG&E went to the PUC and said, 'This is the way the world is going to unfold. You have to give us permission to do bilateral contracts,'" says Higgins. "At that time, there were contracts available for 3 to 3.5 cents per kilowatt hour. The people who intervened against us were the consumer groups and the generators."

Higgins blames the consumer groups' "continued myopic focus" on breaking the backs of the utilities, and corporate greed on the part of the new players in the electricity generation market, for killing the long-term contract proposal. "The consumer groups were just fools," he says. "The generators knew exactly what they were doing."

"In California, at the time we thought we'd have additional energy suppliers," said FERC spokeswoman Barbara Connors. "We thought, We'll have so many suppliers that it'll be competitive and benefit the consumers. That was the theory behind all of this. Unfortunately, events conspired to turn things the other way."

Those other events included some outside anyone's control, Connors says. The problems began when power prices spiked last summer, sparked by unseasonably warm temperatures that drove up power consumption. The wholesale price of power jumped from $30 per megawatt-hour to almost $150.

But Mother Nature, the Internet and California population jumps -- all of which have been blamed for a piece of the energy crunch -- are just parts of the problem. And though there is little consensus about anything in this debacle, the parties agree on one point: Nobody saw this one coming. Even the consumer groups' opposition had nothing to do with fears of astronomic jumps in the wholesale price in electricity. They were opposed to the plan because of the rate-payer bailout of $26.5 billion in stranded costs, which was pushed for by the Wilson administration.

The system was designed while there were energy surpluses in California, and its success was predicated on an abundant energy supply, which would lead to fierce competition for energy on the supply side. But what got little attention at the time was the aggressiveness with which the major players in the power plant business seized on the newly opened markets of California. With the economy growing at a record pace and population spikes combining for an increased demand in electricity, bidders aggressively gobbled up utility assets.

As the utilities sold off their power plants at the end of the 1990s, they were all purchased by a handful of small energy producers that were already major players in the industry, including industry giants like Duke Energy and Southern Company.

Essentially, the utilities now say that the utility monopoly that allowed the companies to make a killing under a regulated system has been replaced by an oligopoly of private energy producers. But these producers are under no obligation to provide power to California. We have been taken, they argue, by a market of our own creation.

Energy producers say they were simply playing by the rules set up by the state PUC and the Legislature. But charges of collusion by those producers are currently being investigated by California Attorney General Bill Lockyer. Though a Lockyer spokeswoman refused to comment on the specifics of the investigation, she did say it would focus in part on whether the buyers of those plants have used unfair market practices to drive up the price of wholesale energy in California.

California Gov. Gray Davis has also focused on the energy producers, which he labeled "out-of-state profiteers" in his State of the State address earlier this month, and blasted the FERC, saying "it has shirked its responsibility to protect ratepayers from this legalized highway robbery."

In his videotaped testimony before the FERC, Davis said, "I'm pleased that the commission agrees with me ... that the market place in California is dysfunctional and wholesale prices are neither just nor reasonable. However, having made that determination, I was greatly disappointed and perplexed that the commission did not take the next logical step and order refunds to rate payers."

PG&E's Nelson also used the robbery metaphor to describe the FERC's unwillingness to step into the fray. "It's akin to a policeman happening upon a robbery and saying 'Yep, there's a robbery going on here,' and walking away, even though you've got the guy standing right there with the flashlight and the loot."

But Goldberg says that's revisionist spin coming from the utilities. "Anyone who says PG&E did not actively pursue deregulation is just smoking something," he said. "They had a lot of control of the PUC. From our perspective, one of the things that attracted us to the deregulation issue in the first place was that the utilities were getting everything they wanted at the PUC. They wanted the deal because they were going to get a big buyout."

The consumer watchdog group Public Citizen accused the utilities of playing a "shell game" -- readying for a California taxpayer bailout while their parent corporations rake in the cash.

While Edison and PG&E claim to have racked up such significant losses that they are threatening to file for bankruptcy, their parent companies have embarked upon a billion-dollar spending spree, spending more than $22 billion on power plants, stock buybacks and other purchases that far exceed their alleged $12 billion debt from California operations, the group said in a Jan. 8 statement.

State legislators are checking into allegations of creative bookkeeping by the utilities and contemplating the unpleasant prospect of another utility buyout. The PUC has also opened the utilities' books for an audit. Since the utilities still own a sizable chunk of the power plants in the state, they too are profiting from the wholesale price spike. Though PG&E and Edison claim to have ended 2000 with $6.6 billion and $4.9 billion in debts respectively, the profits they made from selling power have jumped through the roof. The San Jose Mercury News reported Friday that PG&E's power selling profits shot up from $382.7 million in 1999 to $1.2 billion in 2000. Similarly, Edison's revenues spiked from $128 million to $1.1 billion. These spikes came after both utilities sold off most of their plants. But utilities claim they were playing by the rules, and those rules state that ratepayers will end up swallowing the utilities' "debt."

"We have to be very careful that we don't view these companies as the victims in all this," said Doug Heller, spokesman for the Foundation for Taxpayer and Consumer Rights. Heller called the utilities "extortion artists who have state officials on their knee, particularly Governor Davis and [Assembly Speaker Robert] Hertzberg (D-Los Angeles) asking how they can help."

Observers of California's electricity crisis have blamed everything from onerous environmental restrictions to NIMBYism that prohibited large new power plant construction, as well as the daunting state bureaucracy you have to overcome to build a new power plant. But Goldberg says a big part of the blame can be placed on the utilities for the lack of sufficient supply as well.

"There's no question, in the regulated market system, utilities killed proposals for new plants at the PUC all the time," says Goldberg.

But if Goldberg's claims that the PUC simply enacted PG&E's will were ever correct, that relationship has deteriorated in the wake of the energy meltdown. In her testimony before a special state Assembly committee convened to craft a solution to the crisis, PUC president Loretta Lynch criticized the utilities for not entering into earlier long-term agreements to guarantee lower prices for wholesale electricity. Her comments earned her a nasty letter from Edison international senior vice president Bob Foster, blasting Lynch for "some inaccurate statements" given in her testimony. Foster wrote that Lynch's testimony "turns reason and fact on its head. To the contrary, we have every reason" to sign long-term contracts. Foster cited the 1995 PUC decision in which the commission discusses the mandate for utilities to sell their power to the Power Exchange.

The breakdown in harmony between the PUC and the utilities isn't the only fallout beginning to accumulate in the wake of the deregulation debacle. One has only to look as far as the rise and fall of Steve Peace, the chairman of the committee that formulated the deregulation bill, to see how it's beginning to injure people.

Peace, whose claim to fame used to be his authorship of the cult film "Attack of the Killer Tomatoes!" has now posted a 12-minute movie on his Web site claiming he opposed deregulation all along. The movie, which has earned more than its share of guffaws in the halls of the state Capitol, is complete with numerous cuts of Peace as chairman of the committee that formulated AB 1890, stating his opposition to deregulation for the record.

In debunking what it calls a series of myths about California deregulation, the movie hits upon "Myth No. 2," that Sen. Steve Peace was the architect of deregulation. Ironically, if anything, "the opposite is the case," the narration says. The film then cuts to Peace addressing a legislative committee in August 1996. "It has never been my view that this is a good idea. I have always been a reluctant participant in attempting to accommodate in the least onerous way a transition that was initiated by the [federal government], supported by our public utilities commission ..." Peace says on the tape. "As you know, it has always been my view that that is a mistake ... I think the federal government is nuts."

But Peace wasn't always so willing to make his disrespect for deregulation known. Until the market collapsed this year, Peace never intervened when reporters casually referred to him as the godfather of California electricity deregulation. Quite to the contrary, the state senator had hoped to parlay his legislative success into a run for California secretary of state next year. But last week, Peace closed his fundraising committee, effectively removing his name from consideration. And with that, the California energy crisis claimed its first casualty.

By Anthony York

Anthony York is Salon's Washington correspondent.

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