The politics of power: Lessons from California's electrical wars
Higgins, Thomas J.
Thomas J. Higgins THE POLITICS OF POWER A letter from California It may be that the first big crisis to confront any elected official is rarely the one he or she would have anticipated. John...
...They just had to read each other's bid signals...
...When the Federal Energy Regulatory Commission (FERC) investigated prices last summer, they found them to be "unjust and unreasonable...
...But the FERC refused...
...That meant control of most of California's generating capacity passed to new, out-of-state owners...
...A man whose political life has been defined by caution and problem avoidance is now widely viewed as largely responsible for allowing a problem to become a catastrophe...
...This was a key finding, because federal law requires the FERC to take action to mitigate prices when it makes such a finding...
...For the first eighteen months of his term, Davis enjoyed great political fortune...
...Banks and other lenders ceased lending money to the utilities in late November, because the PUC would not grant assurances that these costs could eventually be recovered...
...Indeed, at one point he said, "I could have solved the problem in twenty minutes if I had been willing to raise rates...
...The activists thought they were getting a more "open" market...
...Bill Clinton probably underestimated the furor over his proposal to allow gays to serve in the military...
...Prices for energy bore no relationship to costs of production, even taking into account a rise in the price of natural gas, the principal fuel for the power plants...
...Aside from a handful of gestures, the governor did very little from May to December...
...Finally in early April, Pacific Gas & Electric, the utility which serves San Francisco and Northern California, filed for protection against its creditors in federal bankruptcy court in San Francisco, and Southern California Edison teetered on the brink...
...Last month the PUC approved an average residential rate increase of over 40 percent, which was greatly magnified by the long delay, but which further erodes the governor's political strength...
...Capital is fungible, as every investor knows, and without such assurances no sane lender wanted to continue throwing good money after bad...
...It is not lost on Californians that much of the rest of the country often takes guilty pleasure when the Golden State is in trouble...
...But when California's economy stumbles, the rest of the country is also at risk of a fall...
...They just want to know that when they flick a switch, the lights will go on...
...The legislation passed both houses of the General Assembly unanimously, and was signed into law in 1996 by then-Governor Pete Wilson, a Republican...
...It may still pass, but a lot of political capital has been squandered by the year-long delay, and most legislators are reluctant to approve the bonding required to finance the purchase...
...John Kennedy did not foresee the Bay of Pigs...
...Thereafter, they didn't need to collude or otherwise conspire to distort the market...
...Electricity isn't a subject that most people even think about...
...The commissioners were asked to impose firm price caps on a market that was manifestly dysfunctional, but a majority of them were ideologically opposed to meaningful price caps and resisted attempts to effectively control the market...
...He lives in San Francisco...
...Thomas J. Higgins is a retired senior vice president of Edison International...
...And Gray Davis, a Democrat elected governor of California in 1998, certainly never imagined the mortal threat to the state's economy—to say nothing of his own career—from a dysfunctional wholesale electricity market...
...Much later, he had to...
...Under California's law, electricity rates were frozen, and so costs in excess of rates could not be passed on to consumers...
...But state regulators—the California Public Utilities Commission (PUC)—made two fateful decisions that created the conditions for a virtual oligopoly to exist and to set prices in the market...
...And the blackouts have already begun...
...Prices, which had been fairly stable for two years, soared into the stratosphere, averaging more then ten times the previous year, despite similar conditions of supply and demand...
...First, the PUC compelled utilities to sell most of their existing power plants, more than the law required...
...The price of California's political paralysis will be paid in higher electricity rates and a damaged economy for more than a generation...
...But the governor was deeply concerned he would be blamed for even a slight increase in utility rates, and he refused to take action...
...It isn't hard to sympathize with both impulses, but that begs the question of what actions the administration needed to take to avoid a worsening situation...
...The role of Governor Davis has been central to the crisis...
...As one trader put it, "California is short in a spot market for a commodity that can't be stored, and you don't want to be there...
...This unfortunate decision meant that the electricity needs of 20 million people had to be met every day in the spot market, the market for sales within twenty-four hours of delivery...
...All through the summer, and into the fall, debt for power procurement at the utilities mounted...
...The utilities were forced to borrow billions of dollars in the capital markets to finance power procurement for their customers and, under the law, they were not allowed to profit on the activity...
...He is the most prodigious fundraiser in 8 California's history, and two years before his next election already had banked more than $20 million for his campaign committee...
...Finally, the state was forced to step in and begin purchasing power in the spot market with funds from the state treasury...
...Then he blamed the FERC for not imposing price caps...
...By the time the governor finally began seeking long-term contracts, and conceded the need for utility rates to increase, it was too late to solve the crisis...
...Along with some painfully naive consumer activists, the new owners of the power plants had lobbied the PUC successfully in the spring of 1999 to reject long-term contracting by the utilities...
...The electricity crisis is a cautionary tale about putting faith in markets without fully understanding how markets operate, especially for products with inelastic demand...
...The law might have worked as intended, with meaningful competition and a new era of cleaner, more efficient power plants...
...The budget was running a large surplus and Democrats controlled both houses of the legislature...
...His closest advisors urged him to act forcefully to get power under contract and to calm the financial markets by assuring that transactions for power purchases would be creditworthy...
...The governor's first move was to blame his predecessor, saying that he "had inherited this mess...
...In retrospect, the eight months between May and December were a crucial lost opportunity...
...But, as summer nears, even that is increasingly in doubt...
...Davis hopes to salvage the situation through a complicated plan to purchase the transmission lines owned by the state's utilities so they can use the net proceeds to pay down their debt...
...Few power deals were available under reasonable terms, the premiums being paid for risk had become the largest element in the price of electricity, and Davis's standing in the legislature was so low that his own party was balking at passing his legislative package...
...In other regions of the United States and the world, similar markets produced consumer and environmental benefits...
...The suppliers knew exactly what they were doing...
...Then, the PUC rejected the utilities' request to purchase electricity from the new plant owners under long-term contracts, the way the vast bulk of electricity is purchased in every other market in the world...
...Suppliers, fearing they would not be paid, responded by raising their prices even higher, despite the low demand of the winter months...
...PG&E's bankruptcy makes the resolution even more difficult...
...Suppliers will always act in their own interests...
...Until a year ago, no one outside the industry paid much attention to how California's new law deregulating the supply of electricity was working...
...When their interests conflict with the public interest, there are enormous market risks when political leaders won't lead...
...And beginning last May, that is what they did...
...It is hard to imagine even a Pledge of Allegiance passing the California legislature unanimously, but this law had a broad base of support from large industrial customers, environmental groups, and the state's investor-owned utilities, such as the one where I was then employed...
...As the combined utility and state debts climbed past $20 billion, California's credit rating slipped and political gridlock set in...
Vol. 128 • June 2001 • No. 11
