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Dec 31, 2002

California Deregulation Brought Chaos to Power Market (Update2)

(Sacramento, California) California’s plan to deregulate its electricity market had overwhelming support back in 1996. Power companies, a unanimous state Legislature and then-Governor Pete Wilson backed the move, saying an open market would improve service and lead to cheaper power.

It didn’t work out that way, partly because the state deregulated wholesale prices but left caps on customer costs. Now consumers, after enduring blackouts amid power shortages, pay the nation’s highest electricity rates. The state’s largest utilities piled up debt. A state budget surplus evaporated as California paid $11.5 billion for power that utilities couldn’t afford.

“Deregulation came to California with such a wave of enthusiasm that no one wanted to believe it wasn’t working,” Joseph Fichera, chairman of Saber Partners LLC, said in an interview. “We’re still paying for those mistakes.’’ Fichera’s firm has been hired to advise the state.

Three years after deregulation took effect, PG&E Corp.’s Pacific Gas & Electric utility, the state’s largest, faces a bankruptcy reorganization. Southern California Edison, the utility owned by Edison International, may not be able to buy electricity until 2003. Enron Corp., Dynegy Inc., Duke Energy Corp. and other companies face investigations for allegedly manipulating the market. Governor Gray Davis trails his likely Republican opponent in polls ahead of next year’s election.

Fichera said the crisis has hobbled California’s finances, and pointed to the state’s stalled plan to sell $12.5 billion in bonds to pay for power purchases. A smaller bond sale may still happen in the new year, he said.

Early Missteps

The seeds of California’s troubles were planted in its deregulation law, which took effect in 1998. The law allowed wholesale-electricity prices to fluctuate with supply and demand, and required utilities to sell some power plants. Long-term energy contracts were banned, and the utilities were forced to buy power through an exchange.

A shortfall in power supplies and dry weather that cut into hydroelectric generation led to soaring energy prices that the utilities couldn’t pass on to customers because consumer rates were fixed. Power prices on the California-Oregon border soared as high as $3,000 a megawatt-hour in December 2000, almost 100 times the average price in December 1999. One megawatt-hour is enough power to light 750 typical California homes for an hour.

California, unlike Texas and other states that were deregulating, didn’t encourage enough new power-plant construction, even as the state’s economy boomed. Between 1990 and 1998, the state’s energy commission approved 1,316 new megawatts of plant capacity. This year alone, in response to the crisis, new plants generating 2,100 megawatts of electricity began operating.

“We made mistakes,” said Richard Bilas, a Republican on the state Public Utilities Commission, which oversaw the implementation of the deregulation law. “Once you put something in stone, it’s very difficult to change it, even when conditions tell you it must be changed.”

Pleas for Help

PG&E and Edison appealed to the commission for greater ability to buy power through long-term contracts and asked for rate increases of more than 20 percent. The PUC in January of this year approved a 10 percent increase.

“The two most important things that would have mitigated greatly the California power crisis were long-term power contracting on the part of the utilities and earlier rate increases,” Edison Chief Executive John Bryson said in an interview. “It wasn’t done.”

By January, PG&E and Edison utilities were on the verge of bankruptcy and federal energy officials were ignoring calls by California leaders to impose price caps on wholesale electricity. Millions of Californians lost their electricity during six days of blackouts in January, March and May, when power had to be shut off an hour at a time as demand outstripped supplies. Davis called the state Legislature into an emergency session.

Davis won praise from lawmakers, utility executives and Wall Street for his campaign to increase energy conservation, and the speeding of permits to allow new power plants to be built. California residents reduced their energy use on average 7 percent over the past 11 months, according to the state Energy Commission. The moves helped avert anticipated blackouts during the summer.

It’s “a conservation program like the world has never seen,” said PG&E Chairman Robert Glynn.

Price Tag

California has paid at least $11.5 billion to buy power on behalf of its utilities. It is left with $43 billion in long-term electricity contracts, which critics say could hamper the regional economy for years.

California has failed to issue the $12.5 billion in bonds to repay its general fund for purchasing electricity. The state PUC says the current plan for selling those bonds will lock the state into above-market prices for power, and wants the long-term contracts renegotiated.

“There are serious questions about the context under which the contracts were negotiated to begin with, and I think there are legal claims,” PUC President Loretta Lynch said.

Generators are under investigation by the California Public Utilities Commission, California Attorney General Bill Lockyer, and a California state Senate committee. The Federal Energy Regulatory Commission is considering California’s request for refunds from the generators.

California is still buying electricity in place of Pacific Gas & Electric and Edison. Edison doesn’t expect to return to creditworthiness until 2003, and Pacific Gas & Electric’s bankruptcy case could last even longer. Sempra Energy’s utility in San Diego avoided insolvency by winning early rate increases.

“This energy crisis, is, by no stretch of the imagination, over” said Republican Assembly Leader Dave Cox.

–David Ward and Daniel Taub in San Francisco and Los Angeles (415) 912-2995 or (323) 801-1261, with reporting by Michael Marois in (Sacramento, through the San Francisco newsroom/dfr/*cs/jmg


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