OGJ Editorial: California's real problem

Oct. 7, 2002
Before foes of electricity deregulation draw grand conclusions from an official opinion against El Paso Natural Gas Pipeline Co., they should ask why the supposed market manipulation didn't happen in Pennsylvania.

Before foes of electricity deregulation draw grand conclusions from an official opinion against El Paso Natural Gas Pipeline Co., they should ask why the supposed market manipulation didn't happen in Pennsylvania. Here's a hint: California botched what Pennsylvania got right.

The Sept. 23 opinion by Curtis L. Wagner Jr., chief administrative law judge of the Federal Energy Regulatory Commission, accuses El Paso of illegally exercising market power by not delivering gas at capacity rates during California's energy crisis of late 2000 and early 2001. The decision follows disclosures of shady round-trip trading of electric power during the crisis and inevitably will join them in controversy.

Touchy issues

The exposed deceptions by greedy power traders have helped state officials dodge blame for the electricity shortages and rate leaps of 2000-01. State handling of the crisis and consequent fiscal distress are touchy issues in current election campaigns. Wagner's El Paso opinion will be seen by many as new evidence that California's energy consumers were victims mainly of corporate misbehavior.

That view will be wrong for what it ignores. There was corporate misbehavior, to be sure. Power traders have admitted using duplicative trades. But the manipulation was of reported volumes and revenues, not prices, which were naturally rising in a short market. The victims of phantom trades were the companies' deceived owners, lenders, and potential investors, not California's energy consumers.

Wagner opens a distinct realm of suspicion with his allegation that El Paso Natural Gas withheld pipeline capacity—and, therefore, supply—while California desperately needed gas for power generation. The automatic assumption is that the company squeezed the market to raise prices.

If that was the motive, El Paso had an easier way to do the job: trading manipulations with gas comparable to those under way with electric power. Yet Wagner's finding reaffirms an earlier determination that El Paso's trading unit didn't exercise market power. It recommends dismissal of a related complaint.

So why didn't El Paso use all the California-bound pipeline capacity cited by Wagner? The company says it physically couldn't do so. In a filing with the Securities and Exchange Commission challenging Wagner's legal interpretation and several of his facts, it disputes a "faulty assumption that unless a pipeline runs at its certificated capacity each and every day of the year it is in violation of its certificate." In fact, El Paso argues, pipelines can't safely sustain operations at the implicit pressures.

It's a strong rebuttal. The case now goes to FERC, which has been under political pressure for its handling of the California crisis. The outcome is anybody's guess. At this point, it suffices to wonder whether utilization rates of gas pipelines serving California would be an issue at all if suspicion about companies were not already so high and politically useful.

Nothing similar to this is happening in Pennsylvania. Like California, Pennsylvania was among the first states to restructure its electric power industry in response to federal initiatives. Unlike California, Pennsylvania actually deregulated the business. For example, it lifted all price controls except for protective caps at the retail level. California decontrolled wholesale but not retail prices, centralized power purchases, and limited contract flexibility of energy suppliers.

Pennsylvania didn't encounter problems like California's. The citizen-action group PennFuture reported in August that the state's residential energy users paid 20% less for electricity in 2001 than they had 5 years earlier under regulation. It credited deregulation for most of this goodness.

In Pennsylvania there has been no chorus of complaint about phantom trading and supply manipulation. Those things tend not to happen in free markets. They happen in officially fragmented markets, which distort supply-demand relationships and generate perverse value spreads. Traders crave the resulting arbitrage opportunities. Some of them get carried away. Others are crooks to begin with.

Analogous shenanigans

Trading shenanigans analogous to those in California—including fraudulent misclassification of crude oil—grew out of the multitiered US oil market of the 1970s and early 1980s. They subsided with decontrol. California's electricity business is like the US oil market before 1981. Pennsylvania's electricity business is like the US oil market today.

History's clear. Price and market controls breed trouble. In California's crisis, they—not companies eager to cheat ratepayers—composed the biggest problem.