January's electricity shortages in California will be a major topic of discussion for the 107th Congress and the Federal Energy Regulatory Commission.
The electricity crisis in California caused rolling blackouts and soaring electricity prices, and it brought the utility sector to the brink of bankruptcy. The crisis threatened to spread to the gasoline marketing sector when power was cut to intrastate pipelines that distribute gasoline.
The crisis forced the California Independent System Operator (ISO) to scramble to keep the lights on hour by hour-and sometimes it couldn't. Wholesale prices of electricity were routinely $500-800/Mw-hr. And the utilities that ultimately paid the high prices to serve their customers could not collect enough from customers to pay their bills.
Southern California Edison Co. and Pacific Gas & Electric Co. were on the verge of bankruptcy in January. Since August, they had accumulated over $11 billion in debt purely on the costs of wholesale power. The cash flow problem and missed payments on some long-term debt prompted the ratings agencies to downgrade their credit to "junk bond" status.
When the utilities' credit became so bad they couldn't buy power, the state intervened with emergency legislation to buy power through its Department of Water Resources. That power was then resold to the ISO and ultimately to the utilities. There was talk about the state expropriating power plants and creating a state power authority.
"California is stuck in a vortex where one thing leads to another even worse," said Edward N. Krapels, director of gas and power services at consultant Energy Security Analysis Inc., Wakefield, Mass.
Businesses were being affected because of the rolling outages, and some that were supplied under interruptible tariffs traded firm electricity supply for lower rates. Their electricity was cut day after day for several weeks. Interruptible load customers said they never expected to have power shut off so often for so long.
Kinder Morgan Energy, operating under such an interruptible tariff, was required to shut down its gasoline pipeline in Northern California for 3 straight days. Supply and distribution of gasoline as well as refinery output was put at risk, said Rich Marcogliese, plant manager at Valero Energy Corp.'s 135,000 b/d Benicia, Calif., refinery.
And the crisis poses concerns for the US natural gas industry in particular. The power sector is expected to account for the fastest-growing area of natural gas demand in the years to come. The vast majority of the more than 200 power plants slated to come on stream in the US in the early part of this decade are expected to be fueled by gas. Contributing to the California energy crisis was the startling spike in the price of natural gas that fueled some of the state's power plants.
Accordingly, the favorable market position of natural gas in the US power sector may have been eroded as a result of the role of high gas prices in California's power crisis.
Faulty design
California, initially praised because of its groundbreaking actions to deregulate the electricity industry, recently has been cited by other states as an example of why deregulation should be postponed.
Promised in 1996 that rates would go down and electricity would be plentiful, Californians signed off on deregulation and restructuring of the entire electricity industry.
The utilities agreed to sell most of their generated electricity. They would bid for power to sell to their customers at a nonprofit state entity called the California Power Exchange. Power generators, including the companies such as Dynegy Corp., Reliant Energy Inc., and Duke Energy that bought the power plants, would bid to sell power into that exchange. These markets were for power to be delivered and consumed the next day-the so-called "day-ahead" market. The California Public Utilities Commission prohibited the utilities from writing longer-term contracts or bilateral contracts with generators or hedging the future price of electricity in any way. They were required to buy power on the spot wholesale market. An ISO would dispatch the power to utility customers over the state's power grid. Customer electricity rates were fixed.
The wholesale market or supply side was unregulated, but the demand side wasn't. Even so, the deregulated system functioned for the first few years without huge problems. That's largely because supply and demand for electricity were roughly in balance. Low natural gas prices fed the gas-fired power plants. Rain was plentiful for the hydoelectric plants in northern California and the Pacific Northwest, which sold copious amounts of cheap power south.
Even though electricity flowed, and the state wasn't gripped by emergencies, structural problems began to surface. The fixed price for consumers gave no price signals or incentives for conservation during peak periods, and the supply side could not respond to price signals, either, because of the huge lag and next to impossible task of getting a new plant approved by state and local officials.
Denouement
After the state's high-technology business sector took off in the 1990s, electricity demand soared and a supply crunch emerged.
California, with its laborious permitting processes for new plants, did not build a power plant for almost a decade.
As economies grew in Washington and Oregon, so did their appetite for power, and they had less to share. California had always depended on imports to fill the gap between instate generation and demand.
In early spring 2000, the California ISO warned state officials that supply was getting tight and emergencies were likely that summer. Kellan Fluckiger, chief operating officer of the ISO, remarked recently, "I wished I had screamed louder then."
But the ISO's warning came too late to prevent a crisis over the winter.
Krapels said, "It began as a gas problem last summer." Power demand increased with the rising summer temperatures, and it didn't rain enough to keep the reservoirs full enough to feed the 5,000 Mw of hydroelectric power plants, he noted. This pushed a lot of demand onto the mostly 40-year old gas-fired generation plants.
Every old, inefficient gas unit was pressed into service. Demand for gas began to soar, pushing gas prices into unheard of levels of $20-50/Mcf. The inefficient units also polluted more, pressuring the prices of emissions credits upward. Krapels said emissions credits added as much as $60/Mw-hr more to the wholesale price of power.
With prices escalating, regulators then tried to shore up the system by slapping a rate cap on the price of wholesale power. The cap bounced around $150/Mw-hr for months. The cap began to impact the supply of power as more and more generators went offline for maintenance turnarounds. Observers said that generators couldn't even pay for the gas at the capped price.
From time to time, the ISO would declare emergencies when as much as one third of the generating capacity of California would be out for unplanned and planned outages.
Then the US Department of Energy got involved and ordered all generators that could sell power to California to do so despite the cap. This helped for a while, until the credit situation of the utilities became so dire that they couldn't pay the California Power Exchange or the ISO for power to distribute to customers.
"The credit issue was the frosting on the cake that took the system to near-collapse," said Krapels.
Solutions
Most energy specialists agree that the state will have to remain involved in the market for a while to keep the lights burning, because the utilities are too weak financially to procure the power.
They said a transition to bilateral, longer-term contracts for power must be made.
In mid-January, following 3 days of rolling blackouts, the state legislature authorized the California Department of Water Resources to buy power for the utilities at prevailing spot market prices.
Krapels said that, while that was an immediate fix, a long-term solution requires fixed contracts with the generators over several years that will smooth out the price and bring the system back into balance.
"The contracts should be for about $75/Mw-hr for about 2 or 3 years," he said. "The California governor just has to accept these prices."
Krapels said Californians also must accept the reality of higher rates. "They are living in 'la-la land,' if they think they don't have to raise the price."
He said long-term contracts with the state would keep the lights on at a reasonable, stable price and give the utilities breathing room to work through their financial difficulties.
He said that, with predictable prices, more power plants can be built-if California officials have the political will to approve sites quickly and rationally-and a transition back to a redesigned market can be made.
ESAI's - Edward N. Krapels
"California is stuck in a vortex where one thing leads to another even worseellipse" Californians also must accept the reality of higher rates: "They are living in 'la-la land,' if they think they don't have to raise the price."