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THE ENERGY CRUNCH: The Perfect Storm

California seen as epicentre of power problems

The state's full-blown energy crisis is sending economic tremors worldwide, Barrie McKenna says


Published Feb. 12, 2001

It's late afternoon on a hot mid-July day when the unthinkable happens.

San Francisco and much of Northern California fades to black after BC Hydro, its reservoirs precariously depleted, abruptly cuts off sales to the power-starved state.

Within minutes, hundreds of transformers across the state explode. Cable cars scaling Nob Hill grind to a halt, traffic lights across the city go blank and thousands of office workers are trapped on the steamy upper floors of the city's landmark TransAmerica Pyramid tower.

In Toronto, Internet users are frustrated because they can't access several popular Web sites - the first sign of a radiating economic catastrophe.

Far-fetched? Hardly. Many experts believe the chilling scenario of severe blackouts this summer in California - and elsewhere in the United States - when seasonal power demand peaks, isn't just possible, but it appears increasingly likely. "I don't see an end to this," warned Kellan Fluckiger, chief operating officer at California Independent System Operator, a state agency that manages the power grid. "For the next couple of years, we are going to be in a position where we could lose power at any time."

California - the richest and most populous U.S. state - is in the throes of a full-blown energy crisis, and it's sending economic tremors around the globe. In spite of recent intervention by the California Legislature, experts predict the state will face up to a 5,000-megawatt power shortfall this summer, when air conditioners send demand to near-record levels. That's the equivalent of 10 large gas-fired power plants - which aren't yet built.

For the first time in a generation, an energy crunch is stalking the global economy.

The cartel of oil-producing states - known as the Organization of Petroleum Exporting Countries - has regained a bit of its swagger, fanning fears in the oil-dependent countries of the West.

Surging oil prices have crimped the already slowing U.S. economy, raising the spectre of recession for the first time in a decade. Meanwhile, consumers are paying more at the pumps and home heating costs have exploded.

The crisis has also sparked a renewed interest in conservation and long-neglected alternatives, including wind, coal and even nuclear power. And once-uneconomic plans to tap oil and gas reserves in remote places - particularly in the Arctic - suddenly seem like the Holy Grail of North American energy self-sufficiency.

As with many trends, California may be giving people a glimpse into the future. The state is a microcosm of what happens when wild energy market gyrations collide with consumers' desire for stable prices.

"This was essentially the perfect storm," explained William Smith, manager of load management at the Electric Power Research Institute, an industry-funded think tank in Palo Alto, Calif.

And the storm isn't over.

Rooted in last summer's dramatic spike in world oil and gas prices, California's problems are now rapidly infecting neighbouring markets. The state's insatiable thirst for power has forced up regional electricity and natural gas prices - even in Canada - wreaking havoc on businesses and taking money out of the pockets of consumers.

"California is just the first domino," noted Mr. Smith, a former executive at San Francisco-based Pacific Gas & Electric Co. "Everybody is just squeaking by with available supply. If there is a hot summer this year, you'll see some serious shortages."

The eye of the current storm began to form in 1998 and early 1999, when world oil prices collapsed to $10 (U.S.) a barrel amid the Asian financial crisis. Those rock-bottom prices postponed the search for new oil and gas reserves, and caused OPEC and other producers to stop pumping oil. But the world - and particularly the booming United States - unexpectedly bounced back, sending demand soaring again.

Caught off guard, markets reacted as markets do to tight supplies: prices jumped. Oil has tripled to more than $30 a barrel, driving up the price of everything from diesel fuel to home heating oil.

California's wholesale electricity market, heavily dependent on power generated from natural gas, went haywire. The spot price topped $300 per megawatt hour in December, up from just $25 last April - an increase of more than 1,200 per cent in eight months.

Worse still, if the problem is not contained in California, economists worry that the United States and the global economy may suffer. Economist Mark Vitner of First Union Corp. in Charlotte, N.C., predicted that if the California electricity crisis isn't resolved soon, it could sap up to a full percentage point from U.S. economic growth this year.

"That could make the difference between having a recession or not," he said.

That's because what happens in California immediately affects the rest of the country. The state's economy - representing a 10th of the country's - is larger than Canada's. California is also home to the Internet, and is heart of the critical U.S. high-tech industry. Manufacturers have already cut production, and further blackouts or sharp electricity price hikes could force plants to close or shift production to where there is power.

Experts say the factors that created California's crunch could happen almost anywhere - an unexpected spike in demand, soaring prices, inadequate local supply, transmission bottlenecks and low water levels behind hydro dams.

But don't panic - the world isn't yet in the grips of a full-blown crisis as it was in 1973, when Arab states refused to sell oil to the United States, insists Robert Ebel, director of the energy program at the Center for Strategic and International Studies in Washington.

"The oil market is not in a crisis, at least not in the usual sense of the word," he suggested. "It continues to be a problem of affordability, not a problem of availability."

The economies of the United States and Canada are half as dependent on oil than they were in 1973. OPEC's share of world oil production has also declined - to 42 per cent today from 55 per cent then.

Yet, energy markets have become more volatile, putting intense pressure on governments to react when prices suddenly spike.

U.S. President George W. Bush is convinced that California is a cautionary tale - a warning that the United States must seek out new supplies of energy and encourage new power generation and transmission. He's working on a new national energy policy, and has put Vice-President Dick Cheney, a former oil executive, in charge. Mr. Bush is also looking to Canada to diversify its energy supplies - and not to meddle in a U.S. quest for oil in places such as Alaska's Arctic National Wildlife Refuge.

But as much as Mr. Bush wants California to be the spark for a revival of the North American energy industry, the lasting legacy of the crisis may be to stall the pace of deregulation and privatization.

Once held up as an international model, California-style deregulation has been widely discredited for discouraging investment in equipment and limiting the ability of utilities to pass on wholesale price hikes. The fundamental problem: Politicians, regulators and market players agreed to open the wholesale market to all comers, but they capped the rates for consumers.

"The California system was essentially a bet that the wholesale price in the spot market would stay low," said Howard Gruenspecht, a resident scholar at the Washington-based think tank Resources for the Future and a former top U.S. energy official. "But they lost the bet. . . . It was like building a house without fire insurance, and the house burned down."

Those eager for reregulation and a return to state ownership have seized on the crisis to roll back the clock, and not just in California. The movement's new rallying cry is "public power now."

The Hetch Hetchy dam high in the Sierra Mountains has become a potent symbol of the renationalization movement. The dam, built in 1923, is still owned by San Francisco and could meet about a third of its power needs. But PG&E controls the 400 megawatts of power it produces. And only small amounts of its power now reaches San Francisco.

Critics point to the 130-metre-high dam as proof that California - and indeed the entire country - doesn't lack additional generating capacity, but rather control over what it already has. California sells as much as 5,000 megawatts of power to other states under long-term contracts, or roughly this summer's estimated shortfall.

"We've had power all this time and it's been denied us," complained Angela Alioto, a lawyer with the San Francisco Coalition for Lower Utility Bills, a ratepayer group. "It's time to bring our power back."


This week, Report on Business examines the impact of soaring energy prices on consumers and the economy.

Part 1: The perfect storm

Part 2: How Canada fares

Part 3: The good side of deregulation

Part 4: Energy and the New Economy

Part 5: Alternative forms of power

Part 6: Conclusions

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