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THE ENERGY CRUNCH: California power debacle seen as anomaly

There's chaos on West Coast, but deregulation has done well elsewhere, Lily Nguyen writes


Published Feb. 14, 2001


With the meltdown of the California electricity sector, "deregulation" has become synonymous with blackouts, shockingly high prices, energy shortages and system failures.

Fear and loathing of California-style electricity chaos have prompted one-third of the 24 states contemplating deregulation to either delay or back out of it.

In Canada, the government of Ontario is similarly stalling on deregulation, delaying the liberalization of its electricity market from last year to this year to an indeterminate date in the future.

In New Brunswick, Energy Minister Jeannot Volpe won't even use the word "deregulation" to describe the province's plans to end the monopoly of its Crown corporation utility, New Brunswick Power Corp. She says it's just a "new policy."

But in spite of the highly publicized debacle in California, and to some extent Alberta, the deregulation process has been marked with considerable success. For nearly 20 years, power industries around the world, including parts of Europe, South America and Australia, have been liberalized. In many cases, it has led to more competition, higher efficiency, lower prices, cleaner and more modern generation, and a lighter regulatory regime.

In North America, it has spread through the northeastern United States, including Pennsylvania, New Jersey and Maryland - which form the PJM system - as well as New York and New England. Like California, these jurisdictions have introduced competition into wholesale electricity, the side of the market that generates and sells the power to suppliers, but not to end users like households. And so far, their efforts have been met with some success.

In fact, despite the prevailing view, experts say California is not a leader in the deregulation process, or a typical case.

"California is not a front-runner," said Tom Adams, director of Toronto-based Energy Probe, an energy watchdog group. "There have been some major successes, there have been some big hiccups, but there's never been a blow-out like California so far."

"California's situation is pretty much unique," said William Hogan, research director of the Harvard Electricity Policy Group in Cambridge, Mass., which is studying the deregulation and liberalization of electricity markets.

Mr. Hogan, a professor of policy and public administration at Harvard University, said nowhere in the world has a deregulating market been hit with a severe supply crunch like California's, where blackouts have become a fact of life.

So what made the difference?

It's difficult to pinpoint a single formula for success because each country or jurisdiction has a unique starting point for deregulation - a different political, economic and environmental climate, as well as a unique electrical industry.

But in light of the California situation, perhaps the most powerful lesson can be gleaned from a 1999 study by the International Energy Agency titled Electricity Market Reform.

Jurisdictions considering deregulation, the study says, must "think hard, but move quickly and vigorously."

The study, which surveyed the restructuring of the electricity industry in countries belonging to the Organization for Economic Co-operation and Development, found that deregulation inevitably brings with it a painful transition period. Some workers in the industry lose their jobs; industry has to grapple with new rules; system administrators have to learn how to effectively enforce these rules.

The better the market design in the beginning, and the more clearly and consistently it is implemented, the shorter that transition period, and the more quickly the benefits begin to be felt.

That didn't happen in California, and it also didn't happen in Alberta, two jurisdictions where deregulation has been accompanied by a supply squeeze and skyrocketing power prices.

"The California experience from day one was to adopt more and more complicated rules, because people were able to take advantage of the mistakes in the rules they had," Mr. Hogan said.

In California, power prices have soared so high that utilities that can't pass the increase onto their consumers have already threatened bankruptcy and begun to default on payments. California's two largest utilities owe $12-billion (U.S.) in combined debt, and recently Pacific Gas & Electric Co., the state's No. 1 utility, said it would be paying suppliers 15 cents on the dollar.

Critics trace the supply shortages in California and Alberta back to poor planning at the outset, and a shifting road map for deregulation that discouraged companies from investing in new generation capacity at a time when the economies of the two jurisdictions were booming and demand mushroomed. California also implemented strict environmental rules that made approval for new power plants difficult to obtain.

Nobody wanted to sink hundreds of millions of dollars into new power capacity when it wasn't clear how they would make their money back.

"California didn't have low supply when they went into it, which was 1996," Mr. Hogan said. "The problem was they didn't have anything much in the pipeline, and things came in very slowly, because people were very uncertain about what's going to happen.

"Get it right as soon as you can," he said. The PJM system, in Pennsylvania, New Jersey and Maryland, got it right, he added. That's why deregulation has been relatively painless so far.

"The successful jurisdictions are jurisdictions that have regimes that make it a safe, secure environment for new investment," Energy Probe's Mr. Adams said.

Richard Gilbert, a professor of economics at the University of California at Berkeley who has studied deregulating electricity markets, pointed to the Britain as an example of successful deregulation.

When that country deregulated its electricity industry, he said, "prices turned out to be pretty high, and that attracted a fair amount of new suppliers.

"Customers didn't see a price increase, in fact they saw the price go down a bit. It was a pleasant scenario from a customer's point of view."

Now that the rules in Alberta are laid out, the deregulation horizon looks clearer, although it may be years before it is reached.

Companies looking to benefit from high power prices are rushing to build new generation capacity. Already, plans for more than 3,000 megawatts, or more than one-third of existing capacity, have been announced over the next five years. Once some of those plants come on stream - as early as next year in some cases - wholesale prices are expected to come down, as well as prices charged to consumers.

The future of California's deregulated power industry remains foggy, however.

Mr. Gilbert said there are two big problems with the California system. One is that power rates charged to consumers are fixed. The other is that utilities, which buy power for resale to consumers, aren't allowed to enter into long-term contracts for their power supply.

Because of the fixed prices, there is no incentive for consumers to cut back on their power use, even though power is in tight supply, Mr. Gilbert explained. The utilities suffer, because they have to scramble to find enough power to meet consumers' needs. And because they can't sign long-term contracts guaranteeing any supply, they have to buy it on the market no matter what the cost. That has precipitated their present financial crisis.

In the end, Mr. Hogan said, any system open to competition will be subject to some price spikes and even energy shortages.

"The system works reasonably well without lots of intervention," he said. "Sometimes prices go up for short periods to reflect scarcity and that's a good thing, not a bad thing. It's when prices go up all the time like they have in California that you have evidence of something really dysfunctional going on.

"Deregulation? It's definitely workable, and it definitely offers benefits," he said.

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