Power Play in California

The sunny state of California, home to the digital revolution and the Silicon Valley, is in the throes of an unprecedented electricity crisis. California is faced with rolling blackouts, bankrupt utilities and rising electricity bills. The electricity rates for the consumers with the San Diego Gas and Electric utility jumped by as much as 240 per cent in just one month this summer before regulatory action forced a price cap. The other areas escaped as they are operating with a fixed rate till 2001. The US Energy Secretary, Bill Richardson, said recently “…. California’s electricity market has become dysfunctional.” Five years into the new uncharted territory of unbundling, competition, free market in electricity and deregulation, California’s electricity sector looks to be going belly-up.

CRISIS IN THEELECTRICITY SECTOR

California’s attempts at de-regulating the electricity sector was hailed as a model for others to follow – both in the United States and in other parts of the World including India. The Electricity Bill 2000 clearly has the California model in mind. Recently, Gajendra Haldea, the architect of the Bill, expressed his earnest hope that after the current reforms, with the introduction of competition and a “free market” in electricity, power would be traded as easily as soap. Instead, he should listen to the words of the California Governor, Gray Davis, who, in his January 8 State Address, said “My friends, electricity is not an exotic commodity like pork bellies, to be traded in the chaotic equivalent of a futures market; electricity is a basic necessity of life.”

What is the nature of the crisis that engulfed California last summer and now this winter? Simply put, the power generators in California held up supply during peak demand periods, leading to shortages of power. In order to meet the demand, the utilities and the Independent System Operator (responsible for maintaining the power system in California) then had to buy power on occasions at prices 20 times that of last summer. Not only did the electricity prices rise astronomically during peak demand periods, they “refused” to come down during periods of low demand; even on Sundays, the prices last summer were seven times that of 1999. Obviously, those generating power made a killing as California’s purchasers paid out an estimated $ 10.9 billion more last summer for their electricity than the summer before. The division of this amount between the utilities and consumers is the current divide. The 9 per cent increase in the existing fixed rate regime of two utilities – Pacific Gas and Electric and Southern California Edison, both threatened with bankruptcy – and other measures voted by the California legislature have been opposed by consumer groups.

GENESIS OFCRISIS

Why did this situation come about this year and not earlier? The genesis of this lies in the “restructuring” that California instituted under the earlier Republican Governor Pat Wilson in 1996. California’s Public Utilities Commission and Legislature put in a system designed to separate electricity generation from transmission and distribution. This meant hiving off the power plants from the three major utilities in California, leaving them with transmission and distribution only. The arguments advanced were that once the generation became independent of the utilities, the generators would compete amongst themselves and bring down electricity prices. For enabling such competition, a Power Exchange — on the pattern of a Stock Exchange – was created.

The Power Exchange was the spot market for next day’s wholesale electricity supply. However, this leaves open the possibility that there could be a shortage of supply vis-à-vis demand. In such a scenario, the entity looking after the grid – the Independent System Operator (ISO) — would enter the picture. ISO is responsible for ensuring that there is a balance between supply and demand at each instant of time. It buys power in what is termed as the “real time” power market to meet immediate demands and if need be, instructs load shedding. It was originally envisaged that there would be adequate supplies available and ISO would enter the power market only rarely. Instead, ISO, faced with large shortages and imminent collapse of California’s grid, has been forced to buy very expensive power repeatedly in the “real time” power market.

ARTIFICIAL SCARCITYAND PROFITEERING

What the lawmakers failed to understand is that if the spot market is starved of supplies creating an artificial scarcity, “free market” could then drive the prices through the roof in the real time power market, a phenomenon now called “gaming” the market. This is precisely what happened last summer and is happening during winter as well. The private generators have reaped windfall profits of 800 per cent to 900 per cent last summer. In one week alone ending June 14, 2000, the purchasers of power in California spent $1.2 billion or 1/8th of their total cost of power for all of 1999. Governor Davis has called the power generators “..pirates, marauders, gougers and greedy profiteers.” The California Public Utilities Commission and the Electricity Oversight Board have charged the generators with stonewalling investigations and deliberately withholding information. Six investigations are underway on charges of market rigging. There are now powerful calls for reversing de-regulation and the formation of a California Power Authority to take over the entire power sector in California, a threat recently held out by Governor Davis as well.

Denying charges of gaming, the power generating companies have advanced two reasons for the rise in prices. According to them, a burgeoning Californian economy led to a sharp rise in demand this summer. This created temporary shortages driving up prices. They also argued that the rise in gas prices — the fuel for most of the power plants in the state — further compounded the problem. A committee set up by Governor Davis consisting of Michael Kahn, Chairman, of the Electricity Oversight Board and Loretta Lynch, President of the California Public Utilities Commission has exploded this myth. In their report, they showed ” .. the highest loads for 2000 were consistently well below 1999 peak loads”. With respect to gas price increase, the Kahn-Lynch report argues that even a doubling of gas prices cannot explain why ” .. the wholesale prices for power in June 2000 have increased as much as tenfold over the last year”.

MARKETFAILURE

Why did the markets fail in California? While the ideologues of the free market will undoubtedly come up with some fancy footwork to explain this failure, the real reasons go much deeper. Electricity, unlike any other commodity, cannot be stored. The amount of electricity pumped into the system must be consumed instantly – in factories, offices and homes. In such a scenario, creating an artificial shortage is child’s play. Electricity has another attribute. If your factory is running (or your computers) on electricity, it is difficult to stop consuming it. Electricity demand is relatively inelastic; it does not fall if prices rise. All this creates a situation ideal for rigging the market. Once a scarcity is created, competition fails. Competition only works if there is a surplus of supply over demand.

Interestingly, there is a set of utilities and consumers in California who have escaped the current crisis. These are about 30 publicly owned utilities — the municipal authorities of Sacramento, Los Angeles, etc., with 23 per cent of California’s total generating capacity — that chose not to go under the de-regulatory hammer and maintained their integrated operations. Not only did their subscribers escape any rate increase, these public utilities have even increased their profits last year.

What lessons can we in India learn from California’s example? The first and the most important one is that there can be no free market in electricity when there are shortages. This talk of unbundling and creating a free market for electricity is journey into a never-never land. Instead, we need to strength the grid, integrate the power systems better and make the best use of our installed capacities. Any other road, including the one charted by the Electricity Bill 2000, will only lead down a slippery path to disaster.