1. The California energy crisis Introduction (Wolak March ‘01) –Wholesale: averaged $33 MWH in 1999, $116 MWH in 2000, $310MWH Jan 2001. –Natural gas $3-$4 mm btu in late 1990s –$10 nationally & $56.54 S Cal Dec 2000 –April 6,2001 PG&E, bankrupt with debts of $9 billion. –Deregulated market

2. Investigate cause –Describe old regulated structure –Initial regulated structure –Evolution of the crisis and underlying causes –Mitigation plans –Lessons

3. Old system Deregulation began in 1995. Before this, C-O-S regulation of vertically integrated utilities –Generation, transmission, distribution, retail. –Equivalent of public ownership –Based on idea of natural monopoly –Regulation to set “just and reasonable” rates –Public Utility Commission, Federal Energy Regulatory Commission (FERC)

4. Problems with Old Technical, economic, with treatment of depreciation Very costly No incentive to reduce costs, innovate, increase efficiency, guaranteed return, promotes cost-padding, unwise investment –Green energy, cost overruns in nuclear

5. Goals of deregulation Competition in generation –No natural monopoly here –Increases efficiency, lowers prices, makes better use of existing facilities, gives better signals to generators re new investment Competition in retail –Consumer choice, innovative packaging of energy products, lower prices, less waste.

6. Deregulation program Generation separated, power plants auctioned Utilities allowed to recover $28 bill re. nuclear and green Retail tariffs reduced by 10% and frozen till 31.3.02 or until debt paid PG&E and SCE never paid off. San Diego G&E did.

7. Institutions Cal PX receives price and quantity offers from generators and bids from buyers No long-term arrangements allowed. All day-of or day-ahead. Cal-Independent System Operator: non- profit, role to avoid blackouts, make sure the system works, buy at any price

8. Experience 1998 & 1999 excess capacity, wholesale prices declined, retail fixed, profit of utilities increased, some debt paid off. SDG&E paid off all debt, retail no longer fixed 2000 demand increased (20%?) Result as discussed. Wholesale price increased, retail fixed –PG&E bankrupt, SDG&E customers faced bills up to 20 times higher 2.7 cents to 52 cents kWh

9. What happened? Supply and demand or market power? Supply restricted by the deregulation program –No new power plants, new entrants lumbered with past costs of incumbents, for fairness –Still uncertainty re future regulations/prices restricts new entrants

10. Market power Also evidence of market power –Unverifiable forced outages –Generators purchasing gas at high prices through affiliates Under mediation whether wholesale prices were “just and reasonable”

11. Proposals Price caps, soft and hard Voluntary/compulsory forward contracts Re-regulation of prices

12. Subsequently Natural gas prices in July ‘01 $3/mmbtu NYME, about $4/mmbtu Cal. –Temperate weather, increased conservation, increased gas production, slowing economy. FERC June 19, power emergency in California sets price caps in all western states. Cost of production in marginal plant, was $90MWH.

13. 2001 Some suppliers would not sell, increasing emergency FERC and generators in mediation. FERC claimed $9 bill. Generators offered $1 bill.

14. My view Bad legislation Markets create incentives –True scarcity, high prices give signals to consumers to reduce consumption and producers to increase production (long run) –Here consumers were insulated and producers would not invest for uncertainty. –Result, more scarcity.

15. My view Here the incentives the system created were to increase profit by using the faults in the system, like income tax in many countries. Example: price cap avoidance by selling into other markets, reducing supply to increase price.

16. Lessons Markets often work better than planned economies because the players innovate in ways that cannot be anticipated by the planners. Deregulation should be designed to capture the benefits of this innovation rather than to give an incentive to avoid the rules.