California Electricity Opportunity turned into Risk Risk turned into Challenge Challenge turned into Crisis Crisis turned into Blight

Source: California Energy Commission

California Electricity Opportunity turned into Risk Risk turned into Challenge Challenge turned into Crisis Crisis turned into Blight

Electricity Restructuring Assembly Bill 1890, September 1996 Created wholesale markets –PX, CA-ISO Isolated Consumer from producer of electricity –Retail price control –“Transition charge” to pay for “stranded assets” Increased utility risk bearing –Encouraged divesture of generating assets –Discouraged long term wholesale electricity contracts

Operational Capacity: California’s Three Utilities All Coal, Some Nuclear: Out of State Source: California Energy Commission

Operational Capacity: California’s Three Investor Owned Utilities Some Utility Owned: Out of State Source: California Energy Commission

California Electricity Opportunity turned into Risk Risk turned into Challenge Challenge turned into Crisis Crisis turned into Blight

California Electricity Use (Average MW) Source: California Energy Commission

Problem Was Not Because Californians Are “Energy Hogs” Source: Energy Information Administration; 1999 Data ItemCaliforniaAll US Monthly Average Residential Consumption of Electricity (Kwhr) California Relative to US 37% Below National Average Retail Price (cents per Kwhr) th Highest Average Monthly Residential Bill $59$71 17% Below National Average

Basic Market Forces )Demand for Electricity Increased a Bit More than Expected )Healthy California Economy )Growth of Electricity-intensive Products )Decline in the Retail Price of Electricity )Supply of Electricity Did Not Increase )Until Recently No New Generating Plants on Line )But Many in pipeline )Slow Regulatory Approval Process )Supplies from Pacific Northwest and Southwest Decreased ) Costs of Electricity Generation Increased )Prices of Natural Gas increased )Prices of NOx Prices skyrocketed under RECLAIM project

Pacific Gas & Electric Southern California Edison San Diego Gas & Electric

California Electricity Opportunity turned into Risk Risk turned into Challenge Challenge turned into Crisis Crisis turned into Blight

Day-ahead Prices in the PX

Limitations on Market Adjustment Processes )Normally, when demand increases faster than supply, prices rise. Price rises increase supply and decrease demand, thereby limiting further price increases. )This process cannot occur here )Supply cannot adjust upward once generators reach capacity. Capacity cannot increase quickly, especially with siting regulations. )Demand does not adjust normally )Retail price control insulates retail prices from wholesale prices )No time-of-use pricing which differentiates between high price times and low price times )Net result is high wholesale prices and shortages )Rolling blackouts are direct result of shortages

Source: California Energy Commission

Quantity of Electricity Price of Electricity Supply Function Demand Functions

Quantity of Electricity Price of Electricity Supply Function Demand Functions

Exercise of Market Power By Generators )Individual generators have much market power )They can hold back electricity supplies and cause prices to increase disproportionately )No demand response )Supply response of rivals very limited when rivals are at capacity )Market power would have decreased if much electricity were sold on long term contracts )But this was precluded by AB 1890

Quantity of Electricity Price of Electricity Supply Function Demand Functions

Average Daily Generating Capacity Offline Source: California Energy Commission

Source: California Energy Commission

Other Crisis Impacts Rolling Blackouts PG&E Bankruptcy Edison Electric Near Bankruptcy State Budgetary Surplus Eliminated

Retail vs Wholesale Electricity Prices (Estimates)

Class Discussion Possibility: Did California’s Retail Price Control Protect Consumers? )People of California paying entire wholesale cost 5Utilities Virtually Bankrupt; They are not paying this cost 5State Surplus is Being Spent (For a while, over $50 Million per day) 5State revenue bond sale would not avoid, but would simply delay payments. 5Failure to Raise Rates Simply Hides Costs )Higher retail prices provides incentives to reduce demand )Higher retail prices can increase supply 5Utilities collect more revenues and pay suppliers 5QFs could be fully paid and all can come back on line )Demand decreases and supply increases beneficial to consumers 5Reduce wholesale price 5Avoid rolling blackouts (shortages)

California Electricity Opportunity turned into Risk Risk turned into Challenge Challenge turned into Crisis Crisis turned into Blight

Bond Payments $13 Billion Bonds Proposed 15 Year Payments 4% to 5% Interest Annual Payment for Next 15 years: $1.2 Billion Per Year

Jan-06Jan-07Jan-08Jan-09Jan-10Jan-11 Time (months) $/MWhr Expected Price Range with $3 - $5 Gas

State Actions to Watch Buy transmission assets from utilities ? State Power Authority ? Acquire generating assets by eminent domain ? Elimination of Direct Access ?

Primary Lessons ) Don’t interpret as “deregulation doesn’t work” ) Electricity system restructuring that isolates the supply side of the market from the demand side can lead to disaster ) System structuring that does not allow appropriate risk sharing can lead to disaster ) Fundamental restructuring will invariably lead to errors 5 Legislature and the governor must monitor system and be prepared to take timely actions 5 Failure to take timely decisive actions can lead to disaster

Some Solutions

Energy Demand Reduction Measures ) Retail Price Increases ) Time-of-Use Metering ) Legislation to require companies to reduce use ) Incentives to replace inefficient refrigerators and other appliances ) Subsidies on compact fluorescent lights ) Public Energy Efficiency Investment ) LEDs in Traffic Lights ) Other Energy efficiency initiatives

Reductions In Use, 2001 Vs 2000 Source: California Energy Commission

Real Time Pricing ) Current system provides no incentive to move electricity loads from peak time to off peak time ) Time of Use Pricing, particularly real time pricing will provide that incentive ) California Legislature is providing for time of use pricing for large commercial users 5 How effective will this be in reducing peak demands? 5 Experience by other utilities, e.g. Puget Sound Public Utility District 5 Experience in other countries, e.g. France

Two Part Real Time Pricing

FERC Actions Bid Price Caps Initially Set During Stage 1, 2, or 3 Emergency Based on Index of Natural Gas Prices – Requirements to Bid – Market Clearing Price (MCP) Set by Highest Accepted Bid – Cost-Based Payments at Higher than MCP Last FERC Order – Keeps Bid Caps during Alerts – Adds Price Cap for all other times at 85% of MCP – Extends Controls to entire region, based primarily on California conditions Settlement Hearings for past wholesale prices – “Fair and Reasonable” Standard

Problem Solving For California’s Electricity System DON’T CHANGE IT DID YOU SAY IN PUBLIC YOU COULD FIX IT? DID YOU SAY IN PUBLIC YOU COULD FIX IT? DOES IT STILL FUNCTION? DOES IT STILL FUNCTION? YES NO YES YOU IDIOT ! NO DO THE POLLS LOOK BAD? DO THE POLLS LOOK BAD? NO PRETEND THERE IS NO PROBLEM HAS THE PRESS CAUGHT ON? HAS THE PRESS CAUGHT ON? YOU POOR BASTARD! YES NO HIDE IT CAN YOU BLAME EVERYONE ELSE? CAN YOU BLAME EVERYONE ELSE? NO THEN, THERE IS NO PROBLEM. YES