e 22 p8 energy the california crisis
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Special Presentation
The California Crisis and the Enron Debacle
Will Deregulation Survive?
IEEE
Luiz Maurer
São Paulo, SP
March 22, 2002
Deregulation of power sector in 2001
Focus of this presentation
California and Enron in a snapshot
Enron involvement in the California crisis
Can we blame it on deregulation?
Have deregulation and Enron created any value?
Relevance of this discussion to Brazil
In conclusion
AGENDA
DEREGULATION OF THE POWER SECTOR IN 2001
DEREGULATION OF THE POWER SECTOR HAD MANY SETBACKS IN 2001
California crisis
Enron collapse
Spillover effects on perceived “Enronites” – e.g. Calpine, losing US$ 2 billion
PG&E bankruptcy in San Francisco
Energy shortage in Brazil
VERDICT HAS BEEN SIMPLE: BLAME IT ON DEREGULATION
“Deregulation is a failed experiment” California, first state to fully introduce
wholesale + retail competition – was also the first one to fail
Enron, the champion of deregulation, following a death spiral which led to Chapter 11
Therefore: General skepticism from the public PUCs delaying retail competition FERC more prudent in setting up RTOs More discussions on how electricity should be
traded, transmitted and paid for
WHICH RAISES SEVERAL GENUINE QUESTIONS
Why did those things happen? Points in common?
Could it happen again and again? Is deregulation something evil? What are the alternatives? Go back to the old good days of cost plus
regulation and central planning? Should states put an end on customer
choice?
FOCUS OF THIS PRESENTATION
FOCUS OF THIS PRESENTATIONWHAT IS COVERED WHAT IS NOT COVERED
Competition in power generation
Other industry dynamics and deregulation
Market based prices New accounting rulesReduced barriers to entry New disclosure
requirementsSecond stage: retail competition and customer choice
Regulation in energy derivatives
Contestable provision of electric services
Pension fund regulations (401k)
How to make market forces work: design of power pools
Stock options and executive compensation regulations
CALIFORNIA AND ENRON IN A SNAPSHOT
CALIFORNIA IN A SNAPSHOT Started full deregulation in 1996 First problems in 2000 – price spikes directly
affecting customers, reflecting supply-demand mismatches and T constraints
Winter widespread rolling black-outs Financial distress imposed on utilities, forced to
buy on a spot basis Finger pointing – Enron as the scapegoat -
personal issue between Mr. Gravis and Mr. Lay Proposed solutions: State role as a buyer Last season – problem mitigated, with customer
response and [stranded] contracts (?) Discussions on US$ 9 bi refund from cowboys
ENRON IN A SNAPSHOT (I) Reported losses in October, with significant
write-offs Raised investment community eyebrows, but
explanations far from convincing SEC investigation – need to report retroactively Stock prices declining, triggering clauses of
financial derivatives Cash badly needed, stocks in a death spiral Frustrated attempt to merge with Dynegy Chapter 11 filing in early December, followed
by massive corporate layoffs
ENRON IN A SNAPSHOT (II) Frustrated attempt to sell trading floor and EOL at
a large premium Class actions, Congress hearings, Powers Report Scandals of all sorts, particularly related to special
entities and Enron CFO Key executives and board members fired AA – criminal charges for obstruction of justice Investigations on the way and will continue for
months to come After all, the largest bankruptcy in America
ENRON INVOLVEMENT IN THE CALIFORNIA CRISIS
ENRON IS PERCIEVED AS A SCAPEGOAT IN THE CALIFORNIA CRISIS
The most active proponent on deregulation Learned the “tricks of the trade” to manipulate
the wholesale market Making money on gas and electricity – and
created artificial constraints Not the only one – but played a leading role Strong proponent on no caps on spot prices Gov. Davis: Where do I go to get my money
back?
ENRON DOES NOT DESERVE THE BLAME
Does not own generation facilities (except wind) If claimed refund had merits -- < 0.5% 1994 Hearings – warning that the proposed
system would be capricious and lead to high pricing
State rejected Enron’s offer of long term power in 2001; later, sold to state at prices lower than average (US$ 181/MWh vs. US$ 243/MWh)
Intrastate pipelines are filled to capacity – 5,530 mcf versus 6,150 mcf entering the state
Enron is a net buyer – indeed to receive refund And a lot of high prices reflect scarcity in supply
or T constraints
CAN WE BLAME IT ON DEREGULATION?
CALIFORNIA IS NOT DEREGULATION Several design problems – some anticipated D/Cs not allowed to sign long term contracts And were exposed to spot price volatility But in most cases consumer rates frozen,
creating imbalances for D/Cs, and financial distress
In places where rates reflected spot prices, lack of hourly metering did not help in peak shaving
Extremely complex market design – some rules conducive to price gouging
ISO stakeholder board not capable to change Usually referred as a “botched deregulation”
ONE CAN NOT HONESTLY BLAME ON DEREGULATION FOR ENRON’S DEMISE “Trading Natural gas and electricity, the core
businesses, were solid ventures on deregulated markets” – from nothing in 94 to 900 TWh now
Many failed attempts to enter into new regulated businesses, mostly overseas
No modesty to admit they had different KSFs with diverse industry dynamics
Bulk of non-core assets under-performing – “less than decent rates of return”
Even decent rates of return would not have satisfied investors appetite – based on expected P/E ratios
“Company managed to hide from investors and regulators its bad management and possibly corruption by shamelessly promoting its image”
HAVE ENRON AND DEREGULATION CREATED ANY
VALUE TO SOCIETY?
“ENRON WAS MOSTLY RIGHT ABOUT ONE THING: DEREGULATION”
“Moving aggressively, it became the largest trader of electricity and gas derivatives
Enron had real insight into the role of new types of securities in deregulated power markets
Enron’s actions, while self-serving, were generally good for the economy as a whole
The company promoted greater competition in electric power. Enron battled against entrenched state and local electric power companies that opposed deregulation to preserve their monopolies
Enron’s total expenditures on political influence were tiny compared with the potential benefits to consumers from competition”
“TESTAMENT TO THE FLEXIBILITY OF THE U.S. ENERGY MARKET” “Enron could fail without disrupting gas or electric
supplies” There were no price spikes, electricity outages Enron’s trading functions immediately assumed by
others “Part of the reason the markets adjusted so
smoothly to the Enron collapse was the liquidity and risk allocation provided by the wholesale markets Enron had helped create”
For most regions of the US, there is significant market liquidity with multiple buyers and sellers meeting consumer needs
DEREGULATION HAS BROUGHT SIGNIFICANT BENEFITS TO US CONSUMERS Recent study by Boston Pacific Co. indicates that
1985-99 adjusted prices declined on average by 30% for residential and 36% for large customers
Despite not being the sole factor, large prices decreased occurred when competitive pressure was greatest
Recent study from the US Federal Trade Commission indicates that retail marketing is in a transition period
“In this hybrid environment of regulation and competition, many of the expected benefits have not emerged …
Nothing that has happened so far indicates that competition will not produce additional benefits to electricity customers”
AND THERE ARE MANY SUCCESS STORIES OUTSIDE OF CALIFORNIA AND ENRON
Well functioning power pools in the US do not receive the same publicity as California PJM – considered one of the most dynamic New York New England MISO
55.000 MW installed last year mostly in competitive environments
Other countries/regions have also developed vibrant markets Europe – Nordic countries, UK Australia, New Zealand Argentina
RELEVANCE OF THIS DISCUSSION TO BRAZIL
Embarked on a restructuring program in 1998, towards privatization and deregulation
Alleged lack of incentives for expansion leading to a major rationing crisis
State companies not allowed to expand; private sector not comfortable with risks entailed by the new model
Supply demand imbalance, lack of investments, drought, demand growth, environmental problems, transmission constraints, etc.
On the surface, it bears a strong resemblance to California
Point in common: deregulation
ONE WAY OF TELLING THE STORY
Model designed for Brazil is significantly different from California’s (Appendix)
Most reasonable observers agree that Brazilian reform is half-way through
The issue hinges on implementation, not design It is widely known that some incentives are not in
place, or still entail significant risks to investors – e.g. VN, FX, D/Cs willingness to sign PPAs
Less conspicuous but probably more important – penalties for under contracting Penalty is MAE price exposure This assumes that contracts among consenting
adults will be honored, with no bail-outs Rationing illustrated how sensitive the subject is
THE FLIP SIDE OF THE COIN
The way the rationing program was designed illustrates how market forces may help allocate a scarce resource
Quota system with penalties for those who exceeded this baseline – or bonuses for low income consumers
Penalties linked to MAE price – to avoid the California effect and affect utilities’ finances
Large clients allowed to exchange quotas 9 months of rationing with minor black-outs Recognized as a success story. Brazil saved US$ 10
billion by avoiding rolling black-outs Demonstrable possibility to leverage demand elasticity Customer choice created more appetite for retail
competition, to be introduced in 2003
THERE ARE SUCCESS STORIES ON THE USE OF MARKET FORCES
IN CONCLUSION
For many, California should not be called deregulation – it is a “botched” re-regulation
Deregulation did not kill Enron – the deadweight of regulated businesses did – but no excuses to actions of management
Not fair to blame on Enron for California crisis Enron collapse suggests need for greater financial and
pension fund regulation – but never back to the old days of cost plus regulation in the power sector
Deregulation, particularly in the wholesale market, has worked in many countries/regions and has brought many benefits to customers
There are also good lessons to be learned when designing wholesale and retail competition
Brazil may leverage on those and on the lessons drawn from the market-based rationing program
IT IS NOT FAIR TO BLAME IT ON DEREGULATION
APPENDIX
DEREGULATION MODELS
IN BRAZIL AND CALIFORNIA
DEREGULATION MODELS IN BRAZIL AND CALIFORNIA
BRAZIL
(DURING INITIAL CONTRACTS = CI’s)
CALIFORNIA
RATIONALE CONTRACT AS THE BASIS FOR COMPETITION
CONTRACT PROXY FOR RE VERTICALIZATION
IMPLEMENTATION HALF-WAY THROUGH IMPLEMENTED LEVEL OF CONTRACTING FOR LSE
HIGH MANDATORY
VIRTUALLY NILL HIGHLY RESTRICTED
COMPLEXITY OF WHOLESALE MARKET
LOW – ONE PRODUCT (MWh)
EX-ANTE DECLARATIONS LONG TERM CONTRACTS
FOR ANCILLARY SERVICES
HIGH – SEVERAL PRODUCTS BOTH EX-ANTE AND REAL TIME
DECLARATIONS ANCILLARY SERVICES
PROCURED REAL TIME
ENERGY COST PASS-THROUGH
RESTRICT TO VN SAME FOR SPOT
PURCHASES
TOTAL, AFTER RECOVERY OF STRANDED COSTS
UNCERTAIN BEFORE NATURE OF SHORTAGE AND MARKET POWER
HIGH PEAKING CAPABILITY – LACKING “FUEL”
MINIMAL UNDER TIGHT POOL REGIME
VERY LOW DURING INITIAL CONTRACTS
BASICALLY SHORT ON CAPACITY (PEAK MW)
ALLEGED AS HIGH FOR G “THIN” MARKET FOR
ANCILLARY SERVICES
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