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

Investigate cause

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

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)

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

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.

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.

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

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

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

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”

Proposals

• Price caps, soft and hard

• Voluntary/compulsory forward contracts

• Re-regulation of prices

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.

2001

• Some suppliers would not sell, increasing emergency

• FERC and generators in mediation. FERC claimed $9 bill. Generators offered $1 bill.

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.

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.

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.