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Where'd All the Electricity/Money Go?

Discussion in 'Issues Around the World' started by Coot, Jan 15, 2003.

  1. Coot

    Coot Passed Away January 7, 2010

    The following is what created no small amount of furor here last night and this morning. The following as a substantial revision of something I wrote when the electricity crisis was in full swing in California. I had no idea the earlier draft was still available on the internet as it was on my personal space at earthlink. An account I had cancelled almost 2 years ago, yet they didn't delete the personal page. I have since contacted earthlink and the directory has deleted.




    <center>The Western U.S. Power Debacle</center>


    The Lay of the Land

    Any meaningful discussion of this situation requires a brief history to describe the situations and the players that brought the mess that will not die. While much of what has taken place centers on California, it is by no means a "California" only problem.

    The electrical grid for the Western U.S., Western Canada and Northern Mexico is common and completely interconnected. Prior to deregulation in California, the power industry was well aware of the balancing act that most of the Investor Owned Utilities (IOU's) were doing. Most of the U.S. states connected to the grid were not self sufficient in power production, with the exception of the lightly populated states. What the IOU's and the various municipal and other agencies in different states were doing was relying on seasonal and regional load patterns to keep everything going. For example, in the summer, the southernmost states with the larger population density were the largest users of electrical power, while in the winter, demand in the south would fall and demand in the Northwest would rise. The utilities and various power authorities knew that this scenario could forestall the building of new power plants until 2004 at the latest, provided there was adequate snow pack and water resources to keep the hydro plants, particularly in the Pacific Northwest, running somewhere above 65% output.

    In 1994, a turn of events began to unfold that would expose the achilles heel of the Western U.S. Power system and which held the potential to wreak havoc on the western states economies. In the 1994 regulated electrical market in California, consumers were paying about twice the rate for electricity as consumers in any of the other neighboring states. The majority of the state users were locked into purchasing electricity from the three predominant IOU's, Southern California Edison; Pacific Gas and Electric and San Diego Gas and Electric. The California Manufacturer's Association went to the California Public Utilities Commission and said, "We'd like to buy our electricity from Utah please".

    Now the way things were working politically in California circa 1994 was that the IOU's contributed heavily to Gubernatorial campaigns, the Governor would appoint the Public Utilities Commissioners and the Commission after much chest beating to demonstrate their independence would vote largely to give the IOU's what they asked for. All in all, a cozy little arrangement.

    Let the Cerebral Flatulence Begin

    In 1994, California had a governor with Presidential aspirations (Pete Wilson), who desperately needed some major press to get his campaign off the ground. That one little request from the California Manufacturer's Association started the clamor for electrical deregulation inside the halls of State government. Wilson brokered a deal between The Independent Power Producers and the IOU's. When the terms of deregulation were to the satisfaction of both the IPP's and the IOU's, John Bryson CEO of Southern California Edison, essentially dictated the terms of deregulation to State Senator Steve Peace. David Takameshi, an Edison lobbyist and previously Peace's Chief of Staff left Edison and returned to Peace's employ to pen the legislation.

    Peace, in as fine a display of scorched earth politics as has been witnessed in quite some time, ramrodded the legislation through both houses of the legislature without a single nay vote, and with much fanfare, Wilson signed it into law.

    It's 1996 and Things Are Starting To Smell

    As the brain flatulence wafted over Sacramento, it began oozing it's way over the western part of the continent. Under the terms of deregulation, a rate freeze was imposed for the customers of the three big IOU's. This was to protect the consumer from the vagaries of an untried market while it got its deregulated legs under it. Deregulation required that the IOU's divest themselves of a majority of their generation assets and provided them with a 'Competition Transition Charge' they collected from consumers. These CTC charges were to pay for the cost of "stranded assets". Stranded assets were essentially all of their previous bad investments and antiquated plants they couldn't sell. It was to net the IOU's nearly $30 billion.
    Deregulation also required that during the transition period, the utilities buy their power through the newly formed Power Exchange (PX), thusly prohibiting them from entering into more attractive long term contracts.

    What happened next should have sent shockwaves through the CPUC and the legislature; instead what we heard was a collective "Kewl". The power plants that the three IOU's were selling off were fetching 2-3 times their assumed market value from large energy companies. The reason being was that two-thirds of the state's power was being purchased through the PX. As the large energy companies assumed more and more control of the generation, it became very easier for them and their trading partners to game the market. They began withholding more and more power from the futures or day ahead market at the PX and selling more and more in the "Spot" market. By 1999, electricity that was costing from $29-$35 per megawatt to produce was selling at times for more than $1000 per megawatt in the summer market.

    This is about the time the energy traders were perfecting the strategies that would garner them unprecedented market power.

    The Rules of Acquisition

    During this time, the IOU's were busily transferring their CTC's and the profits from their generation divestiture into their parent companies to the extent that by the summer of 2000, the impending bankruptcy grumblings began. At this juncture, they are paying the extremely high market prices for power, and yet they have to sell it to the consumer under the rate freeze. Due to the out of whack market, the grid manager for California, the ISO or Independent System Operator (created under California Law but who is solely accountable to FERC the Federal Energy Regulatory Commission), capped (with FERCs blessing) the price on the PX at $250 per megawatt for power produced in California. By the time the price cap was introduced, the IOU's who had funneled some $20 billion in CTC's to their parent companies were upside down in the market some $8 billion. Prior to the rate cap, most of the traditional arrangements for the trading of power for regional/seasonal demand had all but broken down. To avoid the price cap, companies like Enron (by no means the largest player) were exporting power across state lines to dummy companies and then shipping it back to California on the spot market at nosebleed prices. Another favorite trick was to schedule bogus power onto the grid at peak times. What this would do is create predicted congestion. The congestion was simply scheduling more power across the lines than they were capable of carrying. The ISO, in response to the congestion would be required to do two things:

    1. Shutdown or throttle generation feeding onto the transmission system
    2. Pay the company that scheduled the excess bogus power not to put it onto the grid.

    This created artificial shortages and disrupted the regional trade of power.

    At this time, California had the only deregulated electrical market in the west. Neighboring states and privately held generation in California began withholding power until the market prices were obscenely high and then fixed their plants and jumped in. The city of Los Angeles with its municipal power company did likewise with its excess generating capacity. Kaiser Aluminum in Washington State found the California market so attractive they shut down their operations, laid off their workers and began selling the electricity they had purchased at low contract price from the Bonneville Power Authority into the California market. The ISO and FERC felt the only solution would be to cap prices which; they did in August of 2000.

    The price caps brought some temporary stability, but by fall, many of the plants in California were taken offline for traditional seasonal maintenance, but with no one scheduling maintenance between the different generators, excessive amounts of generation were offline at the same time. For the first time, California had insufficient resources to meet its much lower cool weather demand and was unable to sell into the still regulated markets in the neighboring northern states who normally counted on our excess capacity. By winter, with few generation resources online, and the Northwest hydro plants exhausted, FERC in its infinite wisdom, simply lifted the cap. Prices in the market immediately hit $1000 per megawatt. The IOU's, having funneled as much cash as possible to their parent companies, began threatening bankruptcy in earnest. Due to the downgraded creditworthiness of the IOU's, many generators began refusing to sell into the California market at all, even when ordered to do so by FERC. By the time the Public Utilities Commission relaxed the rules and allowed the IOU's to purchase on long term forward contracts, they couldn't find anyone willing sell to them for fear they wouldn't get paid.

    Wait, There's More

    Pacific Gas and Electric, which services the Central and Northern Parts of California, is as the name implies both an electric company and a gas company. Their state of insolvency had caused natural gas suppliers to refuse to sell to them and they began heavily drawing down their reserves to meet customer demand. Many of the power plants in the north have their own natural gas contracts with suppliers and use the PG&E pipeline for delivery.

    Under state law, should gas supplies become insufficient, the different gas companies are required to divert the gas to residential use. Under that threat, many generators simply quit producing electricity and sold off their gas deliveries that werent already injected into storage before they hit the inbound hub.

    While all of this was happening, El Paso Gas and El Paso Merchant, sister companies who controlled virtually all the gas pipeline into California, moved to restrict the pipeline so that even deliveries into the state were down by 15%end result was a 400% 2 month price spike in natural gas prices in the state. (Had I known then what I know now, I would have pursued litigation with Enron, as that was who we had contracted with for gas. They simply abrogated our contract and threw our account back onto SoCal Gas at market rates).

    Load Management Schemes

    California for many years has had an emergency electrical curtailment program in place that is two-tiered. One is load that is classified as "voluntarily interruptible" and the other is rolling blackouts. The voluntary interruptible load is handled by tariff and accounts for about 2500 megawatts of power. Large Industrial and Commercial users were offered contracts with attractive rates in exchange for their willingness to cutback to a pre-arranged level or in some cases to shutdown completely. These voluntary curtailments were seldom sought and only used in case of dire emergency: earthquake, spates of large generation breakdown or other short term difficulties. The summer of 2000 saw the ISO use this program as a resource and ordered shutdowns some 19 times, clearly outside of its intended purpose. Each November participants in the program either sign up for another year or are allowed to opt out. The Public Utilities Commission pre-empted the usual November opt out provision and froze these customers in their contracts.

    During the week of January 14th, 2001 the ISO had most of the manufacturing and a substantial amount of the commerce in the state shutdown up to 18 hours a day. Failure to comply with a shutdown order results in penalties that are equal to 100 times the customer's current rate for electricity. For a manufacturing facility using 5.5 MW, defying a 4 hour shutdown would cost somewhere in the neighborhood of $65,000 in penalties after adjustments for load profile are accounted for. You can't stay in business at those rates, and you can't stay in business if you can't produce. You can look at the interruption history for Southern California here. Each minor block is approximately 250 MW, and each minor block that is red is an interruption of service. Each interruption was between 4 and 6 hours. It is important to note that these are not the rolling blackouts that made so much publicity.

    Still Not Enough?

    Governor Joe Grayout Davis was busily accepting campaign contributions from Enron up until November of 2000. That should speak volumes to his inaction during the previous summer as well as the inaction of his Public Utilities Commission. When then President elect Bush commented on the situation, he so astutely said, California has a problem with their lawthey need to fix their law. Never mind that a goodly portion of the manipulation happened outside California and the state has no jurisdiction. Never mind the fact that Enron hadnt tanked yet and they were one of his heaviest contributors. Never mind the fact that when the Presidents portfolio went into blind trust, some of his heaviest holdings were companies that made out like gangbusters through all the manipulation.

    Curtis Hebert, who had been the only Republican member of the FERC during the Clinton years was in line for the chairmanship upon Mr Bush's inauguration and did in fact become the chair. However, the following summer, Mr. Hebert received a call from Ken Lay advising him that he could keep the chairmanship if he were willing to play ball with Enron on the deregulation issues. Mr. Hebert declined and was replace not long after as chairman by Pat Brown, a known Ken Lay lackey and former head of the Texas PUC under one GWB.

    California is still hampered by long term contracts that Joe Davis negotiated, with a gun that he himself helped hold to his head. To be sure, a number of businesses have picked up and left, and who knows how many more have refused to consider opening or expanding to this state due to this. The California economy is just behind that of Great Britain. The rest of the country should be catching a cold when California sneezes.
     
  2. ShinyTop

    ShinyTop I know what is right or wrong!

    Excellent guide to the debacle. Thank you again, Coot.
     
  3. Sierra Mike

    Sierra Mike The Dude Abides Staff Member

    Quite the scholarly work! I'm impressed, and wish to hire you as my ghost writer on future essays I might inflict upon this forum. my only criticism is that it could have benefited from some nudie pics...

    SM
     
  4. Robert Harris

    Robert Harris Passed Away Aug. 19, 2006

    So send him some of your animal porn for the next edition.
     
  5. Sierra Mike

    Sierra Mike The Dude Abides Staff Member

    No animal porn here, Robaire.

    SM
     
  6. Robert Harris

    Robert Harris Passed Away Aug. 19, 2006

    Too bad. Those utility execs sure behave like low-life animals, and deserve some special recognition...
     
  7. Robert Harris

    Robert Harris Passed Away Aug. 19, 2006

    Getting to a more serioos note.

    This case study serves as a reminder that government regulation can be quite beneficial. Indeed, many of the schemes of government regulation were adopted after industries in one way or another royally screwed the public.

    Deregulation has become a slogan, much loved by those who are anti-government in general, and is often assumed to be good in itself. But deregulation has done the most good in cases where the regulatory mechanisms were captured by the industries they were supposed to regulate, which turned them into vehicles for effectively creating cartels that could -- ta-da -- screw the publci. Cases in point, the airline industry and the trucking industry.

    In cases where the regulatory mechanisms have been captured to work for the benefit of an industry the industry folks strongly opposed it, knowing that deregulation would end their cozy cartel.

    A suggestion. Where a regulatd industry seeks and supports deregulation it is quite like4ly that the reguilation is effective and is protecting the public, and that ending it will open up opportunities for induatry to screw the public -- as in the above case.
     
  8. Coot

    Coot Passed Away January 7, 2010

    That's an excellent point. Electricity was regulated near the turn of the last century to mitigate abuses. As its use proliferated, utility companies sought to gain a stranglehold.

    The FERC, under Pat Brown's lead, is moving ahead with its Standard Market Design. Essentially, what the feds are trying to do with this is to own the transmission system throughout the country and effectively nullify the various state Public Utilities Commissions. Once that happens, a standard rate design would follow. This would essentially have parts of the country subsidizing electricity for other parts of the country...irrespective of how the power is produced and the native resources employed to produce it. The guys pushing for this are the energy companies and a few consumer groups...the people fighting this are the states, some consumer groups and the utility companies.

    Natural gas deregulation went fairly painlessly as supplies were abundant. Note that the strongest proponents of electricity deregulation are energy companies...ie, natural gas companies.

    This smooth ride with natural gas deregulation may be coming to an end though. Market volatility is becoming more and more the norm as supplies start to shrink. There is admittedly in excess of 60 Trillion cubic feet of the stuff sitting in the Alaskan oil fields. The oil companies just re-inject it back into the ground, sometimes using it to help force oil up.

    This is where the conundrum starts to develop. Wholesale gas prices are varying from $2.50/MMBTU in the summer to $4.00 or $4.50 in the winter. Sustained prices of $4.00 or so would make it just marginally attractive to build a pipeline for gas from Alaska down to the lower 48. However, just as soon as the gas arrives, the price would drop to about $2.50/MMBTU, effectively killing the return on investment. For the project to actually work and for a company to take it on would require sustained prices in the $6.00/MMBTU range to work.

    Destabilized energy prices aren't good for anyone, business or consumer. Soooo, do we insist that the pipeline be built with government subsidy? If we were to do that, how do we see to it that the government's (our) investment is repaid? Or is the payback we get for this task simply the stabilizing of energy prices?
     
  9. Robert Harris

    Robert Harris Passed Away Aug. 19, 2006

    Do not expect any creative thought or help from Washington on these matters. Mr. Bush will defer to Mr. Cheney who will defer to the affected industry executives. And the public be damned.
     
  10. Coriolis

    Coriolis Bob's your uncle

    Coot -- a very compelling read. This is mind boggling stuff, to say the least.

    The very fact that every single Democrat and Republican in the California state Legislature voted in favor of the deregulation law is of some interest. Was Kenneth Lay sitting at the table?

    Some <A HREF="http://www.consumerwatchdog.org/utilities/">supplemental reading on the topic</A> appears to concur with your analysis. The deregulation law is rife with loopholes, which one could argue were put in place for rampant misuse and abuse by energy traders. Whose pockets were being padded in the state legislature, I wonder. The public utilities companies clearly saw this as a perfect get rich quick scheme. Freezing consumer rates at higher than national average, and then making the consumer pay for their heavily debted nuclear power plants, these so-called "stranded assets"! The utility companies were then free to play the spot market, and rake in the big bucks.

    Of course, the promise was to lower costs to the consumer in the long run, by encouraging competeition to drive down prices, but it didn't work. Why? The energy industry is quick to say "It's those damn environmentalists blocking new power plant construction", and of course who could have predicted El Nino?

    Ah! The best laid plans of mice and men.

    Or, was it even supposed to work? History has shown, time and time again, that greed is fairly shortsighted, with little regard for future consequences.
     
  11. yazdzik

    yazdzik Veteran Member

    Dear Friends,
    My wife traded the energy sector in equities, and, this is the most compelling read, and, the most frightening read, as the implications are more profound, on the whole, than the oil situation in Iraq or Venezuela.
    The information is accurate, and, any of you following the OSX, which for obvious reasons Naomi no longer trades, can see that the volatility is as dangerous to the major energy providers, their employees and shareholders, as the public at large, and that is very dangerous indeed. Looking only at the betas of the equities underlying the drillers, one can see the futures traders, those whose swings create the swings in the equities, and so forth, are creating a market the likes of which has not been seen since the eighteen nineties.
    The implication of Coot's post, and let its golden writing not distract us from its horrifying content, is that the volatility will result, as a logical consequence of equity loss by futures traders, equities traders, and long term shareholders and debt holders, create a decline in supply, not because of resource scarcity, but resource allocation.
    There is as yet, at least as far as I can read, no sufficiently developed model for the inflationary consequences of a redistribution of the magnitude that would occur if, for example, the Standard Market Design were to become a static reality, or, were a natural gas pipeline from Alaska to be built.
    HAL, SII, WFT, and friends would change, either becoming immensely more profitable, thus moving the risk somewhere else, like the pink spot of Dr Seuss, or the fluctuations in the delivery system would create futures trader millionaires, like the .com kings, with the attendant bubble, or, at some point, in order to even things out, we would all pay southern summer, northern winter energy prices year round.
    Looking at energy price inflation over the last ten years, no one has yet been able to described the benefit or detriment of real energy price inflation, in an economy of real growth. Suffice it to say, that unparalleled swings will result in unpredictable monetary expansion and contraction, and, as we learnt a bit back, for every short selling millionaire, there are thousands unemployed, and interest rates so deflationary as to induce the depression they were intended to avoid.
    Great post, lousy situation.

    All good wishes,
    Yazdzik
     
  12. Coot

    Coot Passed Away January 7, 2010

    Martin, you make excellent points. The FERC is attempting a substantial balancing act on the one hand, as Californians are owed substantial monies due to the obfuscation. Monies that the various energy companies could have likely paid had Enron not brought down the house of cards. As it stands now, and largely due to Enron and the companies' own complicity in the rigging, most of these companies have seen their stock values take serious hits. As large as Enron was, it wasn't a particularly big fish in this venue of the energy sector. Enron was a trader, and as such had limited exposure to potential risk.

    What Enron did, was parlay that limited risk, along with daring and bold moves, into a position of leadership. Enron was the darling of Wall Street only becuase they, with the complicity of their accountants and government, ran the ultimate shell game without a pea.

    So, how does the FERC move in order to fulfill their legal mandate to the public and still not destroy the remaining energy companies whose actions were so atrocious? Obviously their functions are absolutely mandatory.

    When I wrote the original piece that was earlier linked, much of the puzzle pieces weren't in play, and I had to make inferences, many of which were not substantiated, for I underestimated the lengths and degrees all of the players in this were willing to go. This updated post reflects several points that were largely unknowable at the time, or were so horrific that it was an affront to my way of thinking and experience in the industry that it was originally unimagineable.

    The unfolding of events in this situation has sufficiently colored my perspective to the point that I consider the governor of my state, the legislature and much of the federal government to be guilty of treason.

    The actions of none of the participants can be legally justified. The actions of all the participants is legally actionable. The only reason that no one is bringing any meaningful charges is that the people responsible for bringing these charges are the very same people responsible for the mess.

    Perhaps the correct government model is one wherein the watchdogs have no legal authority, but rather they turn their findings over to a judicial authority without ties to the problem.
     
  13. EMIG

    EMIG Yup

    And Davis was re-elected. Dubya probably will be also. Shakes my faith in Democracy.
     

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