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California electricity crisis

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The California electricity crisis (also known as the Western Energy Crisis) of 2000 and 2001 followed a failed partial-deregulation, in 1996, of the electricity market in the state. The energy crisis was characterised by a combination of extremely high prices and rolling blackouts. Price instability and spikes lasted from May 2000 to September 2001. Rolling blackouts began in June 2000 and recurred several times in the following 12 months.

Chronology [#endnote_timeline]
1996 California begins to loosen controls on its energy market and takes measures to increase competition.
April 1998 Spot market for energy begins operation.
May 2000 Significant energy price rises.
June 14, 2000 Blackouts affect 97,000 customers in San Francisco Bay area.
August 2000 San Diego Gas & Electric Company files a complaint alleging manipulation of the markets.
January 17-18, 2001 Blackouts affect several hundred thousand customers.
January 17, 2001 Governor Davis declares a state of emergency.
March 19-20, 2001 Blackouts affect 1.5 million customers.
April 2001 Pacific Gas & Electric Co. files for bankruptcy.
May 7-8, 2001 Blackouts affect upwards of 167,000 customers.
September 2001 Energy prices normalize.
December 2001 Following the bankruptcy of Enron, it is alleged that energy prices were manipulated by Enron.
February 2002 Federal Energy Regulatory Commission begins investigation of Enron's involvement.
Winter 2002 The Enron Tapes scandal begins to surface.
November 13, 2003 Governor Davis ends the state of emergency.

Contents

Causes

Controversy

There has been considerable controversy over whether the energy crisis was the result of natural swings of supply and demand coupled with an incomplete (and thus imperfect) attempt at energy deregulation or of malicious manipulation of the market by several companies. Controversy has been especially strong because these issues have been perceived to link up to wider moral and political issues such as the rightness of market deregulation itself.

On one side of the debate, Susan Pope writes of the cause as "a perfect storm, in which a number of unfavorable demand/supply events improbably coincided, leading to increases in electricity prices".[#endnote_pope] The Enron Tapes, while shocking, show that companies were attempting to manipulate the market during this "perfect storm", but only a detailed investigation could show that these attempts succeeded. Even then, the issue remains as to what proportion of the crisis can be attributed to the "perfect storm" and what proportion to market manipulation.

The Federal Energy Regulatory Commission concluded in 2003:[#endnote_ferc_conc]

"...supply-demand imbalance, flawed market design and inconsistent rules made possible significant market manipulation as delineated in final investigation report. Without underlying market dysfunction, attempts to manipulate the market would not be successful."
"...many trading strategies employed by Enron and other companies violated the anti-gaming provisions..."
"Electricity prices in California’s spot markets were affected by economic withholding and inflated price bidding, in violation of tariff anti-gaming provisions."

Supply and demand

In the 1970's, California had decided to end the development of nuclear energy. Following this decision, California failed to develop sufficient in-state electricity generation capacity and came to depend in part on the import of excess hydroelectricity from the Pacific Northwest states of Oregon and Washington. Legislation relating to clean air standards resulted in in-state electricity generation depending on natural gas, which linked together the gas and electricity markets. Rapid growth in demand for electricity, resulting from strong economic growth, ate into any excess capacity remaining in the system. In the summer of 2000 two events combined to worsen the situation: a drought in the North West states, and a large increase in the price of natural gas.

Regulation and deregulation

The deregulation of the California energy market was supported by both parties in the California legislature and signed into law by then-Governor Pete Wilson in 1996. Then-state senator Steve Peace was the chair of the energy committee and the author of the bill that caused deregulation, and is often credited as "the father of deregulation".

Part of California's deregulation process, which was promoted as a means of increasing competition, involved the partial divestiture in March 1998 of electricity generation stations by the incumbent utilities, who were still responsible for electricity distribution and were competing with independents in the retail market. A total of 40% of installed capacity - 20,164 megawatts - was sold to what were called "independent power producers." These included Mirant, Reliant, Williams, Dynegy, and AES.

Then, in 2000, wholesale prices were deregulated, but retail prices were regulated for the incumbents as part of a deal with the regulator, allowing the new power producers to recover the cost of assets that would be stranded as a result of greater competition.

When electricity wholesale prices exceeded retail prices, end user demand was unaffected, but the incumbent utility companies still had to purchase power, albeit at a loss. This allowed independent producers to manipulate prices in the electricity market by withholding electricity generation, arbitraging the price between internal generation and imported (interstate) power, and causing artificial transmission constraints. This was a procedure referred to as "gaming the market." In economic terms, the incumbents who were still subject to retail price caps were faced with inelastic demand. They were unable to pass the higher prices on to consumers without approval from the public utilities commission. The affected incumbents were Southern California Edison (SCE) and Pacific Gas & Electric (PG&E). Pro-privatization advocates insist the cause of the problem was that the regulator still held too much control over the market, and true market processes were stymied — whereas opponents of deregulation simply assert that the fully regulated system had worked perfectly well for 40 years, and that deregulation created an opportunity for unscrupulous speculators to wreck a viable system.

Prior to deregulation, the electricity market in California was largely in private hands. The main players were PG&E, SCE, and San Diego Gas and Electric (SDG&E). The problems arose from an inefficient deregulation of the market. Ownership of certain power stations was transferred in order to increase competition in the wholesale market. In return for divesting some of their power stations the major utilities negotiated a deal to protect them from their assets being stranded. Part of this deal involved price caps for retail customers.

Market manipulation

As the FERC report concluded, market manipulation was only possible as a result of the complex market design produced by the process of partial deregulation. Manipulation strategies were known to energy traders under names such as "Fat Boy", "Death Star", "Forney Perpetual Loop", "Ricochet", "Ping Pong", "Black Widow", "Big Foot", "Red Congo", "Cong Catcher" and "Get Shorty".[#endnote_deathstar] Some of these have been extensively investigated and described in reports.

Megawatt laundering is the term, analogous to money laundering, coined to describe the process of obscuring the true origins of specific quantities of electricity being sold on the energy market. The California energy market allowed for price distinctions between electricity produced in-state and out-of-state. It was therefore advantageous to make it appear that electricity was being generated somewhere other than its true origin.

Overscheduling is a term used in describing the manipulation of transporting electricity along power lines. Power lines have a defined maximum load. Lines must be booked (or scheduled) in advance for transporting bought-and-sold quantities of electricity. "Overscheduling" means a deliberate reservation of more line usage than is actually required and can create the appearance that the power lines are congested. Overscheduling was one of the building blocks of a number of scams. For example, the Death Star group of scams played on the market rules which required the state to pay "congestion fees" to alleviate congestion on major power lines. "Congestion fees" were a variety of financial incentives aimed at ensuring power providers solved the congestion problem. But in the Death Star scenario, the congestion was entirely illusory and the congestion fees would therefore simply increase profits.

In a letter sent from David Fabian to Senator Boxer in 2002, it was alleged that:

"There is a single connection between northern and southern California's power grids. I heard that Enron traders purposely overbooked that line, then caused others to need it. Next, by California's free-market rules, Enron was allowed to price-gouge at will."[#endnote_fabian]

Consequences of wholesale price rises on the retail market

As a result of the actions of electricity wholesalers, Southern California Edison (SCE) and Pacific Gas & Electric (PG&E) were buying from a spot market at very high prices but were unable to raise retail rates. PG&E and SoCalEd had racked up $20 Billion in debt by Spring of 2001 (PG&E declared bankruptcy in April of that year), and their credit ratings were reduced to junk status. The financial crisis meant that PG&E and SoCalEd were unable to purchase power on behalf of their customers. The state stepped in on January 17 2001, having the California Department of Water Resources buy power. By February 1 2001 this stop-gap measure had been extended and would also include SDG&E. It would not be until January 1 2003 that the utilities would resume procuring power for their customers.

Between 2000 and 2001, the combined California utilities laid off 1,300 workers, from 56,000 to 54,700, in an effort to remain solvent. San Diego had worked through the stranded asset provision and was in a position to increase prices to reflect the spot market. Small businesses were badly affected.

The involvement of Enron

One of the energy wholesalers that became notorious for "gaming the market" and reaping huge speculative profits was Enron Corporation. Enron CEO Ken Lay mocked the efforts by the California State government to thwart the practices of the energy wholesalers, saying, "In the final analysis, it doesn't matter what you crazy people in California do, because I got smart guys who can always figure out how to make money."[#endnote_lay]

S. David Freeman, who was appointed Chair of the California Power Authority in the midst of the crisis, made the following statements about Enron's involvement in [testimony] submitted before the Subcommittee on Consumer Affairs, Foreign Commerce and Tourism of the Senate Committee on Commerce, Science and Transportation on May 15, 2002:

"There is one fundamental lesson we must learn from this experience: electricity is really different from everything else. It cannot be stored, it cannot be seen, and we cannot do without it, which makes opportunities to take advantage of a deregulated market endless. It is a public good that must be protected from private abuse. If Murphy’s Law were written for a market approach to electricity, then the law would state “any system that can be gamed, will be gamed, and at the worst possible time.” And a market approach for electricity is inherently gameable. Never again can we allow private interests to create artificial or even real shortages and to be in control."
"Enron stood for secrecy and a lack of responsibility. In electric power, we must have openness and companies that are responsible for keeping the lights on. We need to go back to companies that own power plants with clear responsibilities for selling real power under long-term contracts. There is no place for companies like Enron that own the equivalent of an electronic telephone book and game the system to extract an unnecessary middleman’s profits. Companies with power plants can compete for contracts to provide the bulk of our power at reasonable prices that reflect costs. People say that Governor Davis has been vindicated by the Enron confession."
Enron eventually went bankrupt, and signed a $1.52 billion settlement with a group of California agencies and private utilities on July 16, 2005. However, due to its other bankruptcy obligations, only $202 million of this was expected to be paid. Ken Lay was convicted of multiple criminal charges unrelated to the California energy crisis on May 25, 2006, but passed away in July of that year before he could be sentenced.

Handling of the crisis

Governor Gray Davis

Perhaps the heaviest point of controversy is the question of blame for the California electricity crisis. Former Governor Gray Davis' critics often charge that he did not respond properly to the crisis, while his defenders attribute the crisis solely to the corporate accounting scandals and say that Davis did all he could.

In a speech at UCLA on August 19, 2003, Davis apologized for being slow to act during the energy crisis, but then forcefully attacked the Houston-based energy suppliers: "I inherited the energy deregulation scheme which put us all at the mercy of the big energy producers. We got no help from the Federal government. In fact, when I was fighting Enron and the other energy companies, these same companies were sitting down with Vice President Cheney to draft a national energy strategy."

Signs of trouble first cropped up in the spring of 2000 when electricity bills skyrocketed for customers in San Diego, the first area of the state to deregulate. Experts warned of an impending energy crisis, but Governor Davis did little to respond until the crisis became statewide that summer. Davis would issue a state of emergency on January 17, 2001, when wholesale electricity prices hit new highs and the state began issuing rolling blackouts.

Some critics on the left, such as Arianna Huffington, alleged that Davis was lulled to inaction by campaign contributions from energy producers. [link] Meanwhile, conservatives argued that Davis signed overpriced energy contracts, employed incompetent negotiators, and refused to allow prices to rise for residences statewide much like they did in San Diego, which they argue could have given Davis more leverage against the energy traders and encouraged more conservation. [link]

The crisis, and the subsequent government intervention, have had political ramifications, and is regarded as one of the major contributing factors to the 2003 recall election of Governor Davis.

On November 13, 2003, shortly before leaving office, Davis officially brought the energy crisis to an end by issuing a proclamation ending the state of emergency he declared on January 17, 2001. The state of emergency allowed the state to buy electricity for the financially strapped utility companies. The emergency authority allowed Davis to order the California Energy Commission to streamline the application process for new power plants. During that time, California issued licenses to 38 new power plants, amounting to 14,365 megawatts of electricity production when completed.

On May 24 2001, future governor Arnold Schwarzenegger and former Los Angeles Mayor Richard Riordan met with Enron CEO Ken Lay, at the Peninsula Hotel in Beverly Hills, at a meeting convened for Enron to present its "Comprehensive Solution for California," which called for an end to Federal and state investigations into Enron's role in the California energy crisis.

In September 2003, Schwarzenegger was elected Governor of California to replace Governor Davis.

National Energy Development Task Force

Vice President Dick Cheney was appointed in January, 2001 to head the National Energy Development Task Force. In the Spring of that year, officials of the Los Angeles Department of Water and Power met with the Task Force, asking for price controls to protect consumers. The Task Force refused, and insisted that deregulation must remain in place.

Federal Energy Regulatory Commission

The Federal Energy Regulatory Commission (FERC) was intimately involved with the handling of the crisis from the summer of 2000. There were in fact three separate FERC investigations.[#endnote_ferc]

As of January 2006, the refund case is ongoing.

References

  1. ↑  Sources for the chronology include: [Federal Energy Regulatory Commission Chronology], [ERisk.com's The California Energy Crisis 2000-2001],[FrontLine's California Crisis Timeline]
  2. ↑  Susan L. Pope, "[California Electricity Price Spikes: An Update on the Facts]" (Sept 12, 2002), p.1
  3. ↑  [FERC Summary of findings]
  4. ↑  [Congestion Manipulation "DeathStar"], McCullough Research (June 5, 2002)
  5. ↑  Letter from David Fabian to Senator Boxer, February 13, 2002, p.1, quoted in [Congestion Manipulation "DeathStar"], McCullough Research (June 5, 2002) at p.4.
  6. ↑  Widely quoted statement; e.g.: The original statement was made in a phone conversation between David Freeman (Chairman of the California Power Authority) and Kenneth Lay (CEO of Enron) in 2000, according to the statements made by Freeman to the Senate Subcommittee on Consumer Affairs, Foreign Commerce and Tourism in [April] and [May] 2002.
  7. ↑  [Summary of FERC documentation relating to the Western Energy Crisis 2000-2001]

See also

External links

 

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