From the perspective of the Northwest, this paper addresses the electricity crisis currently besetting the entire West. The first section describes where we are, and where we are headed if effective action is not taken. The second section describes how we got here, so that we understand the sources of the problem we are trying to solve. The third section describes potential solutions.
I. Where are we, and where are we headed?
Two of California's three investor-owned utilities, Pacific Gas & Electric (PG&E) and Southern California Edison (SCE), have been on the verge of bankruptcy since January. They are currently unable to pay the $12 billion that they owe electricity suppliers.
This debt arose because of a huge gap between the price of power on the wholesale spot market and the price that the utilities are allowed to charge their retail customers by the California Public Utility Commission (CPUC). The CPUC increased retail rates by between 7 and 14 percent (depending on customer group) in January, but this was not nearly enough to close the gap. In fact, the increase merely negated a 10 percent rate decrease that was mandated by the state legislature when it initiated its restructuring effort in 1996.
California Governor Gray Davis has steadfastly argued that additional rate increases would trigger an initiative to rollback the increase. He has also blocked the efforts of the utilities to enter into long-term power contracts at rates far below the spot market price, on the grounds that the contract price should be even lower. With the spot market ranging from 15-100 cents per kilowatt/hour, Davis proposed in January that five-year contracts be in the 5 to 5.5 cent range. The suppliers reportedly responded with numbers in the 7 to 8 cent range.
For over two months, intense discussions showed no progress. This was at least partly due to Governor Davis' extremely strident approach toward the suppliers, repeatedly railing against "out-of-state profiteers." For example, in his January 8 State of the State address, he said that: "Never again can we allow out-of-state profiteers to hold California hostage." He proposed to make it a crime to deliberately withhold power, and asked the legislature for 50 new inspectors to stand guard at any generation facility suspected of doing so.
With talks at an impasse, and the utilities continuing to lose billions, Davis changed direction. At his behest, legislation was passed that inserts the State of California - through its Department of Water Resources (DWR) - as the buyer of power on behalf of the utilities. To provide the money to perform this role, the state will be issuing billions of dollars of bonds. To date, California has already spent over $2 billion on electricity.
On March 5, Davis announced that the DWR has entered into 40 power purchase contracts, varying in length from four months to 10 years. According to a report in Megawatt Daily, the average price of the deals is 6.9 cents over the 10-year period. For the first five years, the average price will be 7.9 cents, dropping to 6.1 cents for the second five years. This is substantially above Davis' original target price, and close to the price that the suppliers were willing to agree to with the utilities directly.
In making the announcement, Davis said that: "With these deals in place, California's energy future is looking a whole lot brighter." But his optimism appears unfounded. At his news conference, Davis conceded that these contracts cover only between 65 and 70 percent of the state's power needs for this summer. Even if Californians meet Davis' goal of conserving 10 percent, that still leaves 20-25 percent to be purchased on the spot market, which is expected to remain very high.
Meanwhile, negotiations are also underway regarding how to keep the utilities out of bankruptcy by giving them some reasonable prospect of being able to pay the $12 billion. Instead of raising retail rates, Davis' answer is that the state should buy the 32,000 miles of high-voltage transmission lines owned by the utilities. In late February, he struck a tentative deal to buy the SCE portion of the grid for $2.76 billion, and he's working on a similar deal with PG&E. The utilities could then use the revenues from the sales to restructure their debt.
Transfer of transmission ownership from the utilities to the State of California requires the approval of the Federal Energy Regulatory Commission (FERC), which is anything but certain. FERC Chair Curt Hebert has said that the sale would amount to "nationalization," and may not meet the statutory requirement that it be in the public interest. Because publicly-owned bodies are not subject to FERC jurisdiction, transfer of the California transmission system to the State would remove it from FERC oversight, a fact that is likely to concern the entire Commission.
The Northwest has helped California in two ways. First, Northwest suppliers, including BPA, are among those that sold power to the California utilities last Fall, even as the California utilities' financial condition was deteriorating. As the debts mounted, some suppliers raised concerns in December about whether they would be paid. In response, the Secretary of Energy Richardson ordered the suppliers on December 14 to continue selling their excess electricity to California. After several extensions of the order in the closing days of the Clinton Administration and the opening days of the Bush Administration, President Bush directed Secretary Abraham to allow the order to expire in February.
In addition, BPA entered into an agreement with California in early January to exchange power. The agreement has not been made public, but reportedly calls for California to return two megawatts of power for every megawatt that BPA sends. The first megawatt is to be returned within 24 hours, and the second megawatt is to be returned within two weeks. To date, California has fallen behind several times, but apparently is now reasonably current in its return obligations.
Although there has been no tabulation of how much California owes Northwest suppliers, BPA is reportedly owed about $100 million, and the debt to others may reach several hundred million. If so, this may cause severe financial hardship for at least some Northwest suppliers. In the case of suppliers who are utilities, some or all of this loss will be borne by ratepayers.
The continuing uncertainty in California substantially increases the risk that the California utilities will not fulfill their obligations under the exchange agreement with BPA. The reservoirs on the Columbia River are already near historic lows. If the River continues to be run at present levels for power production, and California fails to return power under the exchange agreement, the reservoir deficit would become much worse. This would aggravate the extremely difficult balancing act between power and fish that lies ahead this spring, and would likely lead to violation of the "biological opinion" that mandates certain river flows for salmon listed as threatened or endangered under the Endangered Species Act.
The economic impact of all this on the Northwest is just beginning to be felt. Seattle has increased rates by about 30 percent, and Tacoma has increased rates by over 40 percent. BPA has projected that the price of power to its utility customers will increase by 100 percent starting on October 1, and many observers expect that projection to climb to near 200 percent in the coming months. This will have a devastating impact on the entire Northwest, but particularly on Washington State, which buys approximately 60 percent of BPA's power. The hardest hit will be those rural areas of Washington that are served by public utility districts that buy all of their power from BPA.
This situation has caused many Northwest Democrats (including Senator Murray, Governor Locke, and Governor Kitzhaber) to join with Governor Davis and other western Democrats in calling on the federal government to impose some type of cost-based price caps in the west. Senators Dianne Feinstein (D-CA) and Barbara Boxer (D-CA) have introduced S. 287, which would require FERC to impose cost-of-service based rates on wholesale sales in the West that are subject to FERC jurisdiction. Such rates would remain in place until the market for electricity in the west again reflects just and reasonable rates, as determined by FERC.
In response, Senator Gordon Smith (R-OR) introduced an amendment to S. 287 that would prohibit the imposition of cost-of-service based rates on sales in any state that does not allow its utilities to set retail rates high enough to recover their wholesale power costs (i.e., California). In introducing the amendment, Smith said that California must approve further retail rate increases. Otherwise, he said, if the California utilities fall into bankruptcy, the customers of Oregon utilities who were forced to sell power to California will be stuck with the bill for California's failed restructuring effort. The Senate Energy and Natural Resources Committee will hold a hearing on S. 287 and the Smith amendment on March 15.
II. How Did We Get Here?
There are at least four contributing factors to our present predicament. First, we did not build enough generation in the West during the 1990s, while the economy was booming. The situation was made worse by the fact that the high-technology sector of the economy, which fueled much of the economic growth, consumes enormous amounts of electricity.
In large part, insufficient generation was built because the dramatic changes in the industry created an uncertain environment for the huge capital investment that would have been necessary to keep pace with demand. The electricity industry was, and is, in transition toward a more competitive model, but no one knows how fast change will come, or exactly where it is going. As a result, the utilities substantially reduced their construction of generation, and the relatively new breed of independent power producers were not able to build fast enough. In addition to scarce capital, independent power producers faced, and continue to face, staunch local opposition to facility siting.
Second, we are suffering from an extremely low water year in the Northwest. The extent of the gap between supply and increasing demand has been masked for the last four of five years by extremely good water years. This year, that mask has been abruptly removed, revealing the full extent of the supply problem.
Because BPA and non-federal dam operators in the Northwest sell their output throughout the West, the light snowpack in the Northwest has plagued the entire Western electricity market. The problem is made worse by the fact that measures to protect salmon are increasingly eroding the ability of dam operators to maximize river flow for electricity production.
Third, wholesale natural gas prices have more than quadrupled in the last year. Low prices helped make gas the fuel of choice for new generation facilities, but they also discouraged new gas production. Higher prices have now stimulated a new wave of exploration and production, but it will take time before supplies catch up with demand and at least stabilize prices. In the meantime, all electricity from gas-fired facilities will cost substantially more to produce.
Fourth, the government of California took an extremely command-and-control approach to restructuring. When the CPUC required the investor-owned utilities of the state to sell their generation facilities, it blocked the utilities from entering into long-term contracts with the buyers of those facilities, based on the mistaken belief that prices would decline in the future. They did this despite the fact that both the utilities and the facility buyers were eager for the stability that such contracts would have provided while the industry is in transition.
Instead, the utilities were forced to buy substantial amounts of power in the spot market, which is the last place a buyer wants to be during a severe supply shortage. To make matters worse, the California version of restructuring did not allow utilities to make their own spot market purchases. Instead, California set up a government agency, the Independent System Operator (ISO), to make purchases on behalf of the utilities. Because the ISO was desperately trying to secure power the day before it was needed, and it had no direct economic stake in the price paid, prices shot up dramatically.
Among these four factors, it is clear that insufficient generation is the root cause. If we had 10,000 MW of additional gas-fired generation in the West, we would not be in a crisis. Put another way, if the restructuring of the electricity industry had happened more quickly, or not at all, we probably would not be in this mess. We would still have higher than normal prices because of high gas prices and a lack of low-cost hydropower, but it would not be a crisis.
It is also clear that two or three more great water years in the Northwest would have at least forestalled the crisis, and might have bought enough time for more gas-fired generation to come on line, thereby avoiding the crisis altogether. Instead, hydroelectric output was decimated when the markets were at their most vulnerable.
It is also beyond debate that California's approach to restructuring took a bad situation and made it much worse. If the CPUC had allowed its regulated utilities to manage market risk in a rational fashion, wholesale prices might have doubled or tripled, but they would not have gone up ten or twenty-fold.
The California debacle also proved that the West is a single electricity market. Once sky-high spot market prices were set in California, it attracted sellers from throughout the West, thereby overheating the spot market throughout the region.
III. How do we get out of this mess?
To solve the present problem, we need a combination of short-term and long-term measures. Within the category of short-term measures, there are some that California must employ and some that the Northwest must pursue.
A. The Short Term
California must do three things in the short-term. First, the CPUC must substantially raise retail rates. This is the most important step toward solving the problem. If it had been done late last year, the finances of the utilities would have been stabilized, consumers would have had a real incentive to conserve, suppliers would have been paid, and the enormity of the problem we face today would have been cut in half.
Second, the utilities need power that is subject to stable, long-term contracts. Davis should have allowed the utilities to enter into such contracts directly with the suppliers, rather than putting a state agency in charge of procuring electricity on their behalf. In the end, the cost of paying off the bonds that fund DWR's purchases of electricity may be far costlier to the citizens of California than the cost of a straightforward retail rate increase. But if Davis is intent on using the bonding approach to delay economic pain and obscure its source, he at least ought to make sure that he procures enough power to keep the utilities out of the spot market this summer.
Third, California must get serious about conservation. There is no evidence that California is likely to achieve even its modest conservation goal of 10 percent. The reason is simple: as long as retail rates stay artificially low, consumers have no incentive to conserve.
The Northwest must do four things in the short-term. First, we need to do a better job of conserving. The rate increases that we are beginning to see will give us the incentive, but we should not wait. For example, there are too many office buildings in the Puget Sound area that leave many of their lights blazing through the night.
Second, we must monitor the return of power by California under the one-for-two exchange agreement. We need to tell California and BPA that no further slippage on that agreement is acceptable, particularly with the California utilities so close to bankruptcy. If BPA has any reason to believe that the California utilities cannot or will not perform, BPA should end the agreement. The agreement itself should be made public so that concerned parties in the Northwest can meaningfully monitor the situation.
Third, we need to make sure that all our air emission-limited plants are running, or at least ready to run. For example, last Summer Governor Locke convinced EPA to temporarily waive those emission limits for Avista's generation facility near Spokane. By allowing that facility to run for a relatively few hours beyond its permit, Avista was able to provide reasonably-priced power to Bellingham Cold Storage when the wholesale market was exorbitantly high. That allowed Bellingham Cold Storage to keep its doors open to growers of fresh produce whose product otherwise would have rotted.
Fourth, we need to make sure that the amount of water set aside for salmon is appropriate. This spring will present very tough choices regarding the allocation of meager river flow between power and fish, and our understanding of the impact of those choices must be as complete as possible.
Cost-based price caps is potential short-term measure that is receiving lots of attention, but seems unlikely to produce favorable results. Although price caps are intuitively appealing in our current situation, they have many drawbacks. First, they may discourage investment in new generation, the thing we need most in the long term. Even a cap that exempts new generation (which S. 287 does not) may slow investment because potential financial backers would be concerned that the exemption might later be revoked. If so, we might achieve modest relief in the near-term, but at the expense of extending the fundamental supply shortage for years.
Second, price caps would be very difficult to implement. S. 287 provides that the rate shall include "all the variable and fixed costs for producing the electric energy," presumably on a facility-by-facility basis. This is a daunting task, particularly regarding the hundreds of generation facilities built in the last decade by independent power producers. These facilities have never been subject to rate regulation, and have never had any reason to keep their books and records in a form suitable for review by a regulator. Thus, the idea that FERC is going to assess the costs at each of these independent facilities (not to mention the hundreds of facilities still owned by utilities, many of which are no longer rate regulated) and impose a rate on each of them within 60 days after enactment (as S. 287 requires) is highly unrealistic.
Third, price caps would not apply to the entire generation market. FERC has no jurisdiction over the price charged for electricity from generation facilities owned by publicly-owned utilities.
Finally, price caps will not happen without federal legislation mandating them, which seems unlikely. President Bush and Secretary Abraham have repeatedly stated the Administration's opposition, and FERC Chairman Hebert is adamantly opposed. Although there are rumors that Hebert may not be Chair for long, any replacement appointed by Bush would likely agree with Hebert on this point. With little prospect for Republican Congressional support for price caps, and a strong prospect of a White House veto, Democrats can score political points on this issue, but the likelihood of legislation is low.
B. The Long Term
In the long-term, we need a balanced, sustained attack on both the supply and demand side of the energy equation. On the supply side, the siting of new generation facilities must be streamlined. All the western states, but particularly states like California that consume enormous amounts of electricity, need to site enough generation to keep up with growth. Since 1996, demand in California has grown by over 5,000 megawatts, and yet less than 1,000 megawatts of new generation has been constructed.
Unfortunately, Washington State is very close to making a mistake on this score. On February 16, the State's Energy Facility Site Evaluation Council ("EFSEC") recommended against an application to build a 660 MW gas-fired generation facility near Sumas. EFSEC's decision was based on its determination that the environmental costs of the facility would not be adequately counterbalanced by benefits to consumers in Washington because the facility might sell power to out-of-state purchasers. EFSEC concluded that the applicant "has not shown that the plant would produce direct energy or economic benefits to consumers or lead to lower energy costs in Washington or in the region."
This rational ignores the fact that the West is one huge market, with every significant generation facility connected to a transmission system that moves electricity throughout the region at the speed of light. Therefore, new generation located anywhere in the West benefits all consumers in the West by increasing supply and thereby putting downward pressure on price. Put another way, if EFSEC's logic was applied to all siting decisions in the West, few, if any, projects would be built anywhere, and we would all suffer from the resulting shortage.
EFSEC's recommendation will soon reach Governor Locke's desk, where he will have 60 days to accept it, reject it, or send it back for further consideration.
Along the West coast, the interconnected nature of the transmission system is even more important. The transmission intertie between the Northwest and California was specifically built so that the Northwest could send power to California in the summer, and California could send power north in the winter. That symbiotic relationship has produced tremendous economic benefits for the entire West coast for decades. Those benefits should not be undermined by parochial notions that each state should provide generation only for its own residents.
Also on the supply side, an idea that is long overdue for implementation is upgrading the turbines and related equipment at both federal and non-federal hydro facilities in the Northwest. Particularly at federal facilities, the delays in repairing or replacing inefficient equipment cause a significant loss in electrical output. By streamlining the federal procurement process for this equipment, and providing additional incentives at non-federal facilities, we can substantially increase the efficiency of our hydroelectric system without any additional environmental impact.
Support also needs to increase for non-hydro renewables, such as geothermal, wind, solar, and biomass. Projects that were not economic at the market prices of only a year ago are now bargains. Relatively small distributed generation facilities, such as fuel cells, also have a bigger role to play.
On the demand side, we need more investment in energy conservation and efficiency. One important example is a "smart meter" that provides real-time price information, thereby encouraging consumers to shift usage to off-peak periods when prices are lower. Smart meters can also be programmed to shut off certain appliances in a home when supplies have reached critical levels, in exchange for an agreed upon rate reduction. The result is consumer savings and enhanced system reliability.