We, the Pundits-California-Energy-The Holy Market

Markets Not the Culprit in California 

Commentary. David DeRosa is president of DeRosa Research and Trading and 
manages an investment fund. He is also an adjunct professor at Yale School of 
Management. The opinions expressed are his own.
 

By David DeRosa

New Canaan, Connecticut, Dec. 15 (Bloomberg) -- Pundits are weighing in on 
the deregulation of electricity as the cause for California's energy 
predicament. The truth is that decades of market interference in California 
are to blame. 

The electric utility industry consists of three segments -- generation, 
transmission and distribution. Generation is where power is created. 
Transmission refers to the movement of wholesale, high-voltage electricity 
through a power grid. Distribution is the slicing of high-voltage power into 
lower voltages and delivery to residential and commercial users. 

The California Independent System Operator, a public agency, has 
responsibility for managing three quarters of the transmission system in that 
state. California's problems are with generation and transmission. What has 
exacerbated the situation is the phenomenal growth in power use by the 
state's computer-related industries. 

For decades, the state has allowed citizens groups, environmentalists, state 
regulators and other self-appointed stakeholders in the power market to 
effectively prevent the construction of new generation plants. This is the 
root cause of the problem: California doesn't have enough generation 
capacity. 

No major new power plant has been built in California in 10 years, and most 
of the existing generators are old and require lots of idle time for 
maintenance, planned or unplanned. 

The Golden State now finds itself in the vulnerable position of having to buy 
electric power from neighboring states. 

California buys a lot of power from Oregon and Washington. But hydroelectric 
power output in those states has been compromised by drought conditions. 
Moreover, demand for electricity in these states has risen because of 
colder-than- normal weather. 

Price Controls Mean Shortages 

To make things worse, the California ISO has a nasty practice of placing caps 
on the price it will pay for electricity. When market prices exceed the 
agency's cap, out-of-state utilities refuse to sell megawatts to California 
because they can get a higher price elsewhere. 

Is that a big surprise? California can't set the price of electricity any 
more than it can control the wind and the tides. But it can effectively 
disconnect itself from the other parts of the Western states transmission 
grid by forcing price caps. 

Yet Governor Gray Davis and Senator Diane Feinstein have taken the further 
counterproductive step of calling on federal regulators to cap the price of 
wholesale electricity in the Western region. In a joint statement, Davis and 
Feinstein claimed ``because of California's size, the state is ripe for 
electricity price gouging.'' 

Well, how about the other side of the coin? What have the California 
utilities done to preclude their being ``gouged'' by the so-called ``needle 
peaks'' in pricing? Why isn't it incumbent on them to make contractual 
agreements to mitigate the risk of such peaks? 

Richardson Steps In 

Enter U.S. Secretary of Energy Bill Richardson, who yesterday ordered the 
utilities in the Pacific Northwest to deliver power to California. Citing the 
Federal Power Act, he told the Bonneville Power Administration and the 
Western Area Power Administration ``to get as much power into California 
immediately today.'' 

Whether Richardson has the authority to issue such commands will doubtless 
end up being decided in the courtroom. The subtlety here is that Richardson 
may have the right to order Bonneville and Western Area around because they 
are indirectly under the control of the Department of Energy for some 
purposes. Yet that authority wouldn't extend to other power sellers. 

Out-of-state utilities had previously refused to sell to California because 
of concerns about the financial solvency of the California ISO. They probably 
don't like price caps, either. 

Richardson further said the Department of Energy would set the price for this 
electricity he mandated for California. Get this: Richardson said the price 
would ``ensure generators receive a fair return.'' 

The thing that makes electricity different than other commodities is that it 
can't be stored economically in mass quantities. As such, it is prone to big 
price swings when generation breaks down, transmission fails, or when demand 
soars. So there are going to be times when the price of electricity per 
megawatt hour goes from $30, say, to thousands of dollars. 

But what Richardson undoubtedly meant is that the electricity that he 
commandeered would be priced, by him, at something less than the market 
price. 

Fair return, Comrade Richardson of the People's Energy Department? How about 
this for fair: let the Oregon and Washington power generators sell their 
megawatts wherever they want and at the best price in the marketplace. To do 
otherwise would be to compromise the long-run best interests of the 
electricity market. If Davis, Richardson and Feinstein keep this up, the 
entire West Coast will wind up like California.