*Open Spaces Magazine*

Keeping the Lights On

By Edward W. Sheets

The most basic objective of the electricity industry is to keep the
lights on---providing reliable electricity service to hospitals,
schools, business, and the myriad activities that we depend on. In
general, electric utilities have done a good job providing reliable
service during the last century. In recent years, there is a new
movement to fundamentally change the industry through deregulation. The
experiment in California caused blackouts, bankruptcies, and huge cost
increases. Was California a preview of things to come?

The spring issue of *Open Spaces* featured an article on the real causes
of skyrocketing electricity costs over the past two years. The article,
*California Schemin'*, described how large energy providers withheld
electricity in California to create an artificial shortage and drive-up
electricity prices. This manipulation of the electricity market forced
California utilities to cut off electricity to millions of customers
during rolling blackouts. Wholesale prices in the Western United States
skyrocketed from three cents per kilowatt-hour to over three dollars per
kilowatt-hour during certain peak periods. The debacle in California
increased costs for consumers throughout the West. Estimates of the
damage range from \$30 to \$40 billions.

In this issue we provide an update on the ongoing investigations and a
preview of what may be the next electricity crisis.

**California Schemin'**

California adopted a flawed deregulation plan for its electricity system
several years ago. It required the private utilities to sell off their
power plants and purchase electricity supplies from independent power
producers on a day-to-day market. This removed the obligation of the
utilities to plan for and acquire resources to meet customer needs. The
new structure assumed that the market would provide reliable supplies.

It did not take long for some of the largest energy suppliers in the
country to figure out ways to manipulate the California system. Enron,
Duke Energy, Dynergy, Mirant, Reliant, and AES found that they could
keep some of their power plants out of service and create an artificial
shortage that would drive up prices for all of the rest of the power
they sold. During the height of the electricity problems in California
only about half of the electricity generation controlled by these
companies was offered for sale. This was enough to tip an electricity
surplus into a shortage. It caused prices to increase ten-fold or more
on the remaining power that these large suppliers were selling and
resulted in windfall profits for them and huge increases in the cost of
electricity throughout the West.

California responded by mounting a statewide energy conservation
program. Those efforts reduce peak electricity use by more than 12
percent. Utilities in the Northwest also geared up conservation programs
that had lagged for years. These conservation efforts helped balance the
supply and demand of electricity. The Northwest and California
Congressional delegations also weighed in and convinced the Federal
Energy Regulatory Commission to impose limits on the wholesale price of
electricity.

In the aftermath of the California electricity market disaster, the
newspaper business sections have often resembled a police blotter. To
date, one Enron energy trader has pleaded guilty to a felony and many
companies are under investigation. One large energy supplier recently
agreed to pay \$400 million to the state of California to settle a claim
that they had overcharged for electricity.

While these inquiries are ongoing, we have already learned that there
were a number of schemes to increase the price of electricity by
withholding power production, reselling electricity, and creating
artificial congestion on electricity transmission lines. These
strategies, known as Deathstar, Perpetual Loop, Fat Boy, Black Widow,
and Cong Catcher, were designed to increase the profits from the sale
and transmission of electricity.

The details of these schemes are extremely complex. One of the more
straight forward examples occurred on the Silver Peak transmission line
on May 24, 1999. Enron submitted a schedule to transmit about 3,000
megawatts of electricity (about three times the power used a city the
size of Seattle) over the Silver Peak line in California. This
transmission line is designed to carry only about 15 megawatts, so Enron
received payments from the California system operator to relieve the
artificially induced congestion. An investigation found that this single
transaction had costs consumers between \$4.6 and \$7 million. Enron
paid a fine of \$25,000 and promised that it would not repeat the
behavior.

**Protecting the Public Interest**

The Federal Energy Regulatory Commission (known as FERC) is charged by
law to ensure fair and reasonable electricity prices in interstate
commerce. As Paul Krugman of the *New York Times* asked recently: "How
could a \$30 billion robbery take place in broad daylight? There are
several potential explanations.

**Complexity**: The deregulated electricity market is extremely complex
with a large number of transactions between hundreds of utilities and
power producers. The recent investigations uncovered elaborate schemes
to sell and resell electricity multiple times to increase the profits to
the participants in the transactions.

**Secrecy**: To make things worse, the California system was not very
transparent. It was often impossible to determine which companies were
selling (or withholding) electricity. The California Independent System
Operator has kept a great deal of information confidential to protect
what it considers to be proprietary information. Even when information
was available to regulators it has not always available to the public.
For example, CBS news reported that FERC had copies of audio tapes that
proved that electricity traders from Williams Energy had told power
plant operators to turn off electricity production during the so-called
crisis. Unfortunately, these tapes were sealed as part of a secret
settlement.

**Philosophy**: The Bush Administration and its appointees at FERC are
committed to creating a free market for electricity. In an interview on
the PBS program Frontline, FERC Commissioner Curtis Herbert said: "The
rules of competition govern that economies work, that choice works.
It\'s why we\'re American. We inherently like choice. It\'s why we left
the mother country. We didn\'t like the rules they were setting. We
wanted to make our own rules. We want our own choices. And we believe
that works."

A free market works well for most commodities, but electricity is not
like wheat or pork bellies. Electricity is essential to public health
and safety and there are not currently any realistic substitutes. From a
technical point of view, electricity cannot be stored; the electricity
system must exactly match the supply with the demand during every second
of every day of the year.

**Politics**: The executives at Enron were the biggest contributors to
George W. Bush during his political career. Some observers speculate
that the large energy suppliers assumed that they could act with
impunity once Republicans took control of the Administration and
Congress.

**California Responds**

During the crisis, California mounted a major effort to conserve
electricity. It also formed a state power authority to purchase
electricity. This year, the California legislature and utility
commission have taken actions to restore the obligation of utilities to
develop plans to meet future needs. This was an important step. Over the
past 25 years, utilities in California and the Northwest have led the
nation in developing plans to evaluate all the alternatives for meeting
future energy needs and select a balance portfolio of energy efficiency,
renewable resources, and gas-fired generation. These plans helped the
utilities understand what they needed to buy and what the alternatives
were---a critical step in wise investing. An overzealous approach to
deregulation had assumed that "the market" would supply all of the
electricity that consumers needed.

One of the new California laws requires utility plans to acquire all
conservation that is less expensive than new power plants. Another law
established requirements for the state's investor-owned utilities to
meet 20 percent of their electricity needs by 2017 using renewable
energy.

**Federal Deregulation Continues**

The problems with electricity deregulation in California have caused a
number of other states to rethink or slow down utility restructuring;
however, the Federal Energy Regulatory Commission continues to move
forward. The FERC recently developed a proposal "to remedy remaining
undue discrimination and establish a standardized transmission service
and wholesale electric market design that will provide a level playing
field for all entities that seek to participate in wholesale electric
markets". The complex proposal, known as: Open Access Transmission
Service and Standard Electricity Market Design, is 640 pages long.
Copies are available at
<http://www.ferc.gov/electric/rto/Mrkt-Strct-comments/discussion_paper.htm>.

The standard market design focuses on ensuring that independent power
producers have non-discriminatory access to transmission lines. One of
the provisions of the proposal would require the creation of independent
transmission providers that would determine how much electricity is
needed in an area and assign responsibility to utilities to meet their
share, by either adding new power plants or improving energy efficiency.
In a shortage, the transmission provider would purchase power to cover
shortages caused by utilities that did not secure resources to cover
their share. During blackout conditions, these utilities could have some
of their power curtailed.

The proposal has generated a great deal of controversy. Some state
utility commissions are concerned about a one-size-fits-all approach to
an industry that differs significantly among regions. Others have seen
the proposal as a threat to state regulation that protects consumers. A
number of environmental and consumer groups have provided detailed
comments to promote to use of energy conservation and renewable
resources in the proposal.

**Dejavu All Over Again**

Figuring out who is responsible for developing additional electricity to
meet growing demand is essential to keeping the lights on. The blackouts
and price spikes in 2000-2001 were caused by a combination of a flawed
deregulation scheme in California, growth in electricity demand, and a
drought that reduced the amount of power available from the Northwest
hydroelectric dams. A key problem then and now is the lack of incentive
to build new electricity generation or improve energy efficiency.

Many utilities are reluctant to spend money to develop new resources or
invest in conservation because they fear that they will be competing in
an electricity commodities market and don't want to increase their
costs. The deregulation of the electricity market assumes that there
will be a large number of non-utility companies that will be willing to
build new power plants to sell electricity into the market. During the
California crisis, many of these companies began to develop more power
plants on the assumption that the high electricity prices would produce
handsome profits.

FERC's limits on wholesale prices took away much of the incentive to
game the system. As the economy slowed, the West Coast had a surplus of
electricity and market prices for electricity have fallen below levels
that support new investments in power plants.

The Northwest hydroelectric system creates an added complication for new
resource development. In a poor water year, like 2000-2001, the amount
of electricity generated by the dams dropped 5,000 megawatts below the
levels during the prior five years---that is enough to serve five cities
the size of Seattle. The reduced supply during drought years causes
electricity prices to go up. During a really wet year, hydroelectric
production can go up by the same amount and cause prices to drop well
below the costs of electricity from a new power plant. This large
variation in supply and price increases the risk of developing new
resources to serve the Northwest.

The Northwest Power Planning Council prepares estimates of how much new
generation will be added in the Northwest. In February of 2000, the
Council estimated that the region would need about 3,000 megawatts of
additional power by January 2003 to meet its needs. As of March 2002, it
appeared that the region was on track to meet that goal; however, the
most recent estimate prepared in September of 2002 now shows that new
supplies will be about 500 megawatts short of the estimated need. About
a third of the power plants that were in planning or construction in
2000 have been cancelled and most of the rest of the plans are on hold
until the market price of electricity increases enough to secure
financing for new construction.

So the issue is still with us. Utilities and businesses will be
reluctant to sign the long-term contracts needed to secure financing for
new power plants or invest in saving electricity if they can buy
lower-cost surplus power from the existing plants that are selling into
the wholesale market. In the short term, this keeps costs down and
provides benefits to consumers. Without investments in energy efficiency
and power plants we are headed for trouble. As economic growth,
droughts, or manipulation of the market causes supplies to tighten we
will find ourselves facing shortages and much higher costs that will
reduce reliability and damage the economy.

State and federal regulators, utilities, businesses, and consumer and
environmental groups need to develop a system that will provide reliable
electricity services and protect consumers. This will require a return
to utility planning to meet electricity demand, including an obligation
to provide reliable service if the market doesn't. These plans should
determine how much electricity may be needed and look at all the
alternatives. Utilities will need to acquire all the energy efficiency
improvements that cost less than new power plants. Utilities also need
incentives for signing long-term contracts for new resources and for
sustained funding of energy efficiency and renewable resources. In the
meantime, you may want to buy fresh batteries for your flashlight.

**Short Bio**

**Edward W. Sheets** has been involved in energy and fish and wildlife
issues in the Pacific Northwest since 1973, the last seven years as a
consultant working with federal, local, and tribal governments on energy
and fish and wildlife issues. Ed helped found the Northwest Power
Planning Council and served as its executive director for 15 years. He
also worked as director of the Washington State Energy Office and
principal energy advisor to Governor John Spellman, as special assistant
to the late Senator Warren G. Magnuson in Washington D.C., and on the
research faculty of the University of Washington. Ed also serves on the
editorial board of *Open Spaces*. He can be reached at ed@edsheets.com