A California-style power crisis is headed our way.

By Edward Ericson, Jr.

Here’s what’s going to happen to your electric bill after Jan. 1, 2004 if current trends hold: It’ll double. Then it will double again.

Don’t believe us? You’re not alone. No less an authority than Northeast Utilities’ CEO Michael Morris took the blue-sky approach at a recent meeting of business executives sponsored by the Connecticut Business and Industry Association. “Can California spill itself on Connecticut? Not likely,” he promised.

But dark clouds threaten his silver lining. “I do worry about this,” Morris said. Given a California crisis, “Washington will overreact” by capping wholesale prices, he said. “Let’s not overreact. Because the overreaction is always in the wrong direction.”

Morris’ concern that the government might do something to put a cap on electricity prices reflects those of power-industry insiders across the country. Their problem is simple: After selling America on the notion that electric deregulation would reduce prices by 30 to 40 percent, they’ve watched while wholesale prices instead rose sharply across the country. Their system isn’t working.

Right now the power industry has nothing to worry about. Governments aren’t in a regulating mood.

So the one who should worry is you. Because despite regulators, politicians and energy executives in New England reassuring one another that “Connecticut is not California,” our region is subject to the same monopolistic forces that have caused insane prices and rolling blackouts in the west.

In fact, we’ve already seen a small taste of California-style energy prices–though consumers were not aware of it.

On May 8, 2000 at 1 p.m., wholesale power in New England, which usually goes for around $50 per megawatt hour, sold for $2,870.91. At 2 p.m. the price jumped to $6,000. And it stayed there until 6 p.m.

If those May 8 prices had been passed through to your bill, your price per kilowatt would have increased by a factor of more than 100, from 5.5 cents–the capped, regulated price you now pay–to $6. That kind of five-hour price spike alone could lift a $55 monthly bill to $82.

Under the deregulation law now in effect, prices like this will flow through to your bill beginning Jan. 1, 2004. And although you will be able to switch power companies, none of them will be able to give you a better deal.

So far politicians have focused on how to get more power companies to compete as a way of keeping prices down. “I think everyone agrees that we can’t subject the consumers to a big price hike overnight,” says Connecticut Sen. Thomas Herlihy (R-Simsbury), the ranking senator on the General Assembly’s Energy and Technology Committee.

But the legislature may be powerless to keep prices down in the face of market forces–forces that are consolidating power in the hands of a few, big private companies that control how much power enters the grid, where it goes, and what you’ll pay for it.

The real issue at the hub of the current electricity crises is something called “market power.” Simply put, market power is the ability of power generators to bid up prices to California levels regardless of their cost to produce the power.

Market power is what you get when you remove price controls without first making sure you have a competitive market, which is what California and Connecticut, and Pennsylvania and Montana and 22 other states did.

“Most of these states have been sold a bill of goods,” says David Penn, executive vice president of the American Public Power Association, a Washington, D.C.-based organization representing the interests of the nation’s more than 2,000 community- and state-owned electric utilities.

Increasing the fixed retail rate won’t help matters, critics say. The only cure is radical reform of the deregulated energy market.

In fact, the best and most reasonable way to ensure a reliable supply of electric power at a reasonable price may be to boldly go…back, to a version of the regulated system the state overthrew in 1998.

To understand where we are now, and how we’ve set a course for disaster, we must review where we came from.

For 100 years, until 1998, Connecticut’s dominant energy company was Northeast Utilities, a regulated monopoly owned by private investors. NU owned the power plants, the wires that transmit the electricity and the billing operation.

But state regulators set the price on a cost basis. Bureaucrats from the Department of Public Utility Control examined the utility’s
financial statements, estimated the next year’s power demands and set the price the utility would get for the needed power. Profits were guaranteed, but they were not allowed to be too high.

The system worked fairly well. Power was reliable, affordable and accessible. But economists said the system was inefficient, because capitalist theory posits that all monopolies are inefficient. Electricity cost more in Connecticut and California than in, say, Ohio or Georgia, and so business owners here–especially manufacturers who used a lot of electricity–complained.

In 1992 the federal government declared the electric generation market free and open. Anyone could build a power plant and supply electricity. Big factories warned utilities that they would build their own plants if they couldn’t get a better price. Deregulation of the electric power system was suddenly a foregone conclusion.

The big manufacturers lobbied for deregulation, and the big power companies were waiting for them.

Northeast Utilities agreed to compete in a deregulated market, but only if state lawmakers forced NU customers to eat the huge bills created by its biggest, least-efficient power plants–the nuclear plants. Once the legislature agreed to that, everyone was on the same side. The legislature gave Northeast Utilities $2 billion.

Northeast Utilities also agreed to sell all its power plants to private buyers on the open market, and then buy the power they produce and resell it to its customers at that standard price.

Something unexpected happened next: Instead of selling for peanuts, the nuclear plants sold for a king’s ransom. Across the nation, in fact, old, tired power plants sold on the open market for more than their estimated value.

Utility companies were happy. They got the money. Lawmakers cheered because the market looked good.

They shouldn’t have.

“In California the utilities sold off their power plants for two or three times more than book value. That should have been an indication right there that problems were to come,” notes Tyson Slocum, a senior researcher for the Washington, D.C.-based Critical Mass Energy Project, an offshoot of Ralph Nader’s group Public Citizen.

Clearly the new power plant’s operators expected to get much higher prices for their generated power than the old utilities had charged. They had to, just to recoup their investment.

What did they see that the state and regional authorities didn’t? They saw a power trading system practically designed to facilitate their ability to raise prices for power, no matter what it cost them to produce that power.

The way prices are set in the power business is the exact opposite of how they are set in, say, in the dish towel market.

In the dish towel market, the price is determined by the towels’ availability. If there are lot of them and few buyers, then the price will go down. So in general, the benchmark price is the lowest price–if you charge more, consumers will go elsewhere. So you charge as little as you can while making a profit.

In the power market, however, it’s the highest-priced power on the grid that day that sets the price all the power producers will get.

This “uniform price system” is what caused California power markets to rocket from $27 per megawatt hour in April to $520 in July. In this system, the suppliers bid for the right to supply power, and the lowest bidder’s power is accepted first. This continues, power plant by power plant, until all the region’s power needs are met. The last bid–the highest acceptable price–is then paid to all the power suppliers, regardless of their bids. This is called the “clearing price.”

This system allowed some of the large power suppliers to set enormous prices, sometimes by holding needed power from the grid instead of bidding, and reaping the higher price.

Utility professionals call this “exercising market power.” Everyone else who understands it calls it “blackmail.”

A study by the California Public Utilities Commission estimated that retail electric companies paid at least $6.2 billion more for their electricity last year than they would have in a competitive market.

New England’s wholesale power market works the same way as California’s. And Connecticut currently operates under the same kind of retail price cap system in place there.

The key difference here is the percentage of the region’s total power need purchased through this upside-down auction system. In California, it’s near 100 percent. Connecticut’s “spot market” is more like 23 percent. For now, at least.

Connecticut Light & Power and United Illuminating have long-term contracts for most of their power needs. But when these long-term power contracts expire, the size of the spot market will increase and clearing prices will increase. And when your price cap expires in 2004, you’ll pay. That’s how our system was designed.

“The error that many advocates of competition made was failing to take a calibrated approach to the question,” says Maryland attorney Scott Hempling, who has advised state power commissions, consumer advocates and others on electric power issues for 17 years. “They swept everything under the competition rug and said, ‘Let’s deregulate.'”

Hempling is no advocate of re-regulation. But he sees clearly the limitations of laws and systems built on a misplaced faith in the market. “One cannot have market forces accurately setting prices without the infrastructure of a competitive market,” he says. “That infrastructure requires many sellers, many smart buyers, equal access to the [transmission lines] and an enforcement system that acts on anti-competitive behaviors if not before they happen, then initially after.”

California has none of these features.

Neither does New England.

California’s power plants can generate about 45,000 megawatts, and its typical winter needs average about 34,000 megawatts. Plenty of reserve–25 percent.

So what is going on? According to observers, during times when the power is needed most, some power plants suddenly “break,” triggering crises.

“In the Northeast you have the exact same outage problem as California,” says Penn, of the public power association. “The same ratio of more-than-before as California.”

The state regulators and market operators have rules forbidding plant owners from withholding power arbitrarily. But they can’t enforce them. “You might get some smoking-gun documents if you have a lawsuit,” says Penn. Short of that, “they’ll always tell you it threw a rod or something.”

An unplanned outage or two can increase the price the whole region pays. Or it might just create opportunity for a single power plant. Under the market rules adopted in New England, if power is needed from a plant that bid into the pool above the clearing price, authorities will ask the owner to start the plant up and will pay it the price it bid. This is called “uplift.”

The more expensive electricity is needed quite often, it turns out, because cheaper power can’t always be sent where it’s needed. That happens because the power grid–the electric wires that transmit electricity from place to place–is not robust enough to support the kind of trading system assumed by deregulators. In heavy demand areas like Boston and Fairfield County, these transmission bottlenecks all but ensure that only local power plants must supply those areas.

According to figures kept by ISO New England, the independent system operator that administers the market in Connecticut, Massachusetts, Rhode Island, Maine, New Hampshire and Vermont, uplift charges amounted to more than $7.5 million in March 2001 alone. The bill last year was more than $100 million–all money paid to power generators over and above the clearing price.

ISO New England has proposed rule changes that would curb suspected abuse. But the regional administrator can’t make changes without permission from the Federal Energy Regulatory Commission, FERC.

And FERC so far has refused.

“I’ve been banging on FERC for 20 years,” says Penn, an economist who founded and operated a Wisconsin utility that served 30 cities for more than 13 years. “They’ve never taken up their antitrust responsibilities. And with California they have reached a new height of irresponsibility.”

Last month, FERC agreed that California utilities have indeed been overcharged by power companies, and ordered a refund–of about $100 million. But the amount of overcharge, according to the California ISO, was $6.2 billion.

The difference amounted to FERC’s credulity, Penn says. “FERC did a price inquiry out in California–it was a total whitewash. Instead of saying ‘Oh my God there’s a problem’ they called all suppliers and visited three of them and listened to what the companies told them. They then concluded, ‘We see no proof that people are manipulating prices.’

“You may have that now [in New England],” Penn says.

While competing power companies exist in New England, the trend is toward consolidation. The biggest player on the horizon here is a Wisconsin company called NRG–it could be the largest player in the power business in New England, and could effectively be the company that sets the prices in the future.

New England currently harbors 16 different electricity generators. But several of them are, to borrow George Orwell’s term, more equal than others. North Carolina-based Duke Energy, for example, is a worldwide energy marketer with interest in generators and gas pipelines. Dominion, which just completed its $1.3 billion purchase of Connecticut’s Millstone power station, is the largest gas and electric company in the United States. The Richmond, Va., company has concentrated its holdings in the greater Northeast, from Illinois east to South Carolina to Maine.

NRG owns about 2,200 megawatts of generation capacity in Connecticut already, and has a deal to purchase over 1,100 megawatts more from Wisvest of Wisconsin. If the deal goes through, NRG will own all six of the state’s most polluting plants. [see “Dirty Pool”] With the purchase, NRG alone would control about 15 percent of New England’s current capacity. But its local clout would count for more.

Transmission bottlenecks around Boston and Fairfield County together account for about half of the excess payments made to power producers last year, payments NRG is positioning itself to exploit. “You can’t say you’ve got a working competitive market until transmission bottlenecks are fixed,” Hempling says.

So it’s true, New England isn’t California. At least not yet.

Things will be much worse in California this summer, Penn predicts, because in the coming months the state will need to import electricity. But as with so many other things, California may be a harbinger. “Everyone has taken comfort from the fact that California was so stupid,” Penn says. “And they’re right–but the underlying symptoms are in place in almost every place: they deregulated wholesale markets without assuring that a market is in place.”

State legislators are hoping that the market will fix the problem. “I fully expect competition and market forces to effectively control consumer energy prices as we move into deregulation of the industry,” said Sen. Melodie Peters (D-Waterford), chair of the legislature’s working committee on power, in a press release. “This working group will help to ensure the transition will be as smooth as we originally envisioned it.”

Sen. Herlihy says he doesn’t think wholesale market power will be a factor either. “If any particular power company began to manipulate the market toward their own selfish profit motive you would see the governor’s office, the Energy and Technology Committee and the [Department of Public Utility Control] come together as one to ensure that that didn’t happen,” he says.

This, of course, is what California’s public officials have tried to do. Unfortunately, they no longer have the authority to do it.

And neither does Connecticut.

Perhaps realizing this, Herlihy calls back an hour after his interview to explain what he meant. “I told you on an emergency basis we could probably respond pretty quickly,” he says. “Beyond that–if it’s something broader than the state we would be working simply in conjunction with [ISO New England].”

Which is also practically powerless.

Under the 1998 law, the state holds sway only over the retail price charged by Connecticut Light & Power. And they will very likely increase this charge.

The lawmakers are starting to sound like the power company people, who now say higher electric prices will encourage good old conservation, benefiting the environment.

Given this overall scenario, it’s fair to ask why consumers should support deregulation. Morris, of Northeast Utilities, is dismissive.

“It’s done. It’s a little late to support it,” Morris said at the business forum. “If you believe in the American model that competition always brings prices down, you will be glad we did this. We’re in a unique period when California is driving the public debate.”

So has wholesale regulation been relegated to the scrap heap of history?

Probably not. Governments will turn against deregulation if consumers start pounding hard enough on the door. Some predict that inevitably, the deregulation of power will be reversed.

“It has to be undone. It will be undone,” says Slocum. He says states can jump-start the process. “They need to immediately file lawsuits saying that ‘hey, ratepayers have paid for these plants…as part of their rate base–so therefore they have an entitlement to the power produced.’

“Then make the legal case that this is a public emergency–power is indispensable.” He knows it’s a long shot.

Attorney Hempling won’t be making that case. “The right question for legislators is ‘What’s the right mix of competitive and monopoly services in the industry?'” he says. But in Hempling’s paradigm competition is monitored–regulated even–much like the old system was. “If states are going to have competition they are going to have to develop staff experts who are disciplined in the elements that make competition work–people knowledgeable about auctions, game theory, entry costs…and engineers who are able to predict where load is going to grow,” Hempling says. “These are intellectual needs of recent vintage.”

Of course, if states had regulators and legislators with that kind of wisdom and foresight, much good could be accomplished on many fronts.

More than likely, the correction will be as ill-conceived as the deregulation that required it.

“It’s a Pearl Harbor society,” Penn notes. “Only emergencies make us correct the system.”

Stricker Shock

Greg Stricker cheered in 1997 when Montana passed a power deregulation bill. The owner of Montana Resources, a copper mining and milling operation in Butte, Stricker felt he was spending too much for electricity. He looked forward to a sweet, 30 percent price break.

Last summer Stricker closed his mine and mill, laying off 320 workers. In March he wrote a letter to the Montana state legislature. “Had we known this would have happened we never would have supported deregulation,” he said.

“We had no idea that we would be subject to additional risk so great that that risk would single-handedly threaten the future of our business,” his letter said. “The harsh reality of deregulation is that it relinquishes control of assets that are essential to the health and welfare of Montanans. Those assets were paid for by Montanans; those assets are now being used to reap huge profits at the expense of Montanans.”

Stricker called for “an immediate return to the full regulation of Montana’s electricity market.”

The letter caused quite a stir. Unlike California, Montana has no power shortage. In fact, the state exports more than 40 percent of the power produced there.

And that suits Pennsylvania Power and Light, which bought up the power plants in Montana, just fine. They’re selling the power for about $158 per megawatt. Until his power contract expired last summer, Stricker was paying $28.

Montana’s Republican-dominated legislature has declined to move toward re-regulation, saying it’s impossible.

Montana Power Vice President Jack Haffey said the transition to deregulation is rocky for a variety of reasons, but the problems will be resolved eventually and Montanans will see long-term benefits from deregulation.

–Edward Ericson, Jr.

What the FERC?

When Connecticut deregulated its electric power market three years ago, it passed responsibility for policing the wholesale market to the Federal Energy Regulatory Commission, a five-member body whose mission is to make sure wholesale power prices are “just and reasonable” and set by market forces.

Trouble is, market prices–especially in a monopoly or a manipulated market–aren’t always “just and reasonable.” Then what?

In FERC’s case, then tough.

Last month a delegation from 11 western states asked FERC to solve the region’s electric power nightmare. California officials were especially adamant that the commission–which numbered only three because of two vacancies–directly rein in the companies that have gouged California. They wanted a $6 billion refund.

The commission told California that at least $3 billion of the $6 billion it said it was overcharged last year was beyond its jurisdiction–because the statute of limitations goes back only six months. In the end, the commission ordered just $124 million in refunds–a figure the power companies are fighting to reduce even further.

The issue of federal price intervention split the federal commission. Commissioner William Massey said the “passion for (free) markets must be tempered with common sense.” He called the western situation a “looming disaster.” FERC Chairman Curtis Hebert remained strongly opposed to price caps, saying they would inhibit electricity generation. The third commissioner, Linda Breathitt, joined Massey last week in proposing a one-year sort-of cap on California wholesale electricity to begin May 1.

Under FERC’s proposal, on days in which the region’s power reserve falls to less than seven percent, the price will be limited to the previous day’s highest price. The order was set to go into effect if California only if the state’s power grid operator files a plan to join 11 other westerns states in creating regional transmission organization to coordinate big electric power trades among the states. California Governor Gray Davis denounced the plan.

“It makes no sense whatsoever to condition the 12 months of relief proposed by the Federal regulators to California’s willingness to join a regional organization that under the best of circumstances cannot be functional for another 18 months,” Davis said.

Meanwhile, President George W. Bush named two new members to FERC, including one to replace Hebert as chair. Bush nominated Pat Wood III, chairman of the Texas Utility Commission, and Nora Mead Brownell, a member of the Pennsylvania Public Utility Commission. Wood became the chairman in April.

The Electric Power Supply Association sees the two as “strong proponents of completing the much-needed transition to truly competitive and vibrant power markets all across the country.” The power companies see the two new commissioners as allies–which means consumers maybe shouldn’t.

–Edward Ericson, Jr.

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