Ten years ago, a power crisis in the state of California would have been unthinkable. Yet, five years on from the introduction of power sector reform, the state is entwined in a deepening crisis that requires a minimum of 5000 MW of new generation, equal to ten new plants, to restore supply and meet demand.
Forced rationing in the form of rolling blackouts have become frequent, disrupting domestic and commercial activity and invoking fears of economic decline. Warnings of possible power shortages in other states including New York, New England, and Texas has forced an emergency policy announcement from the White House with President George W. Bush calling it the most serious energy crisis since the oil embargo of the 1970s.
The reasoning behind introducing deregulation in California was to promote competition, stimulate the economy via lower power rates and streamline a cumbersome regulatory process. When the Federal Energy Regulatory Commission orders were put in place in 1996, the average revenue per kilowatt hour of electricity sold in California was 9.48 cents, the tenth highest among 50 states and well above the US average price of 6.86 cents per kilowatt hour.
A growth in electricity demand of 11.3 per cent between 1990 and 1999 combined with a capacity decrease of 1.7 per cent has led to regular power cuts over the past year. During the same period, the state’s reliance on power imports also increased to around 11 000 MW. The precarious balance between supply and demand projected for this summer in neighbouring states implies that there will be a huge reduction in power exports to California.
The state’s residents and businesses are holding tight for a summer that is expected to result in, by some estimates, around 20 hours of extreme shortage. In Silicon Valley, high tech firms are facing up to 11 days (260 hours) of blackouts over the summer according to the North America Electric Reliability Council (NERC). Analysts claim that the consequences for companies in the state are serious in view of the general US economic slowdown.
NERC has estimated 260 hours of shortage in California and blackouts in other states such as Texas, New England and also in New York City. Running concurrently with the crisis, energy companies are reported to be enjoying a ‘boom time’ with record profits and the prospect of further gains.
All of the USA’s states have faced several difficulties in introducing competition into the power sector. Power markets have only a limited storage inventory, have high fixed costs, long lead times, require transmission grid infrastructure and a shortage implies very serious consequences.
A number of theories have recently emerged attempting to explain the Californian crisis. These range from the assertion that abuse of the market power has taken place by electric power generators, to a genuine and unavoidable scarcity of supply situation calling for new generation capacity. The view that the crisis has been caused by the destabilizing effects of partial deregulation has also been voiced by numerous analysts.
Cambridge Energy Research Associates (CERA) has focused on structural flaws, existing obstacles for developing new plants and misalignment of markets as the three main reasons for the power crisis.
A 50 per cent increase in commercial and industrial power rates will cost the Bay Area business over $500 million in lost output per year and 15 000 job losses over three years, according to BAEF
Firstly, policy makers have designed the market in a way to protect consumers from price signals that indicate the price that utilities pay generators. Wholesale prices have been deregulated, while the price that end-consumers has not. As a result, consumer prices have remained static since 1996 while production prices have rocketed due to the rising costs of inputs such as natural gas.
Utilities are therefore unable to pass high wholesale power prices on to their customers. As a result, the state’s utilities are over $13 billion in debt. Meanwhile, consumers hold their politicians in a positive light for keeping electricity prices low.
A second fault that has been highlighted is the failure of regulators to provide incentives for generators to add new capacity. Other states typically hold reserve capacity of 15 per cent. This reserve capacity can meet unexpected rises in demand caused by heat waves, surges in economic growth or a plant outage.
A third explanation for the existing crisis are the numerous hurdles in siting and granting permits to build new plants which makes the state one of the world’s hardest places to build a new power facility.
The plant approval procedure is very costly and time consuming with open ended environmental reviews and well organized community opposition. These factors have contributed to zero growth in new plants in the past five years despite a 29 per cent growth in the state’s economy and a 24 per cent growth in its electricity consumption in the same period.
Power is an essential prerequisite for any business activity, therefore power cuts have the potential to cause a domino effect on the regional and national economy. To assess the damage of the power cuts in monetary terms, the effects are categorized into three areas.
Firstly, the primary costs of the blackouts will be the direct costs, which are measurable and immediate. These include the cost of one hour of lost work due to power failure or the cost of a computer system breakdown.
Secondary costs are those that do not arise immediately but are measurable. These can be losses in new investments in the area as investors loose confidence and re-direct funds. The stifling effect on other sectors of the economy when increasing sums of public money is transferred into the troubled power sector is also included in this category. The private sector having to invest in costly new portable power generating plants could also be calculated under this category.
Finally, any assessment of the economic cost of the crisis will need to make some assessment of tertiary cost not directly calculable. These would include the effects of ‘brain drain’, as professionals emigrate due to the inconvenience or the effect of disruptions to daily life on worker productivity.
The Bay Area Economic Forum (BAEF), which claims that the rolling blackouts this summer could be one hundred times worse than last summer’s, has made some attempt at calculating the economic cost of the California power shortage on the Bay Area. A 50 per cent increase in commercial and industrial power rates will cost the Bay Area business over $500 million in lost output per year and 15 000 job losses over three years, according to BAEF.
The cost to California’s economic output in term of wages, salaries, and profits, is forecast to range from between $2 billion and $16 billion. The basis for calculations were made on estimates of kW of electricity used per unit of economic output and the value of service function placing a monetary figure on what businesses would pay to be exempt from power cuts.
According to the BAEF report, the uncertainty in power supply is set to reduce the region’s projected growth from 3.5 per cent to 2.5 per cent and significantly effect the knowledge economy of the state. If weather conditions prove to be worse than the forecasts, then the impact could be up to four times worse and send the economy into recession.
A survey of 500 Bay Area employers has found that one in five companies has considered relocating if the power cuts were to become more prevalent, and 42 per cent surveyed had reported lower profit margins and competitiveness since the onset of the power cuts.
Additionally, probable residential rate rises and the effects of passing on cost increases of local businesses is expected to reduce Bay Area disposable income by over one billion dollars a year.
Any negative forecast of future development of California should also bear in mind that the state is currently achieving economic growth that is well above the national average and is the leading state in the US in terms of employment creation.
Ironically, California is also the second most energy efficient state after Rhode Island. Sean Randolph, President of BAEF says that it is too early to make any assessment of the state’s power crisis on the US national economy. Nevertheless, the threat of power cuts in other western states has led President Bush to form a national task force headed by Dick Cheney to examine the problem and make recommendations.
Sean Randolph, President of BAEF: An effective long-term solution must address the issue of installing new capacity
Sean Randolp agrees with the overall conclusions of the task force that conservation alone is not sufficient to overcome the current quagmire in the energy sector. He believes that an effective long term solution will also need to address the issue of installing new capacity.
Somewhat controversially, there are now federal government proposals to speed up the re-licensing of existing nuclear reactors and the approval of new nuclear plants. The federal government also intends to extend tax breaks for purchasing nuclear plants and promises of federal backed insurance against accidents. Randolph says that the public, which has traditionally been against nuclear power since the Three Mile Island incident in 1979, is now less averse to the prospect of nuclear energy given the choice between persistent blackouts and continued electricity supply.
On a positive note, the latest figures emerging from the state indicate improvements in conditions for the Californian energy sector. During March and April, consumption of electricity in the state was down nine per cent, with a drop of 11 per cent recorded for May 2001, giving evidence that the conservation policies have had an impact.
Prospects for the long term also look good with reports that repairs on plants are running ahead of schedule and signs of improving rainfall and snow melt in the northern pacific boosting hydropower generation. Federal proposals to strengthen the national grid will also ensure greater security of supply by extending the prospects for energy trading between states.
There is broad agreement on the short-term solution of addressing demand side factors and taking measures to promote conservation. BAEF recommends aggressive conservation measures in the near-term to forestall blackouts this summer, targeting contributors to peak demand. Residential and commercial air conditioning and commercial interior lighting is estimated to account for 40 per cent of peak load. If this was reduced it would reduce demand.
Imports of electricity into California have dropped over the past two years
Other proposals include bringing in temporary mobile generation, giving incentives for overall conservation, time of use pricing, real-time pricing and introducing progressive rate structures designed to alleviate the shortage.
Proposals for the state, now the largest power purchaser in the market, to takeover the transmission wires to provide a billion-dollar cash infusion into the state’s three biggest utilities have made progress.
Analysts have argued that state control of the physical infrastructure necessary for market interactions can have a detrimental effect on power investment. They believe the state might also have to take on the role of supplying new power plants.
Most observers have opposed further interventions and have called for corrections in deregulation rather than abandonment of the process. It is clear that deregulation should not lead to utilities absorbing wholesale market price risks while state regulators deny the utilities the opportunity to manage this risk. Thus, wholesale and retail market structures need to be aligned. The market would also benefit from a consolidation of all of the government’s functions into one single body to give clear and consistent policy direction.
Streamlining the permitting procedure to cut approval time by half have met with wide support. An aggressive push to construct half of the 40 proposed plants would solve the current supply problems in California.
There is broad consensus that in the longer term, introducing the consumer to market price fluctuations would improve conditions. As price is the most effective determinant of demand, market based rates will swiftly improve demand response to tighten supply conditions. CERA estimates that a 20 per cent rise in rates will reduce demand sufficiently to cut the shortfall by one third.
The increasing risk of large-scale disruptions has generated a series of demands for exemption from cuts. The state’s water authorities warned of threats to public health from sewage spills and water pipeline breaks if power was cut to pumping systems. So far, fire fighters, telecommunications and power production and transmission sectors have been granted exemptions.
A perfect storm
While California and much of western US braces itself for an uncomfortable summer, the major energy companies have cheered the Dick Cheney energy policy proposals. The world’s largest maker of gas turbines, GE, said it had worldwide orders worth 173 GW, well up on 1999, swollen by increasing demand for new plants in the US. GE expects a 30-40 per cent rise in sales this year while another energy giant, National Grid, said it expects 60 per cent of its profits to come from the US given these proposals.
Further afield, Brazil, Chile and Vietnam are all currently experiencing major power shortages caused by unexpected weather conditions, lack of new capacity and/or problems associated with deregulation. Other countries such as Malaysia are questioning the whole rationale behind deregulation given the highly publicized examples of its pitfalls.
Typically, power shortage is a phenomenon associated with developing countries and regions that rely heavily on hydropower. In this regard, California’s distress is unique and the lessons from the ongoing experience may not be applicable in other cases. Essentially, the factors of partial deregulation, drought and lack of new capacity have combined to cause the ‘perfect storm’ in California.