A failed experiment?

In early 2000, California was seen as the pioneer of US power market deregulation. Parts of the state were fully deregulated, and residents of San Diego were experiencing the state’s lowest electricity rates. Just a few months on, and a difficult summer of heat waves, blackouts and price spikes have left some Californians branding deregulation a disaster, and calling for reregulation.

The situation is reminiscent of the US Midwest in 1998 and 1999, but the causes are different: deregulation is perhaps partly to blame, but there are other factors, including lack of capacity, an economic boom, transmission constraints and soaring temperatures.

According to Patrick Dorinson of the California Independent System Operator (ISO), the state did not quite reach its record peak demand of 45 884 MW during the crisis, but this was mainly due to voluntary load reductions. Between June and September, the ISO called 31 Stage One emergencies à‚– where reserve margins fall below seven per cent, and 13 Stage Two emergencies à‚– where reserves fall below five per cent. As prices in the state’s spot market spiked, price caps were imposed, first at $500/MWh and later at $250/MWh.

Dorinson likens the causes of the turmoil to peeling an onion à‚– layer upon layer of factors which together resulted in serious reliability problems. At the heart is an economic boom in the western USA, particularly in California. This has been driven by the ‘new economy’, which as well as having a direct impact on power demand, has also swelled the region’s population.

California: reliability through deregulation?
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California has a supply problem, caused by a lack of power plant construction during the 1990s coupled with rising electricity demand. As a result, it has for several years imported between 4000 and 8000 MW from other western states to meet peak load. This summer, however, those states’ reserve margins have fallen à‚– mainly due to increased demand caused by economic growth à‚– from around 25 per cent to just ten per cent. Demand therefore outstripped supply.

Part of the problem, says Dorinson, is that the current economic boom was not expected. Just a couple of years ago, California was coming out of a recession, and no-one saw the need for large amounts of additional capacity.

This capacity problem has been exacerbated by stringent environmental regulations which not only make the permitting of new plants difficult, but also can restrict the operating hours of existing plants. While some new capacity is under construction, delays and possible shortfalls in gas turbine availability could mean a recurrence of the supply problem over the next two summers.

Transmission constraints have also been a factor, according to Dorinson, who said that BC Hydro in western Canada at times had excess capacity but was unable to transmit this due to bottlenecks in the northwest.

But while these causes seem obvious, what everyone is talking about is deregulation. As Dorinson put it, California was a pioneer in this field and has taken the first arrow. He firmly believes, however, that reregulation of the power industry is not the answer.

California was the first state in the USA to introduce large-scale retail choice in the market and competition in generation. On deregulating, the state’s three investor-owned utilities à‚– Southern California Edison, San Diego Gas & Electric (SDG&E), and PG&E à‚– divested most of their generation assets, becoming utility distribution companies (UDCs). All the power they buy from generators is traded through the California Power Exchange spot market, and the ISO operates the high voltage grid, ensuring reliability and competition.

One major flaw in the market design is that the utilities cannot enter long-term bilateral contracts for power; they buy all their power à‚– even baseload à‚– from a spot market subject to price spikes and volatility. It is easy to see how this could cause problems, and is only just changing, with the California Public Utilities Commission (CPUC) recently allowing the utilities to enter long-term contracts for power.

Another issue surrounding deregulation is competition at the retail end of the market. Most residents in California are protected from price volatility by a rate freeze, except in the area served by SDG&E, where wholesale price fluctuations are passed on to consumers. Thus in the San Diego area, residents saw their electricity bills skyrocket, while in other parts of the state, residents were barely aware of the power market problems as they received no price signals or incentives to curtail use.

Eventually, a temporary rate freeze was imposed on retail electricity prices for customers served by SDG&E. While this protected the consumers, it meant that all three utilities have lost out to the tune of millions of dollars, in spite of the price caps in the wholesale market. According to Dorinson, these utilities will look to recoup these losses from consumers.

Several ‘investigations’ into the crisis are now underway, by the Federal Energy Regulatory Commission (FERC), the California ISO, the CPUC and more. And while it is clear that the causes of this crisis must be properly rooted out, the various agencies are not necessarily working towards a common goal.

What is clear is that California needs to get more capacity on the ground by allowing faster permitting, examine the operation of the wholesale power market with a view to reducing volatility, and decide how to take retail competition forward. The answer, says Dorinson, is not reregulation. “We need to look forward, not back. After all, next summer is only eight months away.”

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