California cracks under pressure

California’s energy crisis went from bad to worse in January when California ISO, the state grid operator, ordered the first state-wide power cuts in the organization’s history. A state of emergency was declared and emergency legislation was drafted to shore up the state’s three investor-owned utilities, which have been left financially crippled by the problems.

California ISO ordered utilities to implement rotating outage programmes to curtail supplies in northern California on January 17, 2001. The worst affected areas were the northern and central areas around San Francisco and Silicon Valley, and the blackouts continued on 18 January. A Stage Three Emergency – when operating reserves fall below 1.5 per cent – was declared on 12 January and continued for several days.

Efforts by politicians and industry representatives on a state and national level to find some kind of long-term answer to the crisis provided some temporary relief for the three utilities – Pacific Gas and Electric (PG&E), Southern California Edison and San Diego Gas and Electric, but the situation has been compounded by a shortage of natural gas and the reported refusal of some natural gas suppliers to provide generators with fuel for fear of not being paid.

The utilities, in particular PG&E and SoCalEd, are close to bankruptcy, having been obliged to purchase power at wholesale rates on the state’s power exchange and sell it on to consumers at capped, regulated rates. Severe price spikes in the wholesale market, particularly during the summer of 2000, have meant heavy losses for them.

California’s woes began in mid-2000 when heat waves across the western USA strained California’s power system (see PEi October 2000, Analysis, p. 16). Harsh winter weather has brought no respite to the state, where inadequate generating capacity and an economic boom have combined to create this crisis.

Edison International, SoCalEd’s parent company, implemented ‘cash conservation measures’, withholding payments of $569m to the California ISO in mid-January. PG&E also withheld payments to generators, saying that it needed to preserve cash reserves in order to maintain customer services. These moves rattled financial markets and prompted credit rating agencies to downgrade SoCalEd’s and PG&E’s debt to junk status.

Pressure on the California ISO and the utilities then rose further in mid-January as the utilities came close to exhausting their quota of interruptions to power supplies for custmers under interruptible power supply contracts.

As hope of a federal-backed scheme to bail the state out began to look unlikely, state legislators outlined a plan that would help the utilities pay off their debts, now estimated to be around $12bn. Under the plan, the state Department of Water Resources would use its good credit rating to purchase power from generating facilities under long-term reduced-rate contracts and then sell the power to PG&E and SoCalEd. The utilities would use the profits made from selling the power to consumers to pay off their debts.

As PEi went to press, the bill was expected to receive the approval of the state senate.

According to Leslie Buttorff, Global Practice Leader of Utilities and Energy Services at Arthur D. Little, this scheme is merely a mechanism to survive and involves shifting money around and putting the burden on the state, rather than on the utilities’ shareholders or the end-consumers. This solution also means that the utilities effectively lose their assets, i.e. the hydropower plants that fall into this scheme.

Nevertheless, the utilities’ financial outlook is not good, and, says Buttorff, they will not be able to cover their losses by raising rates to consumers alone. In addition, the power crisis will carry on into the summer of 2001 and possibly longer, until California and its neighbouring states can add new generating capacity to its grid.

“This doesn’t have much to do with deregulation,” said Buttorff. “There is just not enough generating capacity in the [western USA] – with or without deregulation.”

If a more comprehensive solution is not found to help the stricken utilities, another option, according to Buttorff, is for them to declare bankruptcy. This would lead to a change in control but a schedule for the payment of utilities’ debts would be implemented. Although debt repayment would take a long time, this solution would, at least, give certain guarantees to utilities’ creditors.

The utilities are keen, however, to avoid bankruptcy. SoCalEd has welcomed a move by 23 banks not to demand the immediate payment of loans, helping the utility to avoid a bankruptcy filing until February 13.

But as California’s politicians discuss the future of the state’s power industry, the crisis is having a wider impact across the USA. According to Buttorff, some states are using the crisis as an excuse to halt, or at least slow down their own deregulation plans. Others, however, are looking closely at California’s power system to see where they can improve their own deregulation plans and avoid making the same mistakes.

The crisis is also having an impact in the financial community. Utilities used to be seen as a fairly safe form of investment, but investors are now likely to take a more cautious attitude, examining the status and structure of deregulation in utilities’ home states.

The road to recovery: an eight point plan

  • Encourage new build
  • Stabilize investment climate
  • Move towards more balanced utility supply portfolios
  • Encourage market mechanisms that elicit a demand response
  • Encourage market mechanisms that dampen the ‘boom and bust’ characteristic of the market
  • Avoid tinkering with the market
  • Allow for greater environmental flexibility
  • Free PURPA power plants to generate
Source: CERA

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