GUEST JUICE: Red Light, Green Light By CPUC member Geoffrey Brown

By Published On: June 30, 2006

Whenever I’ve talked about California’s energy markets, my starting point has been the energy crisis of 2000-01. The energy crisis has been the defining event of regulators’ tenures and our consciousness. It has shaped the agenda, which has been picking up the pieces after our bold experiment in deregulation went asunder. When I arrived on the California Public Utilities Commission in January 2001, Pacific Gas & Electric and Southern California Edison had multibillion-dollar deficits. Blackouts were occurring. Spot-market prices were at unprecedented levels. The state was compelled to spend its entire surplus buying electricity for the utilities to ensure reliable service and to stabilize prices. We did so by signing expensive long-term contracts. Between 1996 and 2001, the CPUC unhesitatingly embraced the concept of a competitive energy market. Under this regime, utilities would no longer be the monopoly retailers or wholesalers of electricity. The underlying theory was that while retail distribution and transmission were largely natural monopolies, the actual generation of electricity from plants could be a competitive market. The abiding belief was that competitive firms could build cleaner, cheaper power plants because they were not part of a docile, regulated subculture that “gold-plated” everything in the expectation of guaranteed high rates of return. In 2001, in response to extortionate prices and the impending bankruptcy of the major investor-owned utilities, the Legislature acted. It effectively repealed previous statutes deregulating prices. It established extraordinary protections for customers within 130 percent of their residential baseline. Gradually, much of the pre-1996 “cost of service” paradigm of regulation has reemerged. The CPUC exercised its authority and ended future direct-access connections. Utilities gained some additional generation. Stability, of a sort, returned. But, regrettably, we are left with a system no one (right, left, or center) would design from scratch. Instead, we are consigned to a hodgepodge of pre-1996-type regulation with an overlay of heavy dependence on merchant generation. Moreover, we still have a sizable direct-access market for customers whose status was grandfathered in after the suspension of direct access in September 2001. The resultant electricity market allows for only limited competitive forces. Utilities do require requests for offers (RFOs) to supplement their self-produced generation, and presumably they will choose on a competitive basis. However, this point is debatable given that utilities have or may have nonregulated generating affiliates whose bids they are likely to favor. The major utilities are currently burdened with long-term contracts that the state of California negotiated in 2001. These contracts, combined with native generation, represent the bulk of their supply for the next five years. The end result is that we don’t have either real competition or low prices. While the restructuring process did not take proper account of reliability issues, we have yet to take proper account of the creeping escalation of rates. Our renewables portfolio mandate, our solar initiative, our resource-adequacy requirements, and our increasing receptivity to utility costs will necessitate increasing, not reducing, rates, even as expensive state contracts run out. At the same time, we have not given incentives to utilities to become more efficient. Instead, we have shown great liberality in their general rate cases. The question is whether the public will tolerate it over the long term, or whether the public will resort to draconian, possibly destructive legislation to pull rates down. Utilities now must resort in part to merchant generator contracts to meet their customer demand. They must now meet resource-adequacy requirements by having 115-117 percent of their anticipated load tied down a month ahead. This further increases their reliance on merchant generation, because there is no practical way that they can build or acquire generation with such capacity in the foreseeable future. It now appears that with our new resource-adequacy requirements, the CPUC may be compelled to impose further surcharges. However, Wall Street repeatedly tells us that generators cannot borrow money for a new plant if they lack a long-term contract to provide service. And without generator competition, investor-owned utilities will exhibit the same monopoly behavior that necessitates a regulatory commission. Hybrid market forces are widely believed to discourage investment in the independent generator plants that we need for both reliability and stable prices over the long term. Regrettably, eliminating local market power, price caps, and must-offer obligations together probably would, in the short term, have the effect of raising electricity prices. Nonetheless, to encourage the building of new plant, electricity prices paid by utilities, if they reflect real investment costs, may have to go up. And they will soon be reflected in increased rates. For the foreseeable future, our governor and Legislature cannot muster the needed consensus to markedly alter our hybrid system. The investor-owned utilities, generators, and municipal utilities each have enough veto power to prevent anything but minor incremental change. What I see ahead are the following: – A tightly managed energy market governed largely by the CPUC with limited wholesale competition for utility contracts. – A hybrid market without a clear direction emerging in the near term as to whether native or merchant generation is to be favored. – A retail market constrained by surcharges (to prevent stranded costs on the part of the utilities). – Utility rates remaining high to meet social and environmental mandates. – A limited number of communities choosing municipalization or community aggregation. When you inherit a conceptual muddle, you muddle through, a green light here, a red light there. There are many who urge the bold stroke, e.g., going back immediately to full utility domination of the market, or reinstituting direct access on an unlimited basis. I prefer purposeful and incremental steps that emphasize transparency, efficiency, and stability on the grid. As we decide on our future direction, I want to be in a place where we can get out of trouble without getting clobbered. – Geoffrey Brown is a member of the California Public Utilities Commission. A version of this editorial was given as a speech on June 23 to the Western Power Trading Forum.

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