California crisis sparks U.S. re-regulation trend

California, which historically had the highest electric rates in the nation, was the first state to open its electric market to competition, in April 1998. The first year of deregulation ran comparatively well, or at least without widespread problems. However, a volatile mix of factors – including insufficient in-state power supply, dramatic increases in demand, rate freezes, and regulatory requirements that locked utilities into buying power on the spot market – all combined to reveal an inherently flawed competitive model.

As the state continues to sort through the mess, one resolution offered by the California legislature is a clear return to regulation. Bypassing the cash-strapped investor-owned utilities, the State Department of Water Resources has now been given the authority to purchase power to distribute to end-use customers. In addition, reportedly a state power authority will be established to build greatly needed power plants. Such measures recall the days before competition began in California, when the state held a firm grip over the electric market. In fact, one member of the California Public Utilities Commission recently proclaimed that: “Deregulation [in California] is dead.”

The California experience threatens to have tremendous impact on the rest of the country, and possibly the world. For over eight months, the eyes of the energy industry have been fixed on California and what its experience might represent for deregulation in other states. At last count, about 24 US states had adopted some sort of restructuring plan. However, many of them seem to be rethinking their steps, and have either postponed their start-dates for electric competition or suddenly terminated their restructuring plans altogether. The most common reason given is that the states want to avoid a path that they believe will ultimately lead to the mammoth economic and political problems that have nearly brought a collapse to California's energy industry.

NOT HERE, NOT NOW

The number of states retreating from deregulation appears to be growing. Nearly all of them have pointed to the extreme case of California.

  • A North Carolina legislative study panel announced that the California debacle has persuaded it to abandon plans to phase in deregulation in 2005-06. The South Carolina General Assembly also appears ready to delay indefinitely any action on deregulation.
  • Nevada Governor Kenny Guinn scrapped that state's September 2001 target date for deregulation, and stated that he "cannot and will not support deregulation" until he is assured that power supplies are secure.
  • Portland Mayor Vera Katz has called for Oregon regulators to delay the scheduled deregulation of electric markets for a year, saying California's experience shows that lifting controls can have unintended consequences. 
  • The New Mexico Public Regulatory Commission postponed the start of competition in the state from January 1 2001 to January 1 2002. Some state officials have considered a further delay for the start of competition in New Mexico, in response to California's price increases.
  • A group of lobbyists has urged West Virginia lawmakers to step back from plans to deregulate electric utilities this year, despite assurances from the state's public service commission that West Virginia will avoid California's problems.
  • Iowa recently decided that it won't even pursue the issue of deregulation during the 2001 session of its legislature, upon the urging of the state's largest utility, MidAmerican Energy.

This short list represents just the beginning of a growing number of states that have panicked against the California energy crisis and decided to terminate or delay their own restructuring efforts. The interest in returning to or maintaining regulated electric markets does not appear to be based on regional factors. From Alaska to New York, states in various stages of deregulation (and with high and low electric prices) now suspect that electric competition represents a dangerous business proposition.

Also illustrating this trend is a coalition of 23 low-cost energy states that have petitioned Congress to exempt them from participating in deregulation. The Low-Cost Electricity States Initiative (LCESI) has been in existence for over a year, but is gaining momentum again now that it can use California as an example of all that is wrong with deregulation. Some of these states only want to open their wholesale markets to competition, but not their retail markets. Others want to avoid deregulation altogether. As a lobbying group, the LCESI has tried to convince Congress that any federal restructuring law should be secondary to state plans, and that any mandate regarding state participation in deregulation will be appealed. 

On a national level, US Rep. Peter DeFrazio (D-Ore.) has said that the only solution to the country's power crisis is to get the “deregulation genie back in its bottle.” To that end, DeFrazio said he would introduce legislation in Congress that would reverse the 1992 Energy Act and re-regulate the energy industry. “This is not a tenable situation,” DeFrazio said. “Deregulation was a mistake. It never made a lick of sense.”

DeFrazio, a longtime critic of deregulation, believes that the electric industry can never be fully deregulated, and that the objectives of more competition and lower prices have been overshadowed by poor planning and greedy motives. As such, DeFrazio's bill would require that the Federal Energy Regulatory Commission regulate the rates of all electrical sales as it did before 1996. Existing contracts approved during deregulation would still be honoured.

OTHER STATES MOVE FORWARD WITH CONFIDENCE

At the other extreme, several large states are moving forward with their deregulation plans. Two – Illinois and Ohio – actually launched competition this year. Full customer choice began on schedule in Ohio on January 1. In Illinois, choice went into effect for commercial and industrial customers, while residential customers receive full choice in May 2002.

Both Illinois and Ohio have said they continue to watch California closely, but think such problems will be averted in their own states. Ohio points to the fact that its rate freeze won't be lifted for five years, which will protect residents from the kind of price spikes that have hurt customers in San Diego. Illinois customers will also benefit from a longer rate freeze and the fact that regulators in the state – having watched supply problems in California – allowed for incumbent utilities to divest of their power plants, but did not mandate it. Thus, importing power from the wholesale market won't be as necessary in Illinois as it is in California.

Pennsylvania, which deregulated its electric market only a few months after California, is generally considered the most successful competitive electric market in the United States, if not the world. The Pennsylvania Public Utilities Commission (PUC) remains confident that the problems experienced in California will not occur in Pennsylvania, due to two broad differences between the two states. First, in contrast to California, generation in Pennsylvania has kept pace with increasing demand. Second, under Pennsylvania's deregulation plan, rate caps have remained in effect after the first wave of industry restructuring had been accomplished. In addition, electricity demand in Pennsylvania has remained moderate, with supply keeping up with demand, according to Pennsylvania regulators. The result is that Pennsylvania is a net exporter of electricity, while California has become a net importer.

THE LONE STAR STATE CHARGES AHEAD

Texas, often considered the ‘great white hope' of deregulation, as it is the next largest state after California and Pennsylvania to open its market (on January 1 2002) continues to move forward with a great deal of confidence. Texas officials have maintained unequivocally that their state is much better prepared than California to offer competition. “I think our story is one I call the tortoise and the hare,” said Public Utilities Commission of Texas (PUCT) chairman Pat Wood. “We're going a little slower and I think we'll get to the finish line before anybody else.”

According to Wood, Texas' highest ranking power regulator: "You can't make anything look good if the fundamentals aren't good. I think that's the story in California – over-reliance on an intermittent resource like hydro and lack of provision for any additional type of supply like new power plants really make the fundamentals a rough story. In Texas, I think we are starting from a stronger position because we have an excess supply of power for the foreseeable future."

Wood noted that in Texas 22 power plants have come online since 1995, adding more than 5,000 MW to the generation picture. Another 15 plants and more than 10,000 MW are expected to hook up to the grid in the state by 2002. By contrast, California has only seen a few hundred megawatts of power added to its generation pool over the last few years. Another factor present in the Texas model and Pennsylvania but absent in California was a provision that gave incumbent utilities greater control over their own power supply needs, which should pre-empt any supply shortages. 

However, even Texas is feeling some fallout from California. Citing California's electric crisis as a concern, two Houston lawmakers filed legislation on January 24 to expand the state's authority to limit electric deregulation in Texas. The bill would also extend authority to the PUCT to delay the start-date of competition in Texas if that is deemed prudent.

ABUNDANT SUPPLY MAKES THE DIFFERENCE

As the debate over deregulation versus re-regulation rages on, one distinguishing factor present in successful competitive electric markets is the ability to rely upon in-state power supply. Carl Wood believes that the key to Texas' success will be a strong base of generation. Duke Energy's Rick Priory said that although California's problems could foreshadow similar difficulties in other states, the culprit is not deregulation itself but rather insufficient supply that cannot meet demand. The solution, Priory said, is to speed up approval of new power plants around the country.

This seems to be the general consensus among the leading players in the energy industry. California was a unique case study, full of its own inherent problems. Those states that rush to retreat from electric deregulation, which in many cases appears inevitable now that the national ball has started rolling, may be making a misguided conclusion. 

The executive committee of the National Energy Marketers (NEM) met in late January to respond to the California energy crisis. "The good news is that the factors which convened to create the California energy crisis are unique to California, and will not likely be replicated in other regions of the country," stated Craig Goodman, president of NEM. "The bad news is that construction of new energy supplies is not keeping pace with demand, and this could hurt consumers and local economies elsewhere. If California has taught us anything, it is that you can't expect prices to remain stable or decline without construction of new generation."

CONCLUSION

Of all the states mentioned, Pennsylvania comes closest to retaining the integrated utility model because it allows a generation company to serve the energy needs of its affiliated distribution company. California is the opposite extreme, having stripped its utilities of the ability to manage their generation supply. The problems associated with this approach have been well documented and continue to persist as California sorts through its energy crisis. 

Texas falls somewhere in the middle, and of course its competitive market has yet to become operational. Although Texas puts limits on its generation companies and retail electric providers (REPs), the ability to establish bi-lateral contracts does provide greater control over power supply management. California is considered a failed market. Pennsylvania is seen as the most successful model in the country, if not the world. Only time will tell whether Texas follows one of these two states, or carves out its own unique standard.

As other states chart out their own paths to deregulation, they can examine the California, Pennsylvania and Texas models, which serve as blueprints for the things to include, and not to include, in their own restructuring plans.