Calif. Steps to Solve Power Crisis May Backfire April 4, 2001 11:06 am EST

By Joseph Silha NEW YORK (Reuters) - California's efforts to solve its power crisis before summer electricity demand hits may end up backfiring, coming back to haunt the Golden State for years, industry analysts said.

California took a big step last week by boosting rates paid by customers, but other elements of Gov. Gray Davis' plan, such as locking in long-term electricity prices and taking control of the transmission grid, may prove costly.

The state's rapidly growing population, the failure to build new power plants over the last decade and a flawed 1996 electric deregulation law that froze retail rates helped bring the grid almost to its knees in the winter. Worse blackouts are expected this summer, when air conditioning demand peaks.

"Raising retail prices was very important. Customers need to see the real cost of power, and it's the most cost effective way to achieve conservation. But I'm not sure they've done everything to get all the supply available," said Lawrence Makovich, a senior director at Massachusetts-based consultants Cambridge Energy Research Associates.

With the state facing a power shortfall of as much as 6,800 megawatts (MW) this summer, enough to light 6.8 million average U.S. homes, Makovich said higher retail prices could reduce consumption by 2,000 MW, a step in the right direction.

IS STATE TAKEOVER THE ANSWER?

Makovich and other analysts said California's plan to acquire utility transmission assets will only further distort the market.

"Everyplace else they're striving to create an independent power system and here you could have the state as the biggest buyer of power and in control of the transmission grid," Makovich said, referring to the proposed state takeover of the transmission grid now owned by utilities.

With the state's two major utilities -- PG&E Corp's Pacific Gas and Electric and Edison International's Southern California Edison -- facing about $14.3 billion in debt, the state already has become the chief buyer of power.

The proposed state takeover of the electricity grid is designed to put badly needed cash into the hands of the nearly bankrupt utilities who have been unable to recover the soaring cost of wholesale electricity from retail customers due to price caps imposed by the 1996 deregulation law.

"It's bad policy to have the state involved in the power business. It will either discourage investment or raise the cost of doing business, and how will it improve the amount of energy that will be delivered this summer?" said Alan Stewart, a director at New York-based consultants PIRA Energy.

California is expected to float $12-$14 billion in bonds this year, the largest issue in state history, to pay for emergency power purchases, financing that will add up to more costs for consumers.

Moreover, analysts said state control of the power grid could lead to higher transmission costs if California tries to recover profits from suppliers who hold expensive long-term fixed-price contracts with the state.

LONG-TERM CONTRACTS MAY BACKFIRE LATER

In an effort to secure future electric supplies, California did something denied to utilities under its deregulation law -- commit to some $43 billion in wholesale power supply contracts, some of which extend 10 years or more.

But analysts, noting the deals were cut at the height of a power shortage, said the agreements could saddle consumers with some very expensive power once new generation comes on line in 2002 and 2003 and rebalances the market.

"The state has entered into a large set of long-term power purchase contracts at the top of the market. It will not be long before we see buyer's remorse," CERA's Makovich said.

And while Davis' proposal to streamline the approval process for locating and building new power plants was generally seen as positive, analysts said the move came way too late to solve this summer's problems.

"I think they should have seen this coming for a long time. The problem is that environmentalists have driven the politicians and as a result, no new power plants were built," said Ron Barone, managing director at UBS Warburg in New York.

Utilities also held off building new plants in the 1990s while they tried to figure out the shape of the new market under deregulation.

California has not built a major power plant for more than a decade, though new plants are now under construction and some are expected to link to the grid later this year. But most will not be on line to help keep the lights on this summer.

Meanwhile, despite a backlash from environmentalists, steps are being taken to reduce emissions regulations so that older, less efficient plants will be available to meet peak air conditioning demand this summer.

"The root of the problem is the lack of generation. It's a real crisis and they should bypass the normal processes by creating an emergency ability to fast track new generation," said Paul Freemont, electric utility analyst at Jefferies and Co. in New York.

But in an effort to fix a flawed deregulation law, some analysts fear the state may go too far, toward re-regulation.

"If this crisis drives California back to the heavy-handed regulation that launched deregulation in the first place, or to an expansive public power authority, then the state is likely to find its electric sector becoming increasingly inefficient and expensive, and very much disadvantaged compared to regions with properly structured power markets," CERA's Makovich said.

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-- Martin Thompson (mthom1927@aol.com), April 04, 2001