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Sudden Power Glut Puts State in Costly Bind

Surplus bought under long-term contracts was resold at a $46-million loss in July. Paradoxically, if trend continues, higher usage could be encouraged.

JERRY HIRSCH, Times Staff Writer

California may be facing a persistent, escalating glut of electricity as a result of its buying too much power through long-term contracts, according to energy experts and a Los Angeles Times analysis.

The surplus, projected to peak in 2004, could pose a costly burden to ratepayers unless electricity demand rises substantially, according to The Times' analysis, which reviewed the state's power purchases and projections for demand over the next several years. Just last month, the state racked up $46 million in losses after selling surplus power for one-fifth the price it paid. If that rate is sustained, the deficit could reach as much $500 million in the next year alone.

And if the surplus grows, the state could even find itself in the paradoxical position of encouraging Californians to use more electricity to help the state avoid selling large amounts of unused power at a loss.

The specter of a longer-term power surplus belies California officials' portrayal of the recent electricity glut as only a short-term phenomenon resulting from a cooler-than-normal summer and strong conservation efforts.

To be sure, factors such as weather, economic growth and power plant breakdowns could bring the state's bet on energy into balance with demand. Or the state could pursue other measures, such as buying out the contracts or forcing utilities to reduce generation.

State officials, such as S. David Freeman, former head of the Los Angeles Department of Water and Power (who sources say will be formally named to chair a new state power agency), defend the power purchases. Freeman argues that purchasing a "healthy surplus" busted the price spike of earlier this year and will protect against blackouts in coming years.

He said ratepayers have always paid to maintain an electricity surplus. Before deregulation, however, the cost of that surplus was reflected in what the utilities paid to keep idle plants operational so they could be fired up to meet sudden increases in demand. The cost of such standby service was included in rates.

Yet utilities and others have begun signaling potential problems in the state's power-purchasing strategy as it becomes apparent that the surplus could grow in coming years.

Looking forward to 2004, the state has contracts to purchase 43% of the electricity California's three large private utilities need for their combined 10 million customers. But according to current trends, the utilities need the state to supply only about 35%, The Times' analysis shows. The rest can be handled by the power plants they own and through their existing contracts with independent generators.

In documents filed with the California Public Utilities Commission last week, San Diego Gas & Electric said the state might have overestimated what it needs to purchase for the San Diego service area by more than 25%.

California entered the power business in January, when a surge in electricity prices and regulatory limits on rates created billions of dollars in losses for two of the state's biggest utilities, Pacific Gas & Electric and Southern California Edison. The losses pushed PG&E into bankruptcy. Edison has avoided seeking protection from its creditors in Bankruptcy Court, but is technically insolvent.

While it purchased electricity for the two utilities and SDG&E, the state, through its agent--the Department of Water Resources--started negotiating longer-term contracts with private suppliers, signing deals that could total $40 billion in purchases, mostly over the next decade.

Consumers' rates were increased in June by 3 cents per kilowatt hour. A portion of the increase will fund the contracts, as well as payments on an expected $12.5-billion bond issue to repay the state for its energy purchases dating back to January.

Nonetheless, Gov. Gray Davis and his energy officials will face uncomfortable policy choices if the state has guessed wrong and purchased too much power without escape clauses in the contracts, as nearly every energy economist, consultant and power company official who talked to The Times believes.

One fix would be to encourage consumption to eat up the surplus.

That's what happened during an energy glut in the 1980s, when utilities cut back conservation incentives and obtained rate changes that encouraged usage in an effort "to consume their way out of the mess," said Bill Marcus, an economist with JBS Energy Inc., which consults for the Utility Reform Network consumer advocacy group.

PG&E has already broached one rate change suggestion that could result in higher consumption: an increase in the baseline allotment, or amount of power a household can purchase at the least expensive rate.

Other ways to deal with the surplus could include walking away from a portion of the most expensive contracts, a move that would probably spark protracted legal battles; paying generators to cancel contracts; encouraging suppliers and utilities to close plants or reduce generation; or simply absorbing the losses.

"We are all on this huge learning curve for electricity markets," said Doug Larson, executive director of the Western Interstate Energy Board, the energy arm of the Western Governors' Assn. "We have never gone from a shortage to a surplus in an environment where market forces set the prices."

In signing the long-term contracts, the Department of Water Resources bet that demand for power would grow about 2% annually and that an electricity surplus would develop slowly.

That leaves the state exposed if demand grows less than the agency's estimate, leaving it with too much juice. The state's financial risk expands if a power surplus grows more quickly than predicted, depressing spot market electricity prices and cutting off options for how the state can dump its extra power.

The state's energy surplus looks to peak in 2004, but could still be substantial for several years after that.

"Some percentage of the supply will be optional or on standby, but clearly 2004 is when we have the largest supply," said Pete Garris, the Department of Water Resources' chief energy scheduler.

Complicating the state's strategy are the higher rates consumers are now paying and a power plant building boom that is expected to push electricity prices down as thousands of megawatts of new generation in California and the West come on line over the next several years.

Energy economists say that current higher rates have already induced consumers to conserve, causing a change in behavior that will probably continue even with an energy glut. Ratepayers, they say, won't see the benefit of lower energy prices because they will be locked into paying for the cost of the state's contracts and its prior purchases.

Even while the state was selling surplus power, customers in the areas served by its three large utilities used 3.5% less electricity last month than a year ago, after adjusting for weather, according to the California Energy Commission. Peak demand--when consumers are using the most electricity--was off 9.1% after adjusting for a cooler July than a year ago.

Certainly, some of the conservation is transitory, a result of Californians embracing their civic duty to see the state through its expected shortage. Also, the economic slowdown has contributed to less usage compared with a year earlier.

Yet higher electricity prices have prompted businesses and consumers to take long-lasting measures to reduce power consumption, everything from replacing household refrigerators with more efficient models to upgrading lighting systems at businesses, energy economists said.

"Commercial and industrial customers account for two-thirds of the power use in this state, and almost everything they do to reduce electrical loads are durable, long-term investments," said Robert Michaels, an energy consultant and professor of economics at Cal State Fullerton.

Freeman, the chief architect of the governor's energy policy, said locking in the power surplus was done by design and is a necessity. Reserves of up to 20% are what is required to ensure a reliable power system, he said.

"This is a very small cost compared to what a blackout does to the economy," he said.

Others argue that the state should have simply waited for the power surplus to build before signing the volume of contracts it has reached with generators.

Already, nearly 2,000 megawatts of generation capacity will have come on line in California by the end of this summer, an amount equivalent to about 5% of the current peak demand of about 40,000 megawatts in the territory served by the three big utilities. Facilities capable of producing more than 3,000 additional megawatts are under construction and slated to begin operation in the next year, according to the California Energy Commission. Another 2,500 megawatts is scheduled to come online in 2003. Meanwhile, the commission is reviewing requests by generators to build plants for an additional 5,000 megawatts.

In addition, neighboring states such as Arizona are building more plants. With transmission line upgrades, some of this added electricity could be available to California.

"A remarkable amount of plants are in the process of being built," said energy consultant Michaels.

However, not all the new plants will boost megawatt capacity, because some will replace dated or polluting facilities that will be shuttered.

Nonetheless, developments of the past 18 months have demonstrated that the often confounding and unpredictable nature of the energy market makes accurate forecasting exceedingly difficult.

In May, the North American Electric Reliability Council predicted that California would see 260 hours of blackouts this summer, yet none has developed. Cool weather--which took many meteorologists by surprise--along with conservation efforts, a slowing economy and new power plants upended many of the utility industry group's assumptions.

Just a couple of percentage points of error in either direction can make the difference between a price-spiking shortage and a depressed market of surplus power.

PG&E says it doesn't plan to cut back its operations because the Department of Water Resources might have guessed wrong. In a statement, PG&E said the state will have to bear the costs of its mistakes.

Officials at Rosemead-based Edison said it's too early to comment on what might happen.

But Gary Ackerman, executive director of the Western Power Trading Forum, a group of electricity sellers, said the state agency's best option is to get generators to agree to let the private utilities take over the contracts, "where they can be managed in a professional manner."

Because the utilities control an entire "portfolio" of power generation and sources, they are better equipped than the state to manage surplus power with limited financial losses, Ackerman said.

But before any of the utilities would accept the contracts, the state would have to guarantee that they could recover their costs.

http://www.latimes.com/news/nationworld/nation/la-081101glut.story

-- Martin Thompson (mthom1927@aol.com), August 11, 2001

Answers

Back in January, I posted a prediction that, if the "Y2K+1" variant of the Leap Year Date Bug was the primary cause of the power crisis that suddenly escalated in January 2001; that the electricity shortage would mysteriously disappear just as unexpectedly and mysteriously as it appeared.

Of course, the economic slowdown, which is far greater in intensity that is generally being portrayed; is a factor also; so this occurrence, timely predicted, still doesn't prove "Y2K+1" was the cause beyond a reasonable doubt --- just by a preponderance of the evidence.

Apparantly the CA State Water Dept., nor even the I.S.O., apparantly was aware of the impact of "Y2K+1" on power plant failure rates; because if they had been, the long term contracts would not have been negotiated so desperately --- the State and utility electric experts would have made the same prediction; and thus adopted a strategy of "riding the storm out" until the "Y2K+1" failures abated.

With this strategy, a TEMPORARY but DRAMATIC rate increase in January 2001, combined with public disclosure that "Y2K+1" is causing the shortage, that would abate in due time; followed by bankruptcy of all utiltity companies (so the "gouge" part of the high spot rates would be "haircut" in bankruptcy court) would have been the correct course of action.

The bottom line conclusion is that the Y2K Cover-Up will cost California ratepayers and taxpayers untold sums of money for many years to come.

-- Robert Riggs (rxr.999@worldnet.att.net), August 11, 2001.

I have always been, first and foremost, a free enterpriser, one who believes in deregulation wherever possible. But, I must admit, because electricity cannot be stored, but sold as produced, it is probably the exception to this rule. The old system, where onus was put directly on the utilities to provide power, and retain backup facilities for the purposes of controlling spikes and downgrades, was the best.

Power generation close to the point of usage is much more practical than, say, some customer in California is a greenie, and therefore specifies that his power must come from a greenie provider in Vermont. This enables so much waste in long-distance transmission as to be patently ridiculous.

The only way deregulation could possibly work in this business of electricity generation is if the entire industry were entirely deregulated and ratepayers were thrown to the wolves of the spot market.

-- Wellesley (wellesley@freeport.net), August 11, 2001.