The California Energy Crisis
Delivered to the American Public Power Association
Senator Dianne Feinstein
February 6, 2001

Let me just take this opportunity to thank everyone for coming to Washington. You come from many different places and this really is an incredible capitol.

I hope for those of you who are first timers, you have an opportunity to see things other than the Power Association Conference. There are many beautiful monuments and other interesting things to see that are reminiscent of our history and the “specialness” that has made us the American people.

I am almost reluctant to speak to you today because I am not a power expert, so what you’re getting today are simply my observations of the Energy Crisis in California. Over the past months, I have taken a really fast course on energy, and specifically, on electricity.

I thought what I might do today would be share some of my observations on the California electricity crisis; how we got into this situation, and what it may very well take to really get out of it.

AB 1890

It all really begins with a piece of legislation called AB 1890, which was passed in 1996. This was a deregulation bill, and it is my understanding that virtually everyone came together in support of this bill–including the utilities, the generators, and the consumer groups.

The bill was approved very quickly at the end of the session--I’ve been told without even a hearing--and was signed by then-Governor Pete Wilson.

This bill created the current flawed market structure: it deregulated wholesale power, but it regulated the retail side. It also provided that 95 percent of California’s power had to be on the “Day Ahead” or the “Spot Market.”

That was fine when the supply of power was plentiful. But as the supply of power shortened, spot prices rose to unprecedented levels, and those costs could not be passed on to consumers.

The result is that California’s large investor-owned utilities are now on the brink of bankruptcy. They’ve been forced to purchase power that averages $300 per megawatt hour (30 cents per kilowatt hour), while they can only pass it on to consumers at about $75 per megawatt hour (7.5 cents a kilowatt hour).

This has been going on virtually all year with highs as much as $3,000 a megawatt hour (see chart). But no matter how high the price, the utilities have only been able to pass on $75 of that cost.

So to date, their debt is anywhere from $10 to $12.5 billion. They have severe difficulty in obtaining the credit they need to be able to make forward purchases.

I believe that the State must either deregulate the market completely or move toward re-regulation.

If you deregulate the retail market, you send a clear price signal to consumers, you provide them with strong incentives to cut their energy use--preventing blackouts and lowering prices.

If you move toward re-regulation, the state once again takes control of generation, transmission, and distribution systems and eliminates the ability of out-of-state generators and marketers to “game the market” and charge incredibly high prices for power.

But, with the current mix of regulation and deregulation, the current flawed structure continues and with it, a shortage of power, which may well result in further blackouts, and may well destroy the financial stability of the investor owned utilities and, perhaps, even this economy of this very large state--the sixth largest economy on Earth.

As a result of the current hybrid system, California’s in its 23rd straight day of stage 3 energy emergency. This means that California’s energy reserves have remained below 1.5 percent since the middle of January.

In theory, the solution to the crisis is simple: either increase supply, or decrease demand, or do some of both.

In the real world, however, that’s much more difficult to accomplish than it sounds.

Fixing the Market

As I’ve already mentioned, generators are charging exorbitant rates for power, which has led some to suspect that they are gaming the market.

I don’t know whether they are or they aren’t-- the jury is still out. But supporting that suspicion, economist Paul Joskow and Edward Hahn of MIT released a report on this past January 15th, and let me read from that report:

“The high wholesale electricity prices observed in the summer of 2000 can not fully be explained as the natural outcome of market fundamentals in a competitive market since there is a very significant gap between actual market prices and competitive benchmark prices that take account of these market fundamentals.”

“Moreover, there is considerable empirical evidence to support a presumption that the high prices experienced in the summer of 2000 reflect the withholding of supplies of the market by suppliers (generators, or marketers). We base these conclusions on the result of...[our] Competitive Benchmark Price Analysis...[and the] Capacity Withholding Analysis.”

For this reason, I believe the most critical and immediate step that can be taken to address this crisis is to fix the market, which is so clearly broken.

California is currently attempting to fix the market by negotiating bilateral contracts with generators, on behalf of the utilities, to cover up to one-third of the state’s energy demand for the winter, and that was the Governor’s first internet auction of power.

It is my hope that this will reduce dependence on spot prices for power and build more stability into the system.

Furthermore, the State has approved in emergency session, Assembly Bill 1X last Thursday, which authorizes the State to enter into long-term contracts to buy and sell power.

The bill also appropriates $500 million, in addition to the $400 million already spent by the state, to fund purchases on the spot market until long- term contracts provide California’s power needs.

The session also passed legislation to authorize the state’s Department of Water Resources to sell $10 billion in revenue bonds to finance the bilateral deals.

As a result, the State goes into power really in a big time way.

The State also has included a provision for charging power consumers higher rates if they exceed a baseline or minimum power allowance of more than 30%.

This is really the first consequential effort to begin to fix the regulated, retail end of the market, whether it will be enough, or whether it will ever even get done, I do not know.

The Federal Role

So, what is the role of the federal government in all of this?

I believe the federal government has a discreet role to play. The most important thing it can do is provide a period of interim price stability and prevent price gouging until this market straightens itself out.

I believe it is going to straighten itself out one way or another, but in the interim, we have an extraordinarily volatile situation.

The FERC, if it finds that rates are unjust and unreasonable, has the authority to fix rates for power.

But even after finding that the rates are unjust and unreasonable, it has refused to set rates that are reasonable--so the broken market continues with the volatility attached to it.

Now, the FERC had imposed a price cap of $250 on energy purchases made by the ISO. And when the price cap was taken off, the market erupted. But they took it off at a time of intense shortage and prices soared
So when Sempra energy tells me they’re buying spot power at 3 a.m. in the morning at 500 times the normal price, you know something is wrong with the market.

I have introduced legislation providing another option. It would give the United States Secretary of Energy the authority to set reasonable cost-based rates.

This includes a profit margin and a cost margin for power generators if FERC finds rates to be unjust and unreasonable and fails to take necessary action to fix the market.

Or as another option, the legislation would give the Secretary of Energy the authority to set a temporary or interim price cap on the Western region.

Eight governors of the west have already indicated support for this concept.

Additionally, the legislation would give a governor the ability to opt out of that cap if they do not want the state to participate in it.

The bottom line is that until the balance between supply and demand is restored, California is going to continue to face shortages and volatile prices.

Increasing Supply

Now let me say a few words on increasing supply. Since 1990, California has added only 2,670 megawatts of additional electricity, while consumption has grown by 14.7 percent in the last 10 years in California.

As a result, California is having trouble meeting its peak demands. During the winter, that’s approximately 30,000 megawatts a day and in the summer, that level increases to 47,000 megawatts a day.

In fact, the California ISO is reporting that during this summer, California may face an energy shortfall of 2,000 - 5,000 megawatts a day. In June, this shortfall may well reach 7,000 megawatts (See chart).

To address this shortfall, it’s necessary to increase the supply of energy.

The State has already approved 9 out of its 25 additional power plants, which will generate enough energy to power six million households (that’s about 6,278 megawatts), but the rub is that these first 9 plants won’t be online before the end of 2002, so you can see that more needs to be done in the short term.

I think it’s critical for California to do the following:

• Expedite its power plant siting and construction process. I’ve had generators tell me that it takes as much as 6 years to get a permit. That clearly can not continue, so California really has to assume its emergency power and even override local jurisdictions;
• We have more than 30 closed military bases, and I think we need to take a very good look at them and see which are suitable for power plants;
• We’ve got to greatly improve the transmission capacity in the state. Currently, you cannot now transmit power from South to North;
• We have to reduce any environmental obstacles that might be in the way. Today, I am not aware of any incidentally that are in the way, it’s just a very laborious permit process, with agency after agency of bureaucratic overlay that lengthens the process;
• I think we need to ensure that all large buildings, hospitals, hotels with emergency generators, or additional generation capacity, should use these generating facilities in the interim; and
• We should explore the feasibility of bringing in portable generators on barges or flatbed trucks, which was done last summer in Chicago and may well have to be done this summer in some California cities.

To reduce demand for energy:

• I am urging the Secretary of Energy to require that all federal agencies in California reduce energy consumption by 15 percent;
• I have also called upon the Bush administration to fully implement new energy efficiency rules for air conditioners or other appliances, with the recognition that its going to take some time to get in place;
• Last week, Senator Bob Smith (R-NH) and I and 5 of our colleagues introduced legislation to provide tax incentives for energy efficient, homes, buildings and schools, to encourage people to do what they must do in that area;
• And we are also introducing legislation to provide tax incentives for the development of wind and solar
  energy.

On the state level, the Governor recently announced a $800 million energy conservation program to reduce California’s peak load demand by more than 3,700 megawatts, and as I said, the legislature approved that baseline conservation rate, which the PUC should begin to put in play soon.

It’s clear to me that the State is going to have to increase rates--as painful as that is--but do it in a way that gives Californians advanced warning and lets them know what the options are.

That way, Californians can make an informed decision whether to:

• Replace an old refrigerator with a new one;
• Get a smart meter to help them conserve energy;
• Turn computers off at night; and
• Take other steps to reduce their energy consumption.

For those who say that this is just California’s problem, I want to take a moment and disabuse them of that notion.

The same problem that has caused this crisis in California could well cause it in other states. And I want to tell you why.

Believe it or not, California has added more generation in the past decade than any other state in the Western Region. We have added 2,670 megawatts.

At the same time, the demand in these 10 other states has actually grown by a greater percentage than it has in California. So we are in this together, and I think California has just reached the cliff first.

The Impact on the State

The impact on our State has been tremendous.

We’ve spent more than $600 million over the past month purchasing electricity, and that number is about an expenditure of $40-50 million a day.

The state is suffering from lost productivity. A recent study by the Los Angeles County Economic Development Corporation has concluded that California’s few rolling blackouts and interrupted service has already taken an estimated $1.7 billion in direct and indirect costs on the economy.

Last summer, when I went down to San Diego, I witnessed this firsthand.

• Families had energy bills that doubled and tripled quickly;
• Small businesses couldn’t afford to operate; and
• Men and women were being laid off from jobs because their company couldn’t pay the bill.

So, my view is that if the Western Region doesn’t come together to help solve this problem were all going to have these problems. So I think we need to be partners.

Misperception

On that note, I want to clear up a misperception about California.

There are some who believe that as a result of the Energy Department’s Emergency Order, California is taking water and power from other states in the region and causing consumers in these states to pay more, while at the same time leaving reservoir levels insufficient to support salmon and other fish.

In fact, this emergency order only directs that generators provide surplus power to the State. None of this power would have otherwise been used.

In addition, this order has nothing to do with Bonneville Power Association (BPA). BPA is providing the States with power on the basis that they receive two megawatts for every megawatt delivered.

I want to quote from and op-ed written by Stephen Wright, acting BPA Administrator:

“Since this current set of exchanges that began in November, California has returned 170 percent of the power BPA has sent it and it plans to return the full 200 percent.”

“Thanks to the extra megawatts California has sent, we do not need to run our hydro systems as hard and we do not need to purchase that amount of energy in a very expensive market. The exchange is a triple win. It saves our energy, it saves our fish and it lowers all of our electricity bills.”

While I recognize that ratepayers in the Northwest have faced increased prices, this is a result of the dry season and not as a result of the California crisis.

Conclusion

Let me conclude:

The big question before California is that a hybrid system won’t work. You can’t deregulate on the wholesale side and keep retail prices regulated.

So the dilemma facing the State is this: either move to a deregulated market and do so entirely over the next 3 years or re-regulate entirely.

It is my belief that the piecemeal actions taken thus far buy time for this kind of serious look, but these actions do not solve the fundamental problem

You can’t be part fish and part horse; it’s one or the other.