I hijacked this from Doug's posting on LBO to get Gene Coyle to comment on this. Wall Street Journal - May 11, 2000 Deregulation and Heavy Demand Leave Electricity Providers Short for the Summer By REBECCA SMITH Staff Reporter of THE WALL STREET JOURNAL Here's a sobering thought for the first summer of the new millennium: America is running short of electricity. In pockets of the country, from New York to New Orleans, and from Chicago to San Francisco, shortages are likely to strike as the days lengthen and the temperatures rise. The East Coast got a taste of what's coming when a surprise heat wave hit this week just as many power plants were shut down for spring maintenance. Utilities and grid operators temporarily cut voltages, called on big industry to conserve and asked homeowners not to open their refrigerators too often. "There will be outages and brownouts this summer," says Energy Secretary Bill Richardson. "America is a superpower, but it's got the grid of a Third World nation." Consumption and Confusion A decade-long economic boom is one reason for the strain. Americans have spent heavily on juice-guzzling appliances, boosting demand for electricity faster than capacity is being added. The other big reason is deregulation. Loosening the rules that governed how power is generated, supplied and sold was supposed to spur competition and efficiency. But the four-year-old deregulation process has spawned more confusion than improvement so far. The numbers are stark. The U.S. has generating plants capable of cranking out 780,000 megawatts of electricity on a summer's day. But it will take a minimum of 700,000 megawatts to power the nation this summer, according to estimates by the Department of Energy. That leaves little surplus, and in any event, the power can't always get where it's needed most. The buffer of surplus electricity has been whittled by 60% over the past decade. In the old days, utilities generated electricity and delivered it to customers in exclusive territories. To protect consumers from gouging, rates were regulated. The result was tremendous reliability but also inefficiency and waste. Deregulation, now under way in 24 states, upsets that structure and allows new players -- some affiliated with utilities, some not -- to build power plants and sell electricity. Prices are set by competitive markets; risks are borne by investors, not ratepayers. At the same time, utilities are surrendering control of long-haul transmission lines to new nonprofit operators whose job it is to ensure fair access to the grid -- the multistate system of high-voltage lines. The result: a national electricity system that is vulnerable to disruptions caused by equipment breakdowns and human error as newly established regional grid operators assume responsibility for much larger areas than those formerly overseen by individual local utilities. For big energy users, who expected deregulation to bring lower prices, not lower reliability, it has been a worrisome experience. Oracle Corp., for one, isn't taking any chances. Shaken by a huge power failure in August 1996, the big software company has spent more than $6 million to build its own electrical bunker, complete with a substation and generators capable of supplying thousands of servers with electricity at its headquarters in Redwood Shores, Calif. While giant manufacturers have done this for decades, other commercial users are starting to follow suit. "What's the self-sufficiency worth to us?" asks Jeffrey Byron, Oracle's energy director. "Millions of dollars per hour. It's so important, you almost can't calculate the value, to us and to our customers." The problem facing Oracle and others isn't likely to go away soon. The incomplete nature of deregulation has produced planning paralysis that could have long-term consequences. Old-line utilities shied away from adding capacity, worried they wouldn't be able to recoup their investments in a truly competitive energy market. Independent generators, who were supposed to fill the need, mainly held back until they could figure out which markets would be the most lucrative. Regulators, who were often confused as to whether they should be enforcing the old rules or helping tear them down, let things slide. The upshot, today, is plenty of power plants on the drawing board, but few actually built. Roughly 162,000 megawatts of new generation has been announced -- including a doubling of New England's power-plant capacity -- but much of it will never get built, and it will be years before enough is added to have a substantial impact. Utilities in states that haven't deregulated earn their return based on the amount of equipment they put into service. The joke used to be that the utility industry was the only one where you could boost profits by buying new furniture for your office. The incentive system has changed in deregulated states. In some, such as California, some generators receive subsidies for remaining on standby even when their power isn't needed. But these kinds of deals are considered temporary and companies that want to build new plants can't be sure that they will benefit from similar arrangements. That means new plants primarily are getting built where the markets look most profitable. That's not necessarily where needs are the greatest, since an elaborate system of price caps sometimes suppresses the rising prices that signal scarcity. One City's Problems San Diego is a good illustration of how deregulation isn't working out as expected. The flourishing city, home to cell-phone supplier Qualcomm Inc. and a slew of other high-tech firms, doesn't have enough local generating plants to meet its growing needs. It also is poorly connected to plants elsewhere in the region. The transmission lines simply aren't numerous enough to allow San Diego Gas & Electric Co., a unit of Sempra Energy Inc., to import enough juice, according to California Independent System Operator, a nonprofit corporation that manages the state's electric grid. That leaves San Diego dependent on the two existing generators, Dynegy Inc. and Duke Energy Corp., that recently bought the plants from San Diego Gas & Electric. More plants are needed, but many generators want a special price zone set up before they will build within San Diego, because its transmission problems limit their ability to sell power outside the area. Economists believe, however, that such a small market wouldn't have enough bidders to produce competitive prices, says Severin Borenstein, director of the University of California Energy Institute at Berkeley. Because demand for electricity isn't as price-sensitive as it is for most commodities, generators could raise prices by almost 30-fold whenever demand peaks, while still staying within a statewide price cap. That's because the generators would know that little electricity could flow in from the outside and drive down prices, Mr. Borenstein says. Other generators say prices are just one of San Diego's problems. Under California's tough environmental rules, every molecule of nitrous oxide emitted by a new industrial source must be offset by nitrous-oxide reductions from an existing source. PG&E Corp., the only company that is trying to build a new plant in San Diego, has rummaged around for such offsets for the past two years. What it has come up with is pretty extreme. Since San Diego has little in the way of smokestack industry, PG&E is negotiating with private transport companies and the city government to convert dozens of garbage trucks and harbor boats from diesel to cleaner-burning liquid natural gas. That should produce enough offsets for it to build a 500-megawatt plant a few miles from the Mexican border. "This'll work for us, but barely," says Chris Iribe, president of the western region for PG&E's National Energy Group. "I have no idea what the next guy is going to do when he wants to build a plant. There's nothing in the air-quality rules that sees any special value to a power plant. It's treated like any other factory." While the situation in San Diego is tough, it isn't unique. Under the old system, energy surpluses provided a good buffer against occasional mistakes. But now, what would have been a minor setback in the past can be devastating. A 10-Year Snapshot Take weather forecasting. Entergy Corp., a New Orleans-based utility for four Southern states, belatedly jettisoned a software program based on 30-year averaging that understated the effects of global warming. Expecting cooler weather than what it experienced last year, Entergy was caught flat-footed when nine of its generation plants wilted in the heat. The company wasn't able to buy enough electricity from the spot market to make up the deficit. Outages throughout Entergy's four-state territory ensued. The new forecasting model takes a 10-year snapshot, revealing a trend toward hotter summers, spurring the company to secure better sources of emergency power. What Entergy and others are finding out is that the U.S. has become a country in which demand climaxes in the summer and at ever-higher levels. That wasn't always the case. Up until a few years ago, demand was heaviest in winter because of heating. Experts say the shift to summer peaking stems from a population shift to warmer climates, insistence on air-conditioned comfort -- especially for finicky computer equipment -- and the fact that it simply takes more energy to cool a room than to heat it. Forecasting errors of a different sort rattled the mid-Atlantic region last summer, also a legacy of more relaxed times in the power patch. The grid operator there, PJM Interconnection LLC, misjudged the potential output of electricity plants in five states and the District of Columbia. That's because it relied on the "nameplate rating" of the plants, the amount of electricity the manufacturer says the plant can produce. PJM found that 54 generators were cranking out only 70% of what was expected -- a shortfall equivalent to the output of 18 big power plants. The grid operators' demand projections weren't much better. A 10% underestimation of need by PJM resulted in voltage disruptions that produced brownouts. The system can't absorb miscalculations very gracefully anymore. "Make a mistake, and you're using your spare tire -- reserves -- pretty quick," says Paul Elbert, executive vice president of Commonwealth Edison in Chicago. Weak Links While forecasting is expected to be better this year around the country, other problems are tougher to fix. One is the design of the country's transmission system. The U.S. is generally well-wired, but some of the fastest-growing parts of the country, such as San Diego, are virtual islands in the vast electricity grid. San Francisco, Long Island and Florida all have inadequate links to larger regional electric networks. Mr. Richardson, the energy secretary, says he doesn't even like identifying the regions at greatest risk because, as he puts it, he's afraid of "causing public panic." Fixing transmission's weak links won't be easy. San Diego Gas, for example, wants to hook up a second transmission line to Southern California Edison's system. But the 25-mile line has been talked about for a decade, and San Diego Gas still hasn't filed a formal proposal with regulators. That frustrates even some of deregulation's staunchest backers. "New power lines in Southern California? Good luck. Forget it," says Jessie Knight, the executive director at the San Diego Chamber of Commerce and a former member of California's Public Utilities Commission. "Nimbyism is too strong here." But when it comes to the not-in-my-backyard syndrome, it's tough to beat Florida, where the power of old-line utilities hasn't been touched by deregulation. That leaves local utilities with monopoly powers despite looming shortages and the country's highest wholesale power prices for the coming summer season. Duke Energy wants to build a 514-megawatt plant at New Smyrna Beach on property offered by a municipal utility. But the three biggest utilities in the state have gone to court to stop the project. In April, the Florida State Supreme Court sided with them, ruling that Florida law prohibits construction of merchant plants -- which sell electricity on the wholesale market -- by outside generators. Looking to Neighbors When shortfalls occur, more and more states are looking to their neighbors for relief, setting the stage for intraregional conflict. The nation's two most populous states, California and New York, have become net importers of power, at peak times. If the summer is exceptionally hot, California could be short 4,000 megawatts beyond what it is able to beg or buy from other providers. Terry Winter, chief executive of the grid-operating California Independent System Operator, doesn't want to cut off consumers involuntarily. So the operator has put in place a plan to pay big users up to $1,000 for every megawatt hour of electricity they forgo during peak hours this summer. One of them -- the city of San Francisco -- figured it might as well get paid if it was probably going to have to shut down some nonessential services anyway. But even with the financial incentives, admits Mr. Winter, the firm is still short of the commitments necessary to get California smoothly through a really hot summer. All of these problems, especially in a nation that prides itself on finding solutions to complex engineering problems, is resulting in some serious soul-searching. Mr. Richardson, who has been barnstorming the country warning of the shortages, is now pushing the idea of deregulation legislation at the federal level and the creation of a kind of uber-regulator to oversee a cohesive national energy policy. In the interest of harmony, Mr. Richardson is proposing that the Federal Energy Regulatory Commission take the lead, stripping away some powers from state legislators. That doesn't sound like a bad idea to Oracle's Mr. Byron. "The digital economy depends on uninterrupted supplies of the highest-quality electricity," he says. "Something has got to be done." -- Michael Perelman Economics Department California State University Chico, CA 95929 Tel. 530-898-5321 E-Mail [EMAIL PROTECTED]
