Worrying analogies between the EMR process and the California Electricity Crisis 2001

Catherine Mitchell, IGov Team, 7th July, 2014

About Catherine: http://geography.exeter.ac.uk/staff/index.php?web_id=Catherine_Mitchell

The energy challenges (1) facing the State of California in winter 2000 and spring 2001 dominated the news: brownouts, rolling blackouts, uncertain supply, concerns about the State’s economy, Pacific Gas and Electricity (PG&E) bankruptcy, Southern California Edison (SCE) near bankruptcy. By summer 2001, the situation improved and the State turned its attention to working out exactly what had happened and why, and what longer-term improvements needed to be put in place. But the damage was done: an electricity restructuring attempt had gone horribly wrong. The risks of major change in the energy system suddenly became apparent for all to see. Costs of the crisis have been put at $40-45 billion in higher energy costs. Attitudes to restructuring in the US has never been the same again with several State restructurings put on hold or taken off the table completely.

Slowly but surely California has implemented new policies and regrouped and it is now again at the forefront of energy transition in the US: one of the most successful States in terms of renewable energy deployment; energy efficiency; low carbon transport; operation of an integrated efficient energy system; lowest average monthly residential electricity bills in the US and so on. While not everyone feels that the Californian energy Governance issues are entirely satisfactory, it is clear, after disappearing up an expensive multi-year cul-de-sac, that California is back at the forefront (2) of progressive energy policies in the US.

However, worryingly, the decision-making build-up to the Californian Crisis have similarities to the current situation in Britain in relation to the Government’s determination to force through Electricity Market reform (EMR). The Questions must be: how long will it be before EMR is scrapped and Britain gets out of the EMR cu-de-sac; and how much money will it have cost the British public.

The similarities between the California Crisis and EMR are (a) an ideological/political determination to implement a reform in a certain way; (b) the pressure to meet Government set deadlines for implementing EMR rather than due care given to choose rules and incentives in a measured way; (c) a stakeholder process which takes minimal notice of what stakeholders (other than EDF) say; (d) a determination that incumbents would not suffer from resulting stranded assets – in other words, that customers pay (just one example of many being in the EMR case an entirely inappropriate capacity market); and (e) the separation between the system operator and market balancing functions. While the current EMR changes are not of the same magnitude as California restructuring, they are significant. While unlikely to create the Californian havoc of 2001; they are very likely to send Britain up an expensive cul-de-sac before it is changed – something we (and climate change policy) in Britain cannot afford. The UK Government and Ofgem should take note.

California began to think about restructuring its vertically integrated electricity system in the 1990’s. The system was working relatively well but its governance encouraged the investor owned utilities (IOUs, and responsible for about 75% of sales) to build too much capacity at too high cost; and to sell energy rather than to conserve it. In addition, it discouraged appropriate risk sharing on the part of utilities (i.e. all the risk was placed on customers) and it discouraged innovation. All very similar to Britain now in a restructured world!. At the same time, California had very high electricity prices relative to other States and restructuring was intended to overcome these problems. These high prices were due in part to expensive new nuclear power build and PURPA Qualifying Facility (QF) payments for renewable electricity, combined heat and power and energy efficiency mandates – which would not be reduced by restructuring.

Legislation was passed in September 1996 (Assembly Bill (AB) 1890), and following appeals restructuring commenced in 1999. With hindsight, the restructuring decisions by the California Public Utility Commission (CPUC), the California Independent System Operator (CAISO), the Federal Energy Regulatory Commission (FERC), the Power Exchange (PX), Pete Wilson (the Republican Senator, and Steve Peace (a Democratic congressmen) seem risky, optimistic and naive about competition and markets. Nevertheless, it is important to note that the process led by the CPUC involved numerous consultations with major stakeholder involvement. If there were people and institutions warning against the governance proposals, they were not being taken much notice of. The timelines set out for each stage of the process were very short, and much of the process was taken up in solving problems by a certain time rather than thinking: is this the right thing to be doing at all or how does all this fit together? The blow-by-blow decisions made between 1996 and 2002 can be found in the books or papers of Sweeney (1), Weissman (3), Weare, Duane, Sioshani (4) to name but a few.

Much of the California problem was that the IOUs were forced to sell their generation; had to buy electricity in short term markets via CAISO and the PX; had to give an automatic 10% retail price reduction on bills for residential customers; and had their retail prices per kWh capped at a time when wholesale prices were increasing. There were numerous other issues related to gaming possibilities in the new electricity markets, including between the different prices between CAISO (the system operator) and PX (the power exchange), and a lack of penalties for being out of balance.

However, arguably, the central problem arose because of the decision that the incumbent utilities were not to suffer ‘stranded assets’ and it imposed a competition transition charge (CTC) payable by all customers (until 2002) to ensure that was the case. The decision to ensure that utilities did not suffer from restructuring, and the means put in place to ensure that customers paid for this, was at the heart of the retail price capping.

The politically acceptable ‘story’ of California restructuring was that the incumbents would not lose ‘too’ much and residential bills would fall. Everything depended on wholesale prices staying the same or coming down, otherwise retail prices should go up to cover the utility costs. The CPUC and other analysts agreed that wholesale prices would not rise. Mixed in with this optimism was poor governance. When it was clear that wholesale prices were rising and utilities were not covering their costs, it was legally possible under AB 1890 for the CPUC to lift the CTC payments and price cap – but they did not do so as quickly enough as they should have.

Much has changed in Britain since EMR was kicked off in 2010. American shale gas production has rapidly increased; cheap US coal, displaced by shale gas, has come to Europe; Fukishima, and the German decision to speed up their move from nuclear has had several knock-on effects on the business plans of the Big 6, including a cooling for investment in new nuclear; the rapid fall in the price of solar, and increases in the deployment of wind, solar and system operation technologies has led to new understandings of the economically efficient way to integrate and operate energy systems, and the important value of flexibility capabilities in their operation; an increasing recognition that marginal cost pricing of markets has real problems for a non-fossil future, and that other market mechanisms are required for low carbon but that fossil fuels would be negatively impacted by these mechanisms; all European countries are facing a similar challenge of what to do with the fossil fuel ‘losers’ in the move to a sustainable energy economy alongside concerns about affordability and security, particularly given the latest worries about Russia and Ukraine. The traditional, large German utilities in particular are hurting because the increase in variable power has made an existential difference to them, and, as a result, they are changing their business models. Britain however has carried on regardless, determined to push through EMR and a de facto retrenchment of the ‘traditional’ energy system in the face of overwhelming opposition.

The California Crisis was a long time ago but it is a good case study of the calamities that can occur if decision-makers are too focussed on what they want to the extent that they take no (or too little) notice of possible (even probable) short, medium and long term consequences. It provides an important lesson for decision-makers about the requirement to work with the basic technical needs of an energy system; how incentives are linked to economic responses, which may not be what the decision-makers want if the incentive design is not focused sufficiently; and how clear governance is necessary. Without proper scrutiny of these, and an understanding (as far as possible) of the implications of the essentially political decisions that are made, then problems are more likely that not to occur. And this goes for EMR.

Notes:

(1)  The California Electricity Crisis, by James L Sweeney, published 2002 by the Hoover Institution Press, Stanford University

(2)  Kristov and Keehn, Chapter 11 in F. Sioshansi, ed, Evolution of Global Electricity Markets, Elsevier 2013

(3)  Steve Weissman, California Public Utilities Commission, Comments at the Envisioning California Conference, The Year of Our Disconnect-the Politics of Power in California, Sacramento, Cal. (Oct. 5,2001)

(4)  F. Sioshansi, 2008, Competitive Electricity Markets: Questions Remain about Design, Implementation, Performanace, The Electricity Journal, Vol. 21, pages 74-87; F. Sioshansi, ed, Evolution of Global Electricity Markets, Elsevier 2013

Posted by: rhoggett

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