Recalling California's Energy Crisis

- California has ushered in a lot of trends and the latest one to recall Governor Gray Davis has become a hot button issue nationally. It's a pursuit unrelated to malfeasance and directly tied to the electorate's frustrations over its economic future and in particular the state's current $38 billion budget deficit. While the recall initiative is rooted in the state's energy crisis, citizens who look closely will see that blame abounds for that energy debacle.

“In retrospect, it's clear that those who pushed the deregulation plan through, and those who subsequently exploited its loopholes, are the ones who created—and should be held responsible—for the crisis,” the San Francisco Chronicle opines.

Both political parties crafted California's flawed deregulation structure. The problems began soon after the California Assembly passed and then-Governor Pete Wilson, a Republican, signed AB 1890. At the signing ceremony, Wilson called the initiative “landmark legislation” that would “guarantee” lower rates. Davis, a Democrat, was the lieutenant governor at the time. AB 1890 sailed through the state legislature in 1996 without a single "no" vote after weeks of lengthy committee hearings chaired by former state Sen. Steve Peace, who is generally considered the law's primary author.

Electricity deregulation is still in its infancy and the verdict on whether it can be a success remains an unknown. But, California's experiment, no doubt, exposed all the blemishes related to the regulatory and legislative processes as well as the potential greed within corporations, if left unchecked. Davis has felt the brunt of consumer dissatisfaction in the state. And, now, he is enduring the wrath of voters who want someone held accountable not just for the electricity crisis but moreover, for the state's financial woes.

Like all matters of public policy, crafting an energy bill there had been a function of bringing stakeholders together and holding open hearings. Incumbent utilities along with the alternative suppliers came to the fore to debate the policies. Consumer and environmental groups all weighed in before the legislators and regulators formed their decisions. It was a cooperative process—not one done in a vacuum.

“A review of the history of the development of the rules for the California market indicates that the rules, both the initial and modified rules, were the result of a substantial amount of lobbying on the part of all of the stakeholders, including those representing the interests of suppliers and buyers,” says Robin Jane Walther, a regulatory expert in Menlo Park, Calif. “Moreover, the rules were established and modified in a relatively open process.”

Vindication Occurring

To some extent, the Federal Energy Regulatory Commission vindicated Gov. Davis. In a report released in March, FERC staff said that abuse among certain power marketing organizations had run rampant. Now, those organizations are being scrutinized and some of them may be hit with fines or lose their marketing rights. Legislators and regulators, however, did get blamed for allowing significant supply shortfalls and designing a fatally flawed market.

The dynamics combined did work to increase average spot wholesale prices by a factor of 10. Short term prices had risen as high as $2,000 a megawatt hour while averaging about $325 per MWh. At the same time, Davis and the legislature hamstrung themselves by refusing to lift the rate caps on residential rates. Their emphasis back then was on wringing the fat from the incumbent utilities and on forcing the marketers to admit their culpability. The rate caps, however, meant that the state's utilities were unable to recoup their costs—a move that pushed Pacific Gas & Electric into bankruptcy.

To combat excessive spot prices, Davis spearheaded the effort to enter into 59 10-year contracts to the tune of $43 billion. Most were signed at around $69 per MWh—a bad gamble, given that prices have since dropped to about $30 a MWh. Davis contends, however, that the over-priced long term contracts were based on a skewed market and maintains FERC should allow the state to renegotiate those deals. FERC refused in June, saying that the sanctity of contracts generally is of paramount importance.

For his part, Gov. Davis had said from the onset that the energy marketers were manipulating the system and that FERC should act decisively by setting ceilings on wholesale prices that the alternative suppliers were charging the incumbent utilities. Those cries for help initially fell on deaf ears. In June 2001, however, FERC established a rate cap of about $92 per MWh in western markets. Roughly two years later and after several examples of marketplace manipulation surfaced, FERC completed several investigations and has penalized some wrongdoers.

No Justification

Indeed, any flaws in the system's design do not justify the rigging of prices. Traders have already pled guilty to fraud and others are under state and federal investigation. Additionally, companies have admitted to “round trip” trades that are intended to inflate volume and artificially drive up short term prices. Some have had to pay fines, enter settlement talks and fire workers.

Former Enron trader Timothy Belden, for example, has said he conspired to manipulate markets for the purpose of making illegal profits for Enron—and huge bonuses for himself. And Williams Cos. has finalized its settlement with California in an agreement that cuts $1.4 billion off the cost of a $4.3 billion, 10-year power contract. A FERC judge found that the conglomerate overcharged California $192 million—more than any other supplier, so far. Other companies, meanwhile, have acknowledged providing phony data to pricing indexes, including Dynegy Corp. and El Paso Corp.

Just how such entities were able to run amok for so long is open to question. Despite an imperfect regulatory model, policy analysts differ as to which entities bear the most blame: One side says that young traders were given inadequate guidelines and as such were able to work the regulatory scheme to their advantage—a fault that lies with government leaders who helped design and monitor the system.

The other side acknowledges a lack of oversight and any subsequent enforcement. But the rationale goes on to add that corporate organizations that implement strong ethical codes are able to steer their workers in the right direction. In this case, companies placed the profit motive ahead of the well-being of Californians. The cost of such thinking has been profound, damaging not just the perpetrators but also their companies and the economy as a whole.

Certainly, Gov. Davis is not spotless. To some, he mismanaged the ordeal by pointing fingers instead of fixing the problem right away. In the earliest stages of the crisis, it would have been wise to quickly act on what is now in retrospect a failed policy: consumer rate caps, the inability to enter into long-term contracts and the difficulty siting generation plants.

Those discussions are now taking place and have been digested by those going forth with their plans to deregulate electricity markets. But the central point with which California's electorate must wrestle is whether to recall its sitting governor. Unfortunately, it does not have a choice as to whether to revoke the power marketing privileges for those that manipulated prices and enriched themselves in the process.