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Electricity Markets: Lessons Learned from California.
Subcommittee on Energy and Air Quality
Mr. Carl Wood
Good morning Mr. Chairman, and members of the Subcommittee. I appreciate the opportunity to testify before you today on behalf of the California Public Utilities Commission (PUC), the State of California and its 35 million energy-consuming residents. Your invitation asked that I focus my remarks on the cause or causes of the electricity "disruptions" Californians have been experiencing since June 2000 and the elements particular to the electricity deregulation plan implemented by the previous administration which I view as responsible for those disruptions. As I appear before you today, California marks its 31st day of a continuous Stage 3 energy alert. The 3 major investor-owned utilities are experiencing severe financial difficulties, with vendors and independent generators expressing concerns about whether they will be paid for services rendered. As the Governor and Legislature move aggressively to address these challenges--with plans to increase generation and conservation, and stabilize the financial health of the utilities--I think we can learn much from our painful experience with deregulation. Fundamentally, I believe the premise that provision of electricity as an essential service could be effectively traded on the day ahead and hour ahead spot markets absent the full range of generation procurement options, was at the root of the failure of California's deregulation scheme. The flaws in the system adopted reflect this belief--the pool structure that was established; the accompanying reliance on wholesale trading in lieu of native generation; California's retreat from integrated resource planning; and the unmet promise of "customer choice." A balanced reliance on the mix of generation procurement options available has historically been necessary to maintain reliable, reasonably priced electricity--and it remains so today. The Pool Historically, California participated in the Western Systems Coordinating Council (WSCC). The WSCC was a loose pool that permitted coordination and trading of loads and resources in the western states. During the two decades before deregulation, California's utilities relied on trades and purchases from within the WSCC to fill out their resource needs, in combination with native generation and short- and long-term purchases from qualifying facilities. For example, San Diego Gas & Electric Company successfully reduced its average electric rates from a high of 12.3 ¢/kWh in 1985 to about 9 ¢/kWh in 1991. This was accomplished largely by meeting its energy requirements with a mix of native generation, and trades and purchases. SDG&E met approximately 30% of its energy requirements through contracts in 1992. In contrast, the Federal Energy Regulatory Commission (FERC)-authorized efforts to regionalize the Western Interconnect and markets have failed to protect consumers. Beggar-thy-neighbor withholding of generation and sales has replaced the regional cooperation that worked for years. California is now moving to restore a mutually beneficial and cooperative approach. Divestiture and Wholesale Trading A central mistake of California's deregulation experiment was the divestiture of a large portion of cost-of-service utility generation plant. Over a 2 ½ year timeframe, California's investor-owned utilities sold 18,393 MW worth of fossil and renewable generating facilities. These facilities were subject to cost-of-service ratemaking. They now generate power that is sold into the current market at considerably higher prices. The market is dysfunctional. Wholesale prices bear no relation to the cost of production, demand or time of use. The very power the utilities once owned and controlled is now sold on the wholesale market to meet virtually the same demand. Spot market wholesale trading should be used to meet electricity demand on the margin only as part of a mix of resources relied on to meet requirements. But nothing in California's deregulation experiment limited reliance on the spot market to meet any demand, including baseload. California is now moving to permanently reduce its exposure to the wholesale markets. I believe policy-makers at the time should have taken a more measured approach to authorizing the divestiture of native generation. It may have been appropriate to authorize divestiture of some amount of utility generating facilities to improve the development of a workably competitive wholesale market and the Power Exchange. However, losing the benefit of regulatory control over this portion of California's energy requirements in such a short time period significantly diminished California's ability to minimize price volatility during the uncertain transition period. California's PUC, Legislature, and Governor Davis are all in agreement that no further divestitures should be authorized given the current dysfunctional market. Retreat from Integrated Resource Planning Throughout the 1980s and 1990s, the California Energy Commission and the PUC conducted a joint integrated resource planning process. Future resource needs were forecasted and a mix of demand side management, generation, and spot purchases identified to meet those needs. In 1992 this process resulted in a finding by the PUC that 1,300 MW additional generation should be procured from Qualifying Facilites (QFs) through an auction. After receiving bids to provide power it regarded too high, Southern California Edison Company appealed to FERC. Ultimately, FERC found the Commission's auction process flawed and the utilities settled outstanding claims. No additional power was procured through that process, and the PUC determined not to incorporate a state resource planning component into the adopted deregulation experiment. This retreat from integrated resource planning in California aggravated the problems that stemmed from market uncertainty. The state ignored its energy efficiency building standards during the building boom of the mid-1990s and discouraged the construction of cost-of-service power plants, all in the hope that unregulated investors would build sufficient new generation capacity for predicted future needs. No warning signals were built into the deregulation experiment which provided policymakers with adequate warning that the market was not providing sufficient new capacity. The Promise of "Customer Choice" The deregulation experiment also held out the promise that all
customers would be able to choose their energy provider. But in
reality, this promise was a false choice. Direct access sellers, or energy service providers, set up shop in California and solicited customers, but were not assigned a duty to serve customers comparable to the obligation traditional utilities bear. These providers never penetrated the market to any significant extent. At the first sign of trouble in the market, these providers closed their doors and returned customers to the regulated utilities. The prospect of choosing your energy provider provided little more than a rationale for the unbundling of the distribution utility. Corrective Actions As I said before, I regard provision of electricity as an essential service. Policymakers concerned about economic stability should assure a reliable, reasonably priced supply of this essential service. The state and the Federal Energy Regulatory Commission have the responsibility and jurisdiction to take corrective actions when, as today, reliability or reasonable prices are compromised. We are taking those actions in California. Unfortunately, FERC has not exercised its authority under the Federal Power Act to protect consumers from unreasonable rates. FERC recognized last year that the market was dysfunctional, and that the wholesale rates being charged were unreasonable. In spite of FERC's inaction, California's policymakers are working together to restore reliability and price stability to the market. Again, thank you for opportunity to come before you this morning. California Actions under Governor Davis
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