"There is no doubt about it, California has given deregulation a bad name," said Robert Green, President and Chief Operating Officer, UtiliCorp United and Chairman, Aquila Energy, to a recent Toronto Board of Trade luncheon.
"According to one opinion poll, 90 per cent of Californians believe that deregulation contributed to the energy fiasco there. But what failed in California was not deregulation. What failed were price controls on retail electric rates and an overly restricted wholesale market. A perfect storm!" he remarked.
He told delegates that there are other "paths to deregulation" that have worked elsewhere and can work in Ontario, and suggested that Ontario proceed with electric deregulation simply because it is in Ontario's self interest.
The crisis in California, he said, was a long time coming. California in the mid 1990s, was paying on average 50 per cent more for electricity than the rest of the country. There were estimates at the time that the regulatory regime was costing residential customers on average $265 a year, commercial users about $1400, industrial users more than $23,000.
"Yes, it's true that my company would benefit from deregulation. We would benefit insofar as we'd have a freer hand to stabilize our operations, as well as a greater opportunity to meet customer needs and grow market share. However, we'd also face much greater risks. To correct the situation in California, the state decided, in the words of one of their utility executives, to "use the English model as our guide." That is, California wanted to follow the model established by England in the deregulation of its electricity market. Unfortunately, California's model resembles the English one the way Austin Powers resembles James Bond," he joked.
Perhaps the most important difference was England's emphasis on creating excess supply capacity. The country began its deregulation program in 1990 with a legacy of overbuilt facilities. Nevertheless, the English program included an incentive in its pricing mechanism to encourage the development of long-term reserve capacity. Additional supply has grown so plentiful that this incentive is going to be discontinued.
By contrast, California's capacity was in decline when it began to deregulate in 1996. From 1988 to 1998, generating capacity decreased 5 per cent. No new plants have gone on-line since 1990. And under current regulations, it's very difficult to build new facilities. Another difference, the English model allowed retail prices to fluctuate. The English did include price caps in the beginning, but these were discontinued as the market matured and the public had more retail choices," he said.
"California, on the other hand, reduced consumer rates by 10 per cent and then froze those rates for 6 years. Therefore, Californians had no incentive to conserve, and they didn't. And potential new power suppliers had much less assurance that they could recoup their investments if costs increased significantly," he added.
California also made a number of other miscalculations, he said. One of the most serious was not to allow utilities to enter into long-term contracts. By relying solely on the volatile spot market, the utilities could not hedge against price spikes.
In December, wholesale electricity prices soared to more than $600 (U.S.) per megawatt hour. This compares to $120 per megawatt hour in June and $22 at the time deregulation went into effect in March of 1998. As a result, the utilities have paid up to 8 times as much as the $65 per megawatt hour that they can charge consumers, he said.
"So, it's not surprising that Pacific Gas & Electric, the largest California utility, bought out-of-state power in December for $1.7 billion and sold it to its customers for $70 million. The utilities have been threatened with bankruptcy and have ceased paying suppliers. The federal government has invoked emergency orders to force suppliers to keep the electricity flowing. Alternative suppliers, which had provided 23 percent of the total, have threatened to go off-line. And rolling blackouts have afflicted much of the state," he said.
The effects go far beyond the utility industry. Just for the week of January 14th, California's economy suffered an estimated loss of $1.7 billion due to the electricity crisis. In terms of electricity prices, the shockwaves have already extended beyond California. Rates have skyrocketed in Idaho, Montana, Utah and other states that compete for the same power sources. Several factories have closed rather than run up catastrophic power bills, and hundreds of workers have been laid off.
"Of course, not all of the circumstances that led to this predicament were California's fault. Their utility executives claim, with some justification, that a number of factors could not have been foreseen to occur, at least not simultaneously," he offered.
In 1996, few people anticipated the dramatic surge in natural gas prices. Natural gas is the predominant fuel on the margin for electric generation in California. Recently, it has sold for four times as much as it did the year before. In late December, the fuel broke the $10 per million Btu mark. And an earlier explosion at one of the major pipelines feeding the state hasn't helped. The extended economic boom also surprised many. California's economy grew by 32 per cent in the past five years, led by the energy-intensive demands of Silicon Valley, which resulted in a 24 percent increase in the consumption of electricity. Weather also played a part. An unusually dry winter in the Pacific Northwest has decreased its ability to export power to California. And severe storms in Central and Southern California have also hurt. Two of the state's nuclear generators had to limit operations recently to avoid ocean kelp from being driven into their cooling systems. A convergence of events not unlike the perfect storm.
"I believe that Ontario should deregulate its energy supply because it is in your own self-interest. And let's be clear, deregulation is just another word for free markets. I suspect that most, if not all, of you here today operate your businesses every day under the risks inherent in free markets, and you wouldn't have it any other way. And I doubt that I need to emphasize that the alternative to free markets poses even greater risks," he said.
"Some may say, "But electricity is different, it is too vital to our economy to be left to an uncontrolled market." My response to that is, what about gasoline? Does anyone think that gasoline or diesel fuel isn't vital to our economy? That market is fully deregulated in California and in Canada. Clearly, the free market can deliver energy reliably and efficiently. As everyone here knows, trade barriers are falling around the world," he said.
Technology and information are replacing the old pillars of wealth creation -- land, labor and capital. Nowadays you can run almost any kind of business virtually anywhere in the world, or even throughout the world. This new kind of global marketplace puts a great premium on infrastructure. Infrastructure, of course, has always been important. The privately financed railroads of the 19th-century helped to build the United States into a world power. Cheap and available electricity helped jumpstart Central Canada's growth in the early part of last century, he said.
"We have seen this distortion in Canada's electricity prices, which rose more than 30 per cent from 1992 to 1997. And we all know the legacy of Ontario Hydro. Now, in talking about Ontario we have to consider another example closer to home -- namely, Alberta. When Alberta became the first province to deregulate five years ago, it had some of the cheapest electricity rates in North America. Today, only California and Hawaii have higher rates. However, I would submit to you that the price spike is not due to deregulation. Part of the problem has to do with bad timing, but much of it also stems from bad public policy. In terms of timing, skyrocketing natural gas prices had a significant effect on the province. Alberta gets about 30 per cent of its generation from gas. Nevertheless, if Alberta had moved with more determination toward deregulation, and if it had been clearer about its rules, it would have attracted more new suppliers. As it is, good economic times created a rise in electricity demand of 5 percent last year that was not matched by additional supplies," he said.
Fortunately, Alberta is better off than California, he said. Several new generation projects have been announced. And the same boom in oil and gas prices that helped create its high electricity bills has enabled the government to rebate some of the higher power costs back to consumers. So, if Alberta and California are examples for Ontario, they are examples of opportunities missed.
Hopefully, California will learn the right lessons from this crisis. A number of experts have suggested both short-term and long-term solutions. Most of these have to do with creating a true market-based system and allowing appropriate price hedges, such as long-term contracts, into the program.
"In the face of all these misplaced accusations against deregulation, I would respectfully urge Ontario not to miss its own opportunity. To echo the sentiments of at least one Canadian journalist, the timing is good now to move decisively to free up your electricity market over the next several months. The elements are in place, and the important players are ready, or soon will be," he said.
Unlike California, Ontario has a comfortable 18 percent generating reserve, according to a recent IMO forecast. The province has the flexibility of using hydro or coal as well as natural gas. Grid interconnections and enhancements with Quebec and Michigan, as well as the anticipated reopening of the Pickering nuclear station, will all reduce price volatility.
"In fact, Ontario has thought out the deregulation process so well that it has the chance to shine as a leading-edge example of what deregulation can do," he suggested.
"However, at this point, any wavering on the part of officials might scare off a sufficient number of suppliers to make this an optimally contested market. If the examples of Texas, England and Pennsylvania teach us anything, it's that suppliers will turn out in strong numbers if a clear and healthy deregulatory environment is in place. Of course, moving away from regulatory franchises also exposes firms and consumers to a complex set of risks. I don't want to give you the fairy-dust version of deregulation. You do have to stare down the dangers of the real world, but you as business leaders are used to doing that every day," he added. "As our economies become ever more dependent on reliable energy supplies, and as these supplies become more contested, the regions of the world that encourage open energy markets will have a tremendous competitive edge. Competitive markets are the best at allocating resources and attracting investment -- especially the huge investments needed for energy projects. And open markets provide the most socially acceptable method of spreading risk. Besides, we've seen what wonders open markets have done to create prosperity around the world in the past few years. Imagine what an open energy market can do here to build a brighter future for Ontario, as well as for Canada. We believe that Ontario should proceed to deregulate its energy supply on the same free market principles that have worked so well in countless other markets," he said. ET