Slight update, 1 September 2001

If you live in California, or have been following the news, you may have noticed that there has not been a single rolling blackout all summer.  Why?

The simple, albeit unsatisfying, answer is that demand has not exceeded supply.  In fact, electricity demand has been way down all summer, and supply has gone up.  Prices have also fallen dramatically on the wholesale market since June 1 or so.

Demand reduction

No one can really say for sure, but my bet is on two things: There is a third possibility as well: the collapse of the `dot-com boom' probably caused a noticeable decrease in places like San Jose and San Francisco, at least.

Supply Increase

A bunch of new gas-fired plants, including both combined-cycle `base load' plants and `peakers', that have been in the approval-and-construction process since early 1999, came on line in 2001.  All across the country, it takes two to three years to get these things built and running.  More will be coming on line in 2002 and 2003 (all throughout the US west, not just in California).

`Planned and unplanned outage' rate is far lower

In December, as much as 13,000 MW of generation plant was off-line all at once.  Back then, most power was bought and sold through CalPX, on the spot market.  Today, it is mostly bought and sold contractually.  Contracts lead to planning, which leads to scheduling outages sensibly.  Outage rates are now back to their normal ranges, rarely exceeding ten percent (about 4 to 5 thousand MW) and certainly not 30%.  Some of this might also have something to do with greater regulatory scrutiny, but personally I subscribe to the idea: `never attribute to conspiracy that which can be adequately explained by stupidity.'

Not quite out of the woods yet

September and even October can still be hot, and if it does turn hot and air conditioners go on and stay on, and if a major plant or two has a failure then, we could be in trouble again.  But the picture is certainly rosier today than it was in April 2001.

And then there's the matter of pricing

I mentioned above that prices have fallen dramatically on the wholesale market.  (The retail price is still set by the PUC; our new, higher rates have little to do with today's open-market energy prices.  Besides, we have the small matter of PG&E's bankruptcy still looming -- and one way or another, ratepayers are going to be stuck with this tab.)  One might wonder: why?

Of course, the usual supply-and-demand arguments apply.  When the supply is up and the demand is down, prices are supposed to fall.  But last winter, supply should have been sufficient, and demand was well below where it always is in summer, yet prices were high, and spinning higher.

Again, I think part of the reason has to do with buying energy through contracts.  Unfortunately, the bulk of today's contracts were made by the California Department of Water Resources during the height of the crazy prices, and some of those contracts are themselves at quite high prices.  This means retail bills will remain high, even though supplemental spot market purchases are cheap.  This situation will persist for years to come.

Lastly -- but I think perhaps most importantly -- there is the natural gas market.

Topock prices are sane again

Last winter, the `spread' on the price of natural gas as delivered through a pipeline controlled by El Paso Merchant Energy got way out of whack.  Natural gas prices had spiked in the entire country, going from the $2-to-$3 range up to $5, and occasionally even as high as $9 (during a cold snap in New England, for instance).  These prices were to be found pretty much everywhere in the United States -- except California.  Prices in CA, especially southern CA, were sitting at numbers like $15, $30, and even a spike over $50.  These were the `Topock' or `SoCalBorder' prices, named for the ghost town where the gas pipeline crosses the Colorado River from Arizona into California.  (The pipeline itself uses a bridge that used to hold up historic Route 66.  You can see it just to the south as you cross the Colorado driving on I-40, if you go out that way.)

In other words, someone with control of a pipeline could buy gas in Texas for $5, and sell it in San Diego for $30.  Buy low, sell high: this is the recipe for making money.  And boy howdy, did El Paso ever rake it in.  They will not (of course) break out their individual numbers, but corporate profits soared during this period.  Of course, the spread was not always a factor of six; it was occasionally only a factor of 2.5 or 3, although 4x was fairly typical.  For every dollar spent to buy gas in the `producing basin', you could earn $4 selling it again in California -- if you could get space on the pipeline.

Today, though, natural gas in Texas is again in the $2-to-$3 range (sticking closer to $3) -- and the Topock price is in the very same range!  What changed?

It turns out that El Paso had a contract with a `sister company' that expired June 1.  El Paso is a regulated company, meaning FERC, the regulatory agency, gets to breathe down their necks and make sure they are not violating any laws or engaging in illegal pricing practices.  Their sister company, however, is unregulated -- meaning they can charge whatever they want to do whatever they want with the pipeline capacity (within other limits, also set by FERC, but these other limits are much looser).  This sister company held the rights to 40% of the capacity.

There is a lawsuit moving, slowly as lawsuits tends to do, through the courts, alleging that El Paso violated various rules and manipulated the market price of natural gas.  The evidence against El Paso is strong, including the entirely circumstantial item that prices dropped like a rock the moment the alleged-sweetheart-deal expired.

An interesting question is what will happen if the FERC judge finds that El Paso illegally manipulated the market price of natural gas.  The extraordinary price of gas fed into the crazy price of electricity.  So, suppose that FERC were to order a retroactive refund, plus a penalty for market manipulation?  If this produces significant dollar amounts (say, $1 billion), and if the money goes to the electricity-generators, should they in turn refund some of their charges?  There is only one El Paso Energy, of course, but there are many generator companies.  The money trail here is complicated, but should be something accountants can unravel.  So, I think this kind of refund could have two interesting repercussions: it would lower the `past due' bills that the utilities are trying to collect from ratepayers, and it would be a Full Employment Act for accountants and CPAs. <smiley>

So what happens next?

My crystal ball is as cloudy as everyone else's.  I will make a few predictions, though: The states that will be hit hardest -- not necessarily in the form of rolling blackouts, but by price increases -- will be those who are claiming, today, that their deregulation worked.  The reason is simple.  Deregulation, even `done right' (and California's was unarguably done wrong; the rolling blackouts and PG&E bankruptcy suffice as proof), leads to price increases for at least a short while (on the order of ten or so years).  The reason is easy to see in hindsight: under regulation, the cost for power is `the cost from each generator, averaged, plus a profit margin' (this is virtually the very definition of regulation).  Under deregulation, the cost is `the cost from the most expensive generator, multiplied by the amount from the various generators, plus a profit margin.'  Initially, even if there is plenty of generation, there is a mix of costs, and sometimes the expensive generators run.  Whenever that happens, the deregulated system gets a price shock.  Economic theory implies that if you can just survive these shocks, their very occurrence will result in some clever guy figuring out some clever way to make money by charging less, and eventually the prices will fall even further, because the system as a whole will be more efficient -- but if the system today is inefficient somewhere, the real difference between regulated and deregulated is that the deregulated system exposes the inefficiencies -- and it does so via price shocks.

Distributed generation is similarly obvious.  One of the biggest problems today is that we generate electricity cheaply at point A when it is needed at point B.  That means we need a heavy duty `grid' to transport the electricity.  But building up the grid is more expensive than building generation -- often a lot more.  It will be cheaper to build a bunch of small generators all over the place, and fire up whichever ones are `close enough' to the point where the electricity is needed.  As a bonus, those distributed generators will provide heat (which can in turn be used to make things cold -- think of propane-powered air conditioners and refrigerators, for instance), which can in fact make these small distributed generators more efficient than the large centralized systems used today.  So I suspect that within five years, most new office buildings, mini-malls, and even 7-11s will sport some sort of distributed-generation technology, probably in Combined Heat-and-Power (CHP) or Building Cooling, Heating, and Power (BCHP) forms.  Look for these acronyms to appear in the business pages of the newspaper sometime within the next decade, if not sooner.

Solar PV ties in with the distributed generation concept.  Solar power has poor `energy density', by which I mean that it takes a lot of space to generate very much power.  But houses have plenty of unused space, called `the roof'.  Solar panels on the roof produce electricity while shading the roof itself from the elements.  That means the roof lasts longer, the attic stays cooler, the air conditioner does not have to work as hard; and the homeowner even gets a tax deduction on his electricity bill (since the PV system cost is incorporated into the mortgage, which is tax-deductible).  The only reason it does not happen much today is price: solar PV panels are very expensive, on the order of $6-to-$10 per watt installed.  But the long-term trend on this number has been that it goes down, while the long-term trend on the price of electricity has been upward, and rooftop solar PV electricity is already sometimes cheaper to a California homeowner than retail utility electricity.  Prices like $.25/kWh are not that hard to beat.  Even where solar PV is more expensive than utility power (today, this is `almost everywhere else' <smiley>), I think many people will get a sort of satisfaction out of knowing they are paying someone -- anyone! -- other than the utilities, as well as reducing pollution from centralized power plants.  It is also, in a way, part of the American dream: `why rent when you can own'?  Renting may in fact be cheaper (e.g., renting a minivan to take the kids to Grandma's every winter is probably cheaper than buying one), but not all decisions are made purely on a cost basis.


All contents are copyright © 2001 Chris Torek.