California Status Report: What Went Wrong, Why and How to Fix It Rick Shapiro Managing Director...

California Status Report: What Went Wrong, Why and How to Fix It

Rick ShapiroManaging Director

Government Affairs - The Americas

®

2001 RS-California-0301-2


Summary of the Situation in California• De-regulation Has Not Failed in California Because

California Never De-regulated

• If Designed Properly, De-regulation Benefits Consumers and Economy

• Flawed Restructuring Plans Can Have Negative Spillovers– Financial Distress

– Economic Dislocation

– Political Instability

• California Must End the Delay and Focus Action on–Increasing Supply and Reducing Demand, NOW

–Getting Prices More Aligned with Costs—additional rate increases may be inevitable

– Improving the Utilities Financial Position

• Re-regulation and Bankruptcies Will Fail to Resolve the Crisis


The Very Big PictureCalifornia’s Long History of Flawed Energy Policies

• Over-reliance on Imports

• Over-reliance on Monopolies

• Overly Burdensome Regulatory Programs

• Little or No Faith in the Value of Market Signals • State Assumes Role of Energy “Portfolio Manager”

A History of Energy Booms and BustsA Crumbling Energy InfrastructureThe Result


• Demand Is Up Sharply in California and the West

• Inadequate Investment in Supply and Infrastructure

• Uncooperative Weather Patterns (Rainfall/Temperature)

• California Is Living with a Flawed Restructuring Law

• Political Leadership Is Lacking

The Big PictureCalifornia’s Most Recent Energy Problems

A political crisis A financial crisis A looming economic crisis

The Result


What Went Wrong?California Rejected Markets in Favor of a Risky Lab

Experiment

Markets California’s Electric IndustryEasy entry Siting laws block power plant development

Term contracts dominate Utilities forced to buy from and sell to spot market

Prices influence supply and -Consumers pay the same whether they conserve or not

demand decisions -Sitting Laws trump incentives to expand supply

Customers have real choices Lawmakers claim that AB 1890 is “not about” retail competition

• The gap between supply and demand is now a chasm• Government assumed role of electricity “portfolio manager” on behalf of consumers.• Fewer than 2% of customers switched providers

The Result


• Plant capacity in California is down 1,200 MW since 1997 • Demand over the same period in California is up 20% • California’s reserve margin is 6% when 15-20% is needed

• In the West, demand is up 14% • The West is short 10,000 MWs and is not likely to see supply-demand balance before 2003

Some Sobering StatisticsThe Situation Is Serious


• Reliance on gas-fired plants has doubled since 1997 • Gas prices in California are 2-3 times higher than in 2000 • Plants already constrained by annual emission caps

• Emission credit prices have risen dramatically • One of lowest rainfall levels in history in the Northwest • But California prices remain frozen at 1996 levels!

Some Sobering StatisticsThe Situation Is Serious

•Power costs up sharply throughout West•CA’s Import capability down sharply•Plants in CA run harder & fail more often•Blackouts have already started in CA

The Result


• The Governor’s Approach– Exercise extreme caution--avoid political risk at all cost– View the crisis as a “political campaign”– Shift the focus: Assign blame to market power and federal inaction– Rely on Executive Orders and powers rather than work the Legislature– Appease consumer advocates—Insists on ”no new rate increases!”

• The Legislature’s Approach– Follow Governor’s lead– Avoid becoming political road kill– Express increasing frustration with Governor’s tendency toward secrecy

The Response of California Policy Makers Long on Politics, Short on Solutions

• Distrust of Governor by Legislature• Political paralysis• Crisis deepening—no solution in sight

The Result


• Resist rate increases….until now…. reality beginning to

set in

• Re-price QFs and IOU plants; demand wholesale caps in

West• Take over electricity procurement

– Appoint obscure agency (CDWR) with little expertise to procurement

role

– Assume CDWR can purchase power to fit under rate freeze

– Tap State’s general fund as bridge to bond financing

• Take over transmission– Quid pro quo for keeping utilities solvent

• Rescind consumer choice– Fear that choice threatens recovery of DWR costs and bond

repayment

• Establish “California First” energy policy– Confine trade to California’s borders; dictate plant operations

California’s Proposal Nationalize, Re-regulate and Hope

• State viewed as on the wrong track• Contradicts national/international trends• Creates “country risk” on par with Indonesia• Prompts businesses to consider re-locating

The Result


• Any proposal must be better than bankruptcy or the utilities will reject it

• The Bush administration opposes price caps • Finding price that QFs and utilities can agree to is difficult

– QFs sue successfully to sell elsewhere (out-of-state; higher prices?)– PG&E announces it sues not to pay QFs

• Utilities demands in return for transmission sale are steep

– Price PG&E demands for TX is unacceptable to consumer groups– Consumer groups resist end of rate freeze; rate de-regulation

California’s Proposal Faces an Uphill BattleBoth the Math and the Politics Present Problems


• Not surprisingly, CDWR ill-equipped to fill role as energy portfolio manager

– Press reports that DWR is buying at above-market prices– Power purchase costs skyrocketing– Significant rate increases…more to come?

• Legislature becomes increasingly concerned over budget and bond rating

– State budget surplus is evaporating and the economy is faltering– Concerns over bonds prompts rating agencies to put California on “credit watch”– Governor’s staff reveals that bond issuance may exceed $20 billion

California’s Proposal Faces an Uphill BattleBoth the Math and the Politics Present Problems


The Alternative Is PreferableCreate the Market that California Was Promised But Never Got

• Decrease Demand—May Be Too Late

– Give Consumers and Businesses Price Signals

– Give Consumers Financial Incentives Needed to Respond to Those

Signals

– Mine Large Amounts of Reductions Now in Anticipation of Summer

• Increase Supply

– Maximize existing sources—Re-balance power and environmental

goals

– Overhaul Plant Siting Laws to Create a Stream-lined, One-stop Shop

– Remove Road Blocks to On-site Generation

• Get the Utilities Back on Their Financial Feet

– Further increase may be needed; rate shock can be avoided?

• Create a Real Retail Market

– The Market Is the Best Portfolio Manager

– Direct Access can save the State’s budget and its bond rating

• Fix the Gas Market Before It’s Too Late


What Won’t Work?Search for “Good Old Days” Is Futile

• Bankruptcy Is a Bad Idea – It doesn’t solve any problems

• Price Controls Lead to One Thing– Shortages

• Nationalization and Re-regulation Will Make Matters Worse

– Every reason to believe the private sector will outperform

government

– Investment fueled by capital markets or government

coffers? Who bears the risks? Schools or electricity?

– California’s record as portfolio manager Is very weak—Oil

dependence in the 1970s; Nukes in the 1980s;

PX in the 1990s

Fundamental Supply Factors Driving Current Market Prices

Center for Public Utilities ConferenceMarch 25, 2001

Tim BeldenManaging Director

Enron North America

Appendix


The Missing Links

• The relationship between Northwest hydro output and the California crisis

• The pricing of storable commodities


California’s Proportion of 1999 WSCC Demand

Hydro’s Proportion of 1999 WSCC Capacity

59%

41%

Everything Else

Hydro

38%

62%

California

Everything Else


Columbia River California

2001 2000

55%93%

80%94%

1999 116% 108%

1998 98% 153%

1997 152% 84%

1996 138% 129%

Have We Been Fooled by Unusually Strong Hydro in Recent Years?

-7-

Volume Runoff Percent of Normal


Historical Volume Runoff at The Dalles

0

20

40

60

80

100

120

140

160

180

1996

-97

1973

-74

1955

-56

1970

-71

1947

-48

1950

-51

1998

-99

1982

-83

1968

-69

1942

-43

1966

-67

1985

-86

1974

-75

1960

-61

1932

-33

1937

-38

1990

-91

1931

-32

1977

-78

1997

-98

1948

-49

1989

-90

1979

-80

1969

-70

1967

-68

1988

-89

1941

-42

1935

-36

1992

-93

1978

-79

1938

-39

1987

-88

1972

-73

1929

-30

1936

-37

1930

-31

1976

-77

Year

Jan-J

ul Volu

me,

MAF

Average JAN-JUL VOL (MAF)

You are here (00-01):

You were there (96-97):

95-96

99-0097-98

98-99


Northwest Hydro Production: Last Year Actual vs. Normal

-8,000

-7,000

-6,000

-5,000

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

J AN FEB MAR APR MAY J UN J UL AUG SEP OCT NOV DEC

Month

Gen

erat

ion

Dep

artu

re, M

Wa


Northwest Hydroelectric Production: 2001 Forecast vs Last Year Actual

-8,000

-7,000

-6,000

-5,000

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000


Month

Departure

Fro

m L

ast Y

ear, M

Wa


Northwest Hydroelectric Production: 2001 Forecast vs 1997 Actual

-15,000

-13,000

-11,000

-9,000

-7,000

-5,000

-3,000

-1,000

1,000

3,000


Month

Dep

artu

re F

rom

199

7, M

wa


Decreased Hydro Results in Fewer Imports into

California

• Annual average MW


Decreased Hydro Causes Increased Gas Generation in California

• Scatter plot of June through February Year on Year hydro changes vs. Year on Year gas changes.


Decreased Hydro has Tremendous Impact on Prices

• Higher Thermal Forced Outages

• Higher Gas Prices

• Higher NOX Prices

• NOX related Generation Limitations


NOX Limited Plants and Hydro Are Both Storable Commodities

• Peaking Plants in Southern California are Limited to 800 Hours per Year

• BC Hydro Can Store for More than a Year

• Northwest Utilities Can Store for One Week to Several Months


How Do You Price a Storable Commodity?

• Current Offer = NPV (Highest Forward Price)

• Brings Off-Peak and Peak Prices Together

• Creates peak summertime prices throughout the year


Conclusions

• Hydro Fundamentals Explain Current Prices

• Current Studies Have Not Addressed Impact of Hydro

• Current Studies Use Marginal Cost and Don’t Consider Storage Pricing

• Things Will Get Worse Before They Get Better

California Status Report: What Went Wrong, Why and How to Fix It Rick Shapiro Managing Director...

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