Monday, August 28, 2000 |

Charges of Gouging as Power Costs Skyrocket Energy: Critics say tactics allowed in the deregulated market, which let suppliers reap big profits, illustrate flaws in the system. As the state's booming economy taxes the ability to meet electricity demands, a federal investigation is underway.

By CHRIS KRAUL, Times Staff Writer

With Southern Californians reeling from skyrocketing electric bills, critics charge that fewer than a dozen power suppliers are reaping far greater profits than are justified by the recent surge in wholesale prices of the natural gas they use to create electricity.

Their behavior is a major focus of a formal investigation announced last week by federal regulators. Among those under scrutiny are power merchants including Duke Energy, Dynegy, Reliant Energy, Calpine, Southern Co. and the Los Angeles Department of Water and Power. Critics say the companies are earning huge windfalls selling energy to the two state agencies charged with distributing power in California. The power merchants themselves deny any profiteering, describing their market moves as legal business practices and welcoming the investigation. The underlying cause of California's energy turmoil is a severe shortage of power-generating capacity to meet the soaring energy demands of the state's booming economy. This summer the state at times has had to import more than 20% of its energy needs, a shortfall equal to the output of about 20 medium-size power plants. No plants of any size have been built in the state in 10 years. But the problem goes beyond a supply-and-demand imbalance. The so-called merchant power companies' ability to bend the market to their advantage--using what appear to be legal strategies--illustrates what many say are serious flaws in the state's deregulated energy market. One major flaw is that sellers do not have to participate in the state's main electricity auction--the so-called "day forward" sale held one day before electricity is delivered to the state's residences and businesses. Instead, generators are withholding power until the day of delivery, when desperate state agencies are willing to pay steep prices to keep the power flowing.

The upshot has been a doubling of electric bills for the 1.2 million customers in San Diego Gas & Electric's coverage area, and Southern California Edison and Pacific Gas & Electric customers may be facing higher prices once their rates are unfrozen in 2002. There is little prospect for short-term relief; with no additional power generation due for a year, the prices of natural gas and crude oil are still rising. In fact, state officials expect the market to become tighter over the next year as demand and fuel prices rise. In pointing the finger at the power merchants, Gov. Gray Davis, some academics and utility executives charge that California consumers are being victimized by sophisticated trading techniques that take advantage of the market system to extract huge profits. Deregulation "only works if people act responsibly. It won't work if people say their only goal is to make as much money as humanly possible," Davis said last week. This brokering takes place on the California Power Exchange and the Independent System Operator, two agencies created by the 1996 legislation that ostensibly opened up 70% of the state's power market--represented by the PG&E, SCE and SDG&E service areas--to competition. To create that competition, lawmakers ordered the utilities to sell power plants to independent companies, which now are selling electricity to the state.

The Power Exchange is a clearinghouse for the bulk of energy trading that is completed a day in advance of delivery, which normally fills most of the state's energy needs. The ISO, the nominal traffic cop arranging deliveries over the power grid, also has the authority to hold same-day power auctions for immediate delivery in the event of unexpectedly high demand. The Power Exchange is subject to a price cap of $250 per megawatt-hour, a ceiling imposed earlier this summer as prices began to soar. But the ISO has the authority to pay as much as it has to for supplementary power if the previous-day purchases prove insufficient to keep the state's lights on.

And it is the secondary ISO market where power suppliers, leveraging a seller's market, are holding sway. By withholding their energy from the Power Exchange and opting instead to bid their supply to the ISO, they are betting that same-day shortages will generate prices as close to the price cap as possible, possibly even above it. It's apparently working. On some days, the ISO has ended up buying one-fifth of the state's energy needs, not the 5% to 10% maximum originally envisioned. In the process, desperate to meet demand, the ISO is paying premium prices and those prices are being passed along to consumers. The problem with the market apparently defies easy solutions. At an emergency meeting Friday to discuss ways of dealing with the crisis, the ISO board rejected a staff proposal to force energy merchants to allocate at least 90% of the electricity they intend to sell in the "day forward" auction held by the Power Exchange, instead of holding back until the day of delivery. Although ISO Chief Executive Terry Winter said the measure would restore some market order, the board rejected it on fears that it might create unforeseen ramifications, possibly even power suppliers abandoning the state altogether. As the market stands now, independent power companies have been able to exploit the power shortages and the market's quirks to charge the state higher rates than the increases in the price of natural gas would seem to warrant, said Severin Borenstein, a UC Berkeley professor and energy specialist. With fellow UC Berkeley professor James Bushnell and Stanford's Frank Wolak, Borenstein studied the Power Exchange over a 15-month period ended in September and found evidence of "market power," or the power generators' ability to raise prices above competitive levels for sustained periods. Unless there is collusion among two or more power providers, the exercise of market power is not illegal, experts say. But if prolonged, it is a symptom of a seriously dysfunctional market. "I think [market power] has probably gotten worse this year. There are players big enough to move the price and move it a lot. Prices are clearly way above their costs," Borenstein said. Edison CEO John Bryson and Stephen Baum, head of SDG&E parent Sempra Energy, have similar criticisms. Their claims will be investigated by the Federal Energy Regulatory Commission, the latest of five probes underway into California's worsening energy predicament. "We'll see whether there are alternative market rules that should be adopted to have a better functioning, more efficient market," said Daniel Larcamp, FERC's director of market tariffs and rates. "Looking at market power issues is an important focus of our investigation."

Power suppliers Duke Energy and Calpine denied any market manipulation, saying the bulk of their energy is sold on long-term contracts and is not used to unduly sway day-ahead prices on the Power Exchange or same-day sales on the ISO. "No way are we manipulating the market, and we have welcomed investigation into our business practices," said Tom Williams, spokesman for Duke Energy's California regional office in Morro Bay. "It's easy to point fingers at someone who controls only 4% of the market, much of which has already been sold in the forward market months ago."

Calpine spokesman Bill Highlander said the high prices are simply a case of demand far outstripping the state's ability to meet it. "Ten years ago, you had more supply than demand. Now you have a skyrocketing demand from population growth, a robust economy and Internet-fed additions to demand," Highlander said. Charles Cicchetti, a USC professor of government, business and the economy, agrees and said the market is performing exactly as expected, given supply shortages. He objects to the limited price ceilings opposed by state officials. "The choice should be to either regulate the whole thing, go back to where we were or let the market work," Cicchetti said. "This hybrid is causing problems to get worse." But something appears to be worsening an already bad pricing situation, and critics believe it is market manipulation. In the FERC order initiating its investigation, the agency noted that California's wholesale electricity costs on June 29 were $340 million--a sevenfold increase over the same date in 1999. Over the same period, natural gas prices only doubled. FERC will look at other aspects of the state's energy deregulation as well--at the fact that utilities have no choice but to purchase power from the central power exchange and have only limited power to hedge or make bilateral deals on their own with outside firms. In an interview last week, the FERC's Larcamp said his agency is reserving the right to roll back rates, order refunds or even impose a new market framework to replace the Power Exchange and ISO. Larcamp said the FERC's probe will contrast California's troubled power market with the Pennsylvania-Maryland-New Jersey system, which gives end users more freedom to cut their own deals with suppliers. The result is that Pennsylvania has more than 130 power suppliers competing for the state's business, versus no more than 15 in California.

* * * Times staff writers Nancy Vogel and Nancy Rivera Brooks contributed to this story.

http://www.latimes.com/news/front/20000828/t000080772.html

-- Martin Thompson (mthom1927@aol.com), August 28, 2000