California power crisis raises US capacity worries

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Friday January 19, 4:58 pm Eastern Time

ANALYSIS-California power crisis raises US capacity worries

By Marjorie Olster

NEW YORK, Jan. 19 (Reuters) - Economists have always fretted about bottlenecks -- those nasty clogs in the supply chain that disrupt the harmonious feng shui of a balanced economy by keeping energy from flowing freely.

And as economists parse California's power crisis, they recognize classic signs of a bottleneck which raise troubling questions about whether there is ample electrical capacity across the rest of the United States to meet growing demand.

The rolling blackouts this week in California are a stark reminder that the state's capacity to supply electricity is bumping up against its limits. And the rest of the country may not be far behind because the United States is already using 98 percent of its available electricity capacity.

If the country runs short on power, it will almost certainly crimp economic growth nationwide, economists say.

California's botched steps to deregulate the power industry in 1996 have brought its two main utilities to the brink of bankruptcy. By freeing wholesale power prices but keeping tight caps on prices utilities can charge customers, the changes have resulted in a $12 billion shortfall for the two utilities.

DEREGULATION NOT THE ONLY CULPRIT

But economists at the Federal Reserve Bank of San Francisco say deregulation is not mainly to blame for the blackouts in California which, if prolonged, could do serious damage to the largest economy of the 50 states.

Rather, the state's failure to adequately expand electrical capacity at the time deregulation was being planned is the root of the problem, and deregulation exacerbated the problem.

Had state planners ensured that the infrastructure was sufficient to handle growing electricity demand, Californians might not be in the dark.

``We are only the future that could be if you don't take the right actions,'' Fred Furlong, vice president in charge of financial and regional economic analysis at the San Francisco Fed, told Reuters.

CAPACITY STRETCHED

While nationwide demand has been steadily rising, supply has been limited by environmental and regulatory hurdles and high capital costs.

As of last month, there was almost no excess electrical capacity in the country -- utilization was running close to 98 percent according to Fed data released on Wednesday.

Figures from the government's Energy Information Administration (EIA) show overall U.S. demand for electricity rose by nearly 21 percent from 1989 to 1999 while capacity expanded by only 8 percent. The EIA projects demand will increase another 25 percent by 2010.

The pace of capacity expansion over the past decade would have to triple in the next decade just to keep up with demand. Major investment would be needed for such an expansion and it could take years. Until new power plants come on line, prices are likely to rise.

But U.S. energy problems go far beyond electricity. Inventories of natural gas are low, and both oil and natural prices are fairly high, possibly indicating that demand for energy commodities in general is exceeding supplies.

The Fed, in its decision to cut key interest rates by half a percentage point on Jan. 3 to keep the economy from slowing excessively, cited high energy prices as one reason because they were ``sapping household and business purchasing power''.

Paul Kasriel, chief domestic economist at Northern Trust in Chicago and a former Fed economist, questioned whether high energy prices really justified a more stimulative Fed policy.

``Energy is a supply constraint on the economy. Pressing on the monetary accelerator only increases demand,'' Kasriel said. In the extreme, increasing demand for energy may push prices up further and lead to stagflation.

TOO MUCH OF A GOOD THING

The electricity shortages in California and the danger of wider shortfalls across the country are proof that there can be too much of a good thing -- growth.

A record 10 years of unbroken U.S. economic expansion has created capacity constraints, among them the tight power supply and a tight labor market. The boom years in the second half of the 1990s tested the limits.

Jonathan Cogan an energy information specialist at the EIA said the prosperity of the past decade has fueled power demand.

``The overall driver is economic growth which puts more money in people's pockets,'' he said. ``Economic growth drives industrial use of electricity as more products are produced. When people buy bigger houses, they use more light, heat and more appliances.'' Population growth also adds to demand.

The same is true in spades for California, which accounts for more than 12 percent of total U.S. economic activity and would be the sixth largest economy in the world were it an independent country.

California is home to Silicon Valley, the epicenter of the New Economy where many of the cutting-edge technologies of the Information Age are incubated. Demand for power has been rising by as much as 5 percent a year in the past two years in some counties in the state, far more than forecasters anticipated.

In November, employment in California was up 3.1 percent compared to a year earlier, far outpacing the 1.8 percent rate in the country as a whole.

Mary Daly, a senior research economist at the San Francisco Fed, said she sees a number of bottlenecks in the state and particularly the San Francisco Bay Area -- a short supply of commercial office space, of labor and of affordable housing.

``Success brings it problems,'' she said.

But Furlong said steps would be taken by the state to increase generation capacity and although the utility crisis is significant, it is not ``a giant killer'' for the $1.2 trillion a year California economy. To put it in perspective, he said the $12 billion undercharge suffered by the utilities is only 1 percent of the total economy.

``The issue here is clearly there is not enough capacity at this point,'' Furlong said. ``In the near term, we are going to face higher energy costs and on the margin it will be a negative and contribute to the overall slowing.''

-- Bumping up (up@against.capacity), January 20, 2001

Answers

How the mighty have fallen.... With two days of rolling black outs, California has fallen to the ranks of 3rd world status; like Cuba.... Ethiopia and Sudan don't even have rolling black outs anymore!

-- rotflmao (idiots_r_us@california.sucks.com), January 20, 2001.

delusion-ville

-- (yes@you know.me), January 20, 2001.

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