To avoid a California storm, construct shelters now

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To avoid a California storm Source: Milwaukee Journal Sentinel Publication date: 2001-03-18

To avoid a California storm, construct shelters now By DAVID E. PARKER

Sunday, March 18, 2001

The "weather" conditions associated with California's energy crisis -- what many are calling The Perfect Storm -- have been extreme volatility in energy prices; energy shortages, including rolling blackouts; the under-collection of tens of billions of dollars in electricity costs from rate payers, which may bankrupt the state's largest investor-owned utilities; as well as a flurry of lawsuits.

This storm has prompted other states to quickly retool their deregulation and energy policy plans in hopes of averting a Perfect Storm scenario.

The scapegoat in this energy policy disaster has been the California's deregulation efforts. While the flawed energy markets California established as part of its deregulation plan did contribute to the energy market's volatility, other factors played a key role.

These were the signs of an approaching storm:

-- Limited generation investment

In the past decade, no significant sources of new generation assets have been built despite robust growth in demand for power. California's peak demand in 2000 grew over 20% from 1999.

Unfortunately, the same scenario -- limited investment and substantial demand growth -- exists in most regions in the United States today.

-- Limited transmission investment

The significant growth in demand and limited plant construction require that California import over 20% of the power consumed in a year.

As a result, the state's transmission system, its energy highway, is congested on a regular basis, creating bottlenecks at peaks, making it almost impossible to move energy south to north.

Again, in many areas of the United States, transmission systems are being stretched to their capacity in an attempt to provide service to robust electricity demand. The U.S. transmission grid was designed to provide utility companies the ability to borrow energy from neighbors at times of unpredicted electricity shortages.

-- Regulatory uncertainty.

Despite the passage of legislation in 1996, California's deregulation efforts did not establish rules that would interest new suppliers through attractive returns on investment. A 10% mandated rate cut limited potential profitability near term, and the restriction on bilateral power purchase contracts also discouraged investment.

Many independent power producers (IPPs) look to establish more predictable returns on investment by signing long-term power contracts for a portion of a plant's output, a practice discouraged by California law. Regulatory uncertainty concerning future energy policy likewise has limited investment in other U.S. states.

-- Mother Nature.

A hot summer, cold winter and drought conditions in the North provided the last elements for The Perfect Storm. Increased energy demand due to unseasonable weather conditions, combined with a drought in the Northwest that limited power availability from neighboring states, pushed electricity market rates to unprecedented highs.

Weather and its unpredictability typically can play havoc with the energy supply/demand equation. U.S. energy consumers have benefited from abnormally mild conditions in the past five years. The unfortunate consequence is that without a recent weather stress test, the U.S. energy infrastructure has not kept up with the aforementioned changes in demand particularly at peaks.

Electric reserve margins have declined to precarious lows, while natural gas deliverability at peaks is suspect, with substantial growth in consumption of natural gas for electricity generation, as well as heating, customers.

Here's how to prepare for the storm:

While sandbags may only be needed in California, we encourage energy stakeholders to seriously evaluate their current energy policy as if a storm were rapidly approaching.

An inappropriate knee-jerk reaction to California's crisis is to shelve industry deregulation efforts. While some have elected to head to the storm cellar until the weather improves, we believe the challenge to a state's energy policy crisis needs to be addressed now.

As you recall, other past monopolistic sectors --like banks, airlines, trucking and telephones -- were deregulated when policy makers determined regulation had failed to encourage improved service at cost-effective prices. While there have been setbacks, overall, the deregulation efforts have been successful.

-- New investments are needed.

The obvious answer to the energy crisis is to add energy infrastructure. The difficult questions are who, what, when and how?

Without an established long-term energy policy concerning generation, transmission and even distribution markets, investors will continue to be hesitant to invest.

Why? Remember The Perfect Storm in California. When the storm got rough, the investor was forced to shoulder the turbulence. To attract needed capital, California will have to address its propensity to penalize investors when markets are volatile.

To attract capital, investors must see a way to make attractive returns, understanding that deregulation brings increased risk. A market that takes away a majority of the benefits while requiring investors to shoulder all of the downside is outright unattractive.

The significant investment needed to shore up the U.S. energy infrastructure provides excellent investing opportunities for energy companies. The question remains: Will federal and state legislatures and regulators have the foresight to establish energy policy that encourages investment?

-- Establish a direction and timetable.

To encourage investment, the rules of tomorrow's energy markets have to be established today, along with a timeline for implementation. Without a direction, investors will find little reason to invest given future uncertainties.

With the numerous attributes surrounding the electricity market, as underscored by The Perfect Storm, a transition to a fully competitive market typically includes a significant transition time.

A key factor dictating how long that transition time should be is the current condition of a state's transmission system. An electricity and natural gas energy highway that operates efficiently and effective even at peak periods is ready for a rapid transition to a more competitive market. Solid interconnections to multiple energy markets limit the reliance on a key supply source, limiting potential volatility when adverse conditions occur.

We believe that a boost for U.S. energy policy, and therefore investors, would be increased participation in the deregulation process by the Federal Energy Regulatory Commission (FERC).

The California energy crisis highlights a key point: Energy markets are regional and a state's energy policy most likely will influence the regional energy market, thereby influencing other states' energy markets. Since energy policy affects interstate commerce, we believe that FERC should spearhead an effort to define the key attributes that support a robust energy market.

We understand that FERC intervention treads on perceived sacred ground by most state policy makers. However, the benefits of consistent energy policy across state boundaries, combined with expedited transmission-siting authority, could help boost energy investment in states or regions that are lacking a comprehensive energy policy today.

As we mentioned earlier, once the future energy market's rules have been established and implemented, avoiding The Perfect Storm is as simple as letting an efficient energy market take its course.

Proper financial incentives will attract needed capital to correct an imbalance in a supply and demand equation in a cost-effective manner.

California's energy woes validate the theory that has fueled deregulation efforts; regulation is a poor motivator for attracting capital needed to improve or maintain service at cost-effective prices. California's energy policy failure is rooted in its unwillingness to establish a truly unregulated market.

The state's recent strategies to resolve its energy crisis underscore its opinion that big government can solve its energy woes, a giant step in the wrong direction.

May investors and energy customers beware. California provides a case study for others to benefit from. California-style energy policy is disastrous for all energy stakeholders.

The year 2001 should shape up to be important for investors and consumers. If California's energy crisis does not wake up energy policy makers that have been reluctant to make decisions, what will?

The lack of investment in energy infrastructure is not just a California issue. This problem or opportunity exists across the U.S. and is a major point supporting our positive outlook for the utility industry.

If energy markets are properly established, robust energy infrastructure construction is expected to provide strong growth potential for many energy companies in the next decade.

However, without adoption of policy decisions near-term, investors will head for the storm shelter, waiting for the approaching storm to batter policy makers into action before committing additional capital.

David E. Parker is senior vice president for equity research for Robert W. Baird & Co. Inc. He spoke at an energy symposium in Milwaukee on March 8.

Publication date: 2001-03-18

http://cnniw.yellowbrix.com/pages/cnniw/Story.nsp?story_id=19046188&ID=cnniw&scategory=Utilities%3AElectricity



-- Martin Thompson (mthom1927@aol.com), March 18, 2001

Answers

"These were the signs of an approaching storm:"

He lists a number of reasons but why is the number one reason always ignored? A quickly swelling population. If this didn't occur then the other reasons would be moot.

I've never been able to understand this.

-- Guy Daley (guydaley@altavista.com), March 19, 2001.


He also forgot to mention that turning back the clocks only works for a short period of time...oh, and the skwerl prob was not mentioned either.

-- NdewT (NdewTyme@NdewT.com), March 19, 2001.

Yes, all of the factors above are playing a part in this crisis. But the KEY factor in making this a "Perfect Storm," rather than a mild thundershower, is the Y2K Computer Date Bugs in embedded systems, especially the second variant of the Leap Year Date Bug (the so- called "Y2K+1" bug.) I live in San Diego, where the "Y2K Bug Flood" waters rose above our doorstep and water started getting the carpet wet (metaphorically speaking) yesterday, at T + 444 days. In the media news broadcasts, it was admitted that some generating plants were running less than flat-out; and the main problem was in the transmission of electricity, not its generation. The I.S.O. website, http://www.caiso.com/SystemStatus.html showed yesterday, and today, that power demand was/is not at all extraordinary, at about 25 GW (gigawatts, or 25000 megawatts). Typical winter peak power is about 30-35 GW, whereas summer peak loads reached 55-60 GW, in 1999 and earlier, pre-rollover. Also, Los Angeles, which haughtily regarded itself as being "above the fray," with adequate local generation, got very rudely surprisingly "hit" with these Y2K grid-bottleneck induced "rolling blackouts". And the State of California wants to buy this Y2K Bug infested grid??? Talk about buying a "lemon"! Rick Cowles and many other Y2K moderates predicted that CA, since it didn't "lock down" its grid computer configuration, but instead reconfigured the computerization for political regulation changes (so- called "deregulation"), would be more vulnerable than other regions to Y2K embedded system induced grid disruptions. This, of course, from the standpoint of 1999, was largely offset by not needing the grid for survival heat, and (near the coast) even comfort air conditioning. But the economic impact is, and will be, very major.

-- Robert Riggs (rxr.999@worldnet.att.net), March 20, 2001.

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