News Analysis

 

Industry experts debate whether so-called "price mitigation measures" miraculously solved the California crisis.

Wholesale electricity prices are a darn sight lower in California these days than they were last May, before the Federal Energy Regulatory Commission (FERC) implemented price caps in May and expanded them in June. But, there is widespread disagreement over whether the caps were the cause, or merely coincidental with other downward pressures, such as moderate weather and generally increased supply. Get the answer right, and you have the long-term fix for California. Get it wrong, and California will likely see high wholesale prices again in 2005-if not before. And, FERC has until September 2002 to decide.

In the weeks before FERC implemented what it calls price mitigation measures-what most others call price caps-dire warnings were issued by generators that the caps would cause yet more blackouts in beleaguered California. On April 23, the Western Power Trading Forum predicted that price caps "will cause more blackouts in the West, chase away much-needed new generation, and jack up wholesale power costs." After FERC applied caps to California on May 29, but before applying them to the entire western region, Reliant Energy intoned that "[t]he current price caps, which send inaccurate market signals, are actually decreasing supply and increasing demand thus worsening an already dire situation."

In California, the average price per megawatt hour for May was $275; and for June, $104. The real-time average decreased another 40 percent in July, dropping to $63; in August, the slide continued, with the average price at $46. September and October wholesale prices dipped slightly, to $42. California has not suffered a single blackout since the caps were implemented. Perhaps even more striking is the fact that average megawatts offline dropped from 14,911 in April, to 5,044 in July. Something has indeed changed a market that saw frequent three- and four-figure megawatt hour prices and rolling blackouts earlier in 2001.

Whether that something is price caps, or other factors altogether, depends on whom you ask.

Market Magic Sends Prices Down

"It is absolutely not true that the caps caused [wholesale] prices to drop" in the California market, says Gary Ackerman, executive director of the Western Power Trading Forum, a group of 35 energy buyers and sellers. Prices were already coming down of their own volition before the caps, he maintains. At the beginning of May, megawatt hour prices were $300 to $400, and by Memorial Day, were down around $100 to $120. He terms the notion that the caps caused downward price pressure "laughable. It's simply not true."

Ackerman firmly believes that the caps cause deviations in the market, and distort the allocation of power supply. He points to a 45-minute, 100-megawatt outage in Las Vegas last July as evidence that price caps do indeed cause market inefficiencies. That outage was directly related to the cap, he says, because prices were then at or above the capped price.

What has saved California thus far is the weather, according to Ackerman. Regulators are "banking on the fact that weather won't be extreme-which is like my teenager saying 'nothing will happen, so can I please have the keys to your car and a bottle opener,' " he says.

Others attribute the drop in wholesale prices to a plethora of factors, price caps among them. The question of what happened to wholesale prices does not have a simple answer, says Gary Stern, director of market monitoring for Southern California Edison. The caps have had a very beneficial effect of keeping prices at a lower level, he says, but lower prices are also due to milder weather this past summer, increased levels of conservation, and a significant decrease in natural gas prices. "It's unfair to say that price dropped due solely to FERC caps, but they are one of several factors keeping prices stable and lower," he says.

Others concur with Stern's assessment. Patrick Mullen, regional public affairs manager, California operations, Duke Energy, says, "obviously, caps had some effect." But he points out that there was also increased conservation in the wake of the California Public Utilities Commission allowing retail rates to increase, plus a cool summer, and new plants online.

Even FERC refuses to take all the credit for wholesale electricity price drops. "Mitigation has been very successful, but it is unfair to attribute falling prices and stability as 100 percent a result of mitigation," according to one FERC official. "Good weather, conservation-a lot of factors that came into play. ... What mitigation did helped psychologically, FERC and others helped, [because we] signaled a willingness to step in and introduce stability into the market. It's very difficult to parse through how much to attribute to caps versus the weather," the official says.

Did FERC's Incantation Increase Megawatts Online?

Perhaps even more interesting than the downward wholesale price phenomenon is the marked increase in generation levels between May 2001 and June 2001. In May, 13,431 megawatts on average were offline-compared to 4,012 in May 2000. Then in June, the offline level plummeted to 6,794-still far above the offline levels for June in the two previous years (2,683 in 2000; 1,216 in 1999), but a terrific drop nonetheless. () Indeed, the drop between May and June for both 1999 and 2000 was an average of 1,570 megawatts.

According to Michael C. Moore, Commissioner, California Energy Commission, the baseload level of generation did not increase significantly between 2000 and 2001. Yet, the incidences of forced offline outages were dramatically higher in 2001. For example, in February 2000, the average was around 3,200 megawatts; yet one year later, the average generation offline increased to around 10,900 megawatts. Moore says that some of that increase must represent downtime resulting from running plants flat-out during California's extended crisis-there would naturally have been a higher incidence of outage. As for the precipitous drop between May and June, Moore notes, there was more stability in the market, with long-term contracts giving long-term comfort in market. He speculates also that maintenance decisions perhaps were made more routinely.

But those factors account for perhaps half of the forced outages before June 2001, in Moore's view. "Fifty percent of the outages have to represent an economic decision" by the generators, he says. Even if the typical outage level was around 2,400 megawatts, and one assumes 50 percent more outages due to running plants at full capacity for extended time periods, the outage figure should have jumped to 3,600, Moore explains. Even at 100 percent more outages, the outage figure would rise to 5,000 megawatts. April 2001 saw 14,900 megawatts offline, which is nearly one-third of the state's total load.

The five major generators in California showed very low levels of generation in 2000, according to Robert McCullough, principal of McCullough Research. Of the 20,000 megawatts of gas-fired plant capacity in California, roughly 50 percent was in operation then, he says-a situation that lasted until the onset of the caps. McCullough acknowledges that reasons for taking plants offline include environmental restrictions, gas price increases, and breakdowns. But he notes that "by any normal standard, the dispatch rate was low."

Data that McCullough gathered from the California Independent System Operator (CAISO) lends some credence to the theory espoused by many regulators that generators were gaming the system by taking generation offline to create a perceived supply crisis, resulting in sky-high spot prices. In the entire month of May, 30 days saw forced or unplanned outages of better than 3,000 megawatts. The only day in May with less than 3,000 megawatts of unplanned outage was May 31, with roughly 2,800 megawatts-two days after the May 29 FERC price cap decision. In contrast, during June, there were only 11 days with outages over 3,000 megawatts, with 10 days between 2,500 and 3,000, six days between 2,000 and 2,500, and three days below 2,000 megawatts of unplanned outage. July saw even lower levels of forced outages, with only five days of more than 3,000 megawatts offline.

"There is a strong implication that FERC did little to control wholesale price, but much to change the [market] incentives." McCullough says. "In a perfect world, you expect availability to fall in November and May-these are shoulder months, used for repair and maintenance. In 2000, generators took down units in November and never brought them back up. It would be surprising to have extreme maintenance problems last year," he observed. He noted that an entire plant can be built in about six months from start to finish.

Despite the suggestiveness of the data, some regulators are withholding judgment on whether generators gamed the system before price caps. "You can reach the conclusion that caps gave market the right signal, or it could be that old plants were taxed by running at capacity for extended periods," says Richard Bilas, one of the CPUC's commissioners. He also points out that there has not "been anything other than allegations-you need an evidentiary hearing, for generators to be put on the record." Bilas says he "suspects deep down that the generators colluded-but how do you prove it?" Even if solid evidence showed that generators gamed the system, Bilas says there are better ways to signal generators not to manipulate the market. "Caps are a serious interference with the market. . . . [you] can't fix gaming by the permanent disequilibrium created by caps," he says.

Indeed, generators have repeatedly-and heatedly-disputed assertions that they deliberately withheld power from the California market. In a press release last May, Mirant challenged the CPUC and the CAISO to cough up data to back such charges. "It's time to put the political rhetoric aside and speak the facts," Mirant's CEO of western operations, Randy Harrison, stated. "State officials have been to our facilities 65 times since January [2001] and have found in every instance that Mirant is in full compliance." Harrison termed the gaming claims "ridiculous," and also said that the only reason Mirant had taken a unit off line was to address a safety or environmental concern.

"The hypothesis that generators scaled back production in order for their competitors to make money is height of idiocy," Ackerman declares. He says that the precipitous drop in megawatts offline reflects nothing more than generators bringing units back online for summer duty, after routine maintenance. Most of maintenance, he says, was supposed to occur in the fall-but because of CAISO's deep concerns about overall supply, most scheduled maintenance was deferred, and deferred, and deferred, for two quarters. When the generators were finally taken down, he says, "[t]hey were tired dogs that needed a lot of maintenance." Many of the units taken down were old thermal generating plants, previously owned by the utilities, that he says had never been run as hard as they were in 2000. Prior to deregulation, according to Ackerman, those units were running perhaps 15 percent to 20 percent of the hours possible, but in 2000 were pushed to 55 percent to 60 percent of the hours. "That takes a toll, especially when the plants are 30 to 35 years old," he says.

Gazing Into the Crystal Ball

Beyond wholesale prices and outages, another pressing question about the caps is their effect on investment in new generation capacity. Since the beginning of 2001, a total of 2,000 megawatts have come online, according to Moore. He says that beyond stabilizing the market, the FERC caps have shaken out the weaker players, and given pause to the stronger market players, causing them to build generation projects in a more thoughtful, sustained way.

As Mullen points out, California still imports close to 25 percent of its electricity. "We need to see the market actually fixed so it operates as a competitive market, so that we don't need price caps. We need stability in regulations in the state to drive new investment." He adds, "[t]he most important thing is getting the market in balance. Caps can inhibit investment generation. . . . the projects funded are far, far less than before the caps."

At least one company has backed out of building new generation in California as a direct consequence of the price caps. Reliant currently is not building new generation in California, according to John Stout, senior vice-president, asset commercialization at Reliant. What new generation Reliant is building is in Arizona and Nevada, and does not include any peaking capacity, but only baseload. In fact, Stout says that after the June 21 price cap announcement, Reliant put off plans for a peaking unit in Big Horn, Nevada until at least fall of 2002. The FERC price mitigation measures are set to expire in September 2002.

"The rate for projects has dropped off considerably," Ackerman says. While he knows of no new projects in California currently, he also cannot say that the downturn is a result of the caps, because the rates for megawatt hours were already dropping before the caps.

Many, including Ackerman, believe that price caps send the wrong signal to power plant investors. While there is some new investment in generation, there is also wariness, he says. "The most dangerous thing is if FERC extends caps- I guarantee that 2000-01 [rates and problems] will be seen again in 2005-06."

The forthcoming CEC energy outlook predicts an ample power supply for the short-term. "There is quite an adequate cushion for planning purposes, [and] projects are coming online adequately," Moore says. While not saying directly that projects are being withdrawn from the licensing process, he does say that it appears the market for new generation is contracting, so that companies are a good deal more conservative in their expectations. Comparing applications made in 2001 to those made in 2000 is to make a data regression without many data points, he says. "Some of the applications were so inept, they defied description, [and] a lot of those got shaken out." The market conditions were so volatile, Moore points out, that many applicants jumped into the market. The mid- to late-1990s period stands in stark contrast, with no applications filed-and that lack of investment in new generation is widely considered to be the root cause of the recent crisis.

CPUC's Bilas says that while the current power supply is adequate, he is not confident about the five-year supply for California. "The independent generators are absolutely correct not to build" new generation under the current scenario of caps, he says. Regulators cannot say to generators to go build new capacity, if their prices are going to be capped, he argues.

Yet others argue that the caps are not affecting investment decisions. "It's not clear that caps are preventing investment," says SCE's Stern. "Some want the measures removed, to see increases in prices as we had two years ago, but there is no evidence that generation owners are losing money."

Coming Out From Under the Price Cap Spell

The fundamental question underlying this debate, according to the FERC official, remains: Is the market functioning? The fact that FERC put a timeline on the measures, he says, signals that price mitigation is not favored. At some point, FERC would like not to have mitigation in place, and to have a market running with an independent ISO or regional transmission organization (RTO).

As for the future, the official says, all sorts of rules changes are probably necessary, because so many things are not working in California. In addition, he says that FERC is considering some overarching general standardization for all markets. Although declining to say explicitly what areas the Commission is considering standardizing, the official suggested that staff summaries of the "RTO Week" meetings pointed toward some of the ideas under consideration for standardization subjects.

The test of market functioning could come as early as September, if the price measures are permitted to expire then. While no one would speculate on whether the caps would expire, several widely ranging predictions were offered if they do.

Ackerman says that from a trading perspective, nothing changes if the caps expire. "No one is taking the order into account, it just messes [the market] up for a few days."

If the caps expire in September, and the resource balance is still positive, McCullough predicts an immediate return to 2000-01 prices. "There have to be substantive changes. Either FERC has to steel itself to be a market disciplinarian, if it wants centralized markets, or face the fact that commodities don't have a central market," he says.

Stout fully expects more volatile prices, should the caps come off in September. He says "the answer to price caps is demand response." The market needs buyers to be in position to know real-time pricing, he says "The real key to fixing price caps is fixing demand."

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