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California's Power Gamble: Long-Term Contracts, Locked-In Risk

High profit potential will attract new power plants, forcing prices down and stranding the state's long-term electricity purchases.
Fortnightly Magazine - May 15 2001


High profit potential will attract new power plants, forcing prices down and stranding the state's long-term electricity purchases.

Let's consider three questions crucial to California's energy crisis and its plans for solution.

First, what is the likely long-term wholesale power price in California, and how does that price compare with the current cost to the state of signing long-term contracts to buy electricity at prices, terms and conditions common to today's overheated market?

Second, despite the many risks (retail price caps, political interference, environmental restrictions, etc.), are the current rewards great enough to entice power producers to build more power plants - enough to bring prices way down in two or three years?

Third, could it be that, given the current market, long-term power contracts are not in the best interests of the state's electricity consumers?

Overall, many factors appear at work to increase the risks of investing in new generating capacity in California, including:

  • A constrained transmission system,
  • Threats of state takeovers of assets,
  • Voter opposition to necessary rate increases,
  • Calls for re-regulation of power producers, and
  • New legislation that could change the investment landscape.

Yet California, which stands as America's number one energy consumer, ranks only 47th on a per capita consumption basis - far below almost all other states, according to the Energy Information Administration. This fact would appear to leave little additional room for conservation. And, any new plants constructed by power producers are likely to be more efficient than existing plants. Even if the energy crisis ends in California and excess capacity exists, the new plants will be operated over the older, less-efficient ones.

And consider what might happen if new investment comes on line. If that new capacity pushes prices down, that could force the state's Department of Water Resources (DWR) into default on the bonds supporting its long-term power purchase contracts. After all, the state of Washington (Washington Power Supply System) defaulted on its bonds after it was concluded that sufficient power capacity existed in the state and its partially completed plants were no longer needed. But in California, the power from the new plants would still be more competitive than existing plants. By contrast to the stranded WPPS nuclear capacity, these new California producers could still attract customers by selling their output at market prices, and collect revenues above their costs. The key factor remains that this new capacity would replace older, less-efficient production.

Thus, one can identify many countervailing factors that might service to mitigate risks for new plant investment, including:

  • An expanding economy,
  • An expanding population,
  • A shortage of generating capacity,
  • Limited room for additional conservation, and
  • An existing inventory of generation that is older, less efficient, and ripe for replacement by newer, more efficient plants.

So, let's look at the facts. What elements are in place that might affect risks and incentives for power producers in California? How would these factors affect the answers to our three questions - about prospects for power producers and the wisdom of California's plan to invest in long-term supply contracts?

Where We Stand Today