Commission Watch

Deck: 
California anticipates changes in energy policy under its new governor.
Fortnightly Magazine - March 2004

Commission Watch

California anticipates changes in energy policy under its new governor.

The recall of California Gov. Gray Davis in November 2003 almost immediately led to speculation concerning possible changes in California's energy policy. Since his election, Gov. Arnold Schwarzenegger has assembled an Energy Working Group, co-chaired by Professor James L. Sweeney, professor of Management Science and Engineering at Stanford University, and Sean Randolph, president of the Bay Area Economic Forum, who has written extensively about the California energy crisis1 and has been critical of some of Davis' decisions. This informal working group, which includes eight individuals and a liaison,2 has formulated its recommendations for energy policy changes and has forwarded them to the governor's office.

The working group liaison, Dan Skopec-formerly staff director of the U.S. House Government Reform Subcommittee on Energy Policy, Natural Resources, and Regulatory Affairs3- has relocated from Washington to Sacramento and has become Gov. Schwarzenegger's deputy cabinet secretary for energy, resources, and environmental issues. Michael Chrisman, formerly regional manager for Southern California Edison Co., has been appointed secretary for resources.

Despite the personnel changes at the executive level, no near-term changes are expected in the composition of the California Public Utilities Commission (PUC), with Michael Peevey expected to continue in his role of president and the terms of Loretta Lynch and Carl Wood not due to expire until the end of 2004 or beginning of 2005. Given their major philosophical differences with administration policies and initiatives, however, it is unlikely Commissioners Lynch and Wood will be reappointed. A position on the California Energy Commission (CEC) and two appointments to the board of directors of the California Independent System Operator (Cal-ISO), including chairman, remain open. To the extent the Electricity Oversight Board (EOB) survives reorganization, the chair of the EOB also will be replaced.

The governor's energy policy and legislative agenda are expected by early spring. Dramatic policy changes are not expected in the near term, as the looming $15 billion, 2004-2005 budget deficit has dominated, and will continue to dominate, the attention of the new administration.

If anyone expected Schwarzenegger's State of the State speech on Jan. 6 to produce details of his energy policy, he or she would have been disappointed, but certain broad themes of energy policy are expected to follow the governor's energy policy statement, and include market-based structures and incentives, promotion of a diversity of energy supply and energy sources, conservation, and environmental protection. It is unlikely that the Schwarzenegger administration will propose a dramatic shift back to cost-based forms of regulation, as some critics of deregulation have advocated. Rather, Schwarzenegger's energy policy statement indicates he will pursue fine-tuning the market structure, drawing from the experience of Texas, the New England states, and the PJM territory.4

Similarly, Schwarzenegger also is not likely to void the approximately $42 billion of long-term contracts signed during the energy crisis. Rather, as indicated in his state speech, Schwarzenegger intends to bring down electricity costs by renegotiating long-term contracts. Instead of shortening the contracts and reducing the volume of purchases, the governor may lengthen the contracts and/or selectively increase the volume. This is the more traditional "blend and extend" model that is familiar to power contract experts.

Finally, Schwarzenegger is expected to be less confrontational and rhetorical in tone than Davis, trying to avoid the confrontations that plagued his predecessor.

Direct Access and Exit Fees

One of the most controversial outcomes of the California energy crisis was the legislature's decision to suspend direct access, under which commercial and industrial customers had been permitted to purchase electricity from alternative providers. However, even more controversial was the PUC's decision to impose "exit fees" on direct access customers of 2.7¢ kWh, primarily to help the state pay for power purchased by the California Department of Water Resources during the energy crisis and to spread among ratepayers the cost of long-term contracts signed during the energy crisis.5 Recent CPUC decisions have extended the exit fee to customers who never received bundled service from a utility.

Historically, California Republicans have been strong supporters of direct access, and there is every reason to believe that Schwarzenegger will resist any efforts to abolish direct access altogether. Indeed, in his state speech, Schwarzenegger expressed support for reform in retail markets "so that large customers can get competitive prices," and he advocated reforms in the "wholesale power market to attract new energy investment."

However, given the continuing state fiscal crisis, it is doubtful whether industrial and commercial customers can expect any significant relaxation of the exit fees, as onerous as they are. Rather, it appears more likely that the new governor will limit his consideration to piecemeal initiatives, such as exemptions to the exit fee for certain industries on a hardship basis, or for new businesses that are relocating from other states. In this regard, the CEC recently adopted regulations governing hardship requests for exemption from the exit fee.6 It is likely that Schwarzenegger will support this program and perhaps even go so far as to exempt certain types of new industry from the exit fee as a means of attracting new businesses to California.

Structural Changes

One of the more probable structural changes under the Schwarzenegger administration will come in some of the administrative agencies or other organizations respecting energy markets.

The governor's campaign promised to:

(1) Affirm the commitment to private power by dismantling the California Power Authority (CPA). "Its current mission to build and operate publicly owned plants is in direct competition with private industry and serves only to divert private investment in electricity generation and transmission away from the state."7 David Freeman, chairman of the CPA, resigned in October, soon after Schwarzenegger became governor-elect. His deputy, Sunne McPeak, has been appointed to Schwarzenegger's Cabinet as secretary of Business, Transportation, and Housing, signaling the likely imminent demise of the agency, with certain functions-such as bonding authority-perhaps assigned to another agency. The disappearance of the CPA is not expected to be momentous, as it was a recent creation and had released bonds totaling only a small fraction of the $5 billion bonding authority (less than $23 million).

(2) Restructure the California wholesale market by merging the functions of Cal-ISO and the Power Exchange (now defunct) into a single entity to achieve integrated transmission operations, generation dispatch, and wholesale power trading.8 Schwarzenegger also has promised real-time pricing, at least for the largest and most sophisticated electricity buyers.

(3) Abolish the EOB. Its functions were duplicative of other agencies or entities, including the CPUC, CEC, and Cal-ISO.

In his state speech, Schwarzenegger reaffirmed these goals, decrying the existence of "13 different state energy agencies." Each of these changes presumably would require legislative action and attendant delay and uncertainty.

The Campaign Against Out-of-State Energy Producers

The last two years of the Davis administration were marked by a pattern of rhetoric, charges and countercharges, and attacks on the energy industry, punctuated by open assaults on Enron, the bad boy of the industry. California's aggressive campaign against out-of-state energy producers has been well chronicled. It has included:

(1) A series of complaints at FERC, including an attack on the legality of market-based rates;

(2) A series of unfair business practice lawsuits by the California Attorney General against generators, based on the alleged charging of unfair and unreasonable rates (all of the lawsuits were dismissed by a District Court and are currently on appeal to the Ninth Circuit), the so-called "double selling" of power in the day-ahead and ancillary services markets (also dismissed), and Clayton Act (antitrust) cases against Reliant, Duke, and the other acquirers of fossil fuel plants divested by PG&E and Edison; and

(3) An aggressive public relations campaign by the former governor and attorney general.

The various affirmative cases brought by the state have enjoyed little, if any, success. The same is true of Gov. Davis' seizure of block-forward contracts held by the state's largest IOUs, PG&E and Edison, which backfired when the Ninth Circuit ruled in Duke v. Davis9 that the seizures were illegal. Likewise, the state's efforts to circumvent FERC and its rulings in the refund and other proceedings at FERC have been rebuffed in the courts.

Look for Schwarzenegger either to dismiss or negotiate a speedy resolution of most of the pending litigation he inherited. Some matters, such as the inevitable appeal of FERC's refund order, will continue. However, continued confrontations with energy producers would run counter to Schwarzenegger's goals of ensuring an adequate supply of power for the anticipated shortages in 2005 and to make the California business climate more hospitable.

New Generation

The new year hardly had begun when Sen. Dianne Feinstein dispatched a letter to Schwarzenegger expressing deep concern about the potential for recurring blackouts as soon as this summer, and proposed a non-partisan effort to establish a new energy framework. Heavy rainfalls and a rapidly increasing snow pack have alleviated some of the concerns about the 2004 summer peak, as hydroelectric generation is expected to be robust, but real questions remain about 2005.

What about the adequacy of generation, as work on many approved generation projects have been suspended and few applications for new projects have been received by the CPUC?10 To date, Schwarzenegger has not said much about methods to ensure adequate capacity. Thus, questions remain about whether the governor will encourage more central plant projects by utilities along the lines of the recent CPUC-approved Mountain View project,11 adopt incentives for more independent power generation, renew the state's commitment to qualifying facilities under the Public Utility Regulatory Policies Act, or some combination of the above.

Schwarzenegger is likely to endorse legislation that would increase reserve requirements for utilities, thereby encouraging additional supply. Reserve margins of 12 percent have been shown to be inadequate given the vagaries of weather, out-of-state imports, and the availability of performance of the aging fossil-fuel plants, which provide most of the reserve margin for peak conditions. Expect reserve margin requirements for California IOUs to increase to the high teens, whether by legislative action or as a result of actions by the PUC, as suggested by a recent procurement decision mandating a reserve margin of 15 percent. Various tax incentives also may be employed to encourage more generation, and Schwarzenegger also is likely to sponsor initiatives that ensure both the diversity and adequacy of power supply. With respect to the former, the Energy Policy Statement suggests an undue dependence on natural gas, from which 43 percent of the state's energy supply is derived. At the same time, gas transmission system improvements may reduce the problem by increasing access to sources of natural gas.12

Renewables

Schwarzenegger's policy statement expresses his commitment to the California renewables energy portfolio standard, which calls for 20 percent of the state's total power supplies to be generated by renewables by 2017. The governor has advocated accelerating the time deadline by seven years, and it is likely that additional incentives favoring renewables will be forthcoming.

Schwarzenegger has expressed a particular affinity for solar power, with promised additional tax incentives for new solar power installations. The Energy Policy Statement set a goal that 50 percent of all new homes will have solar photovoltaics by 2005, although this goal is probably too ambitious given the costs involved.13 Similarly, the goal of building a network of stations to implement a "hydrogen highway" by 2010 may be over-ambitious given the cost and the state's fiscal constraints. In addition, we can expect new legislation providing for tax credits for companies that install on-site renewable generation projects. Schwarzenegger has not yet expressed a policy respecting expansion of micro- or mini-turbines, another form of on-site generation, but one that is dependent on fossil fuels. However, given his strong support for on-site generation, distributed generation is likely to be an area of emphasis in the new administration.

Other Initiatives

Schwarzenegger frequently has emphasized the need for increased energy conservation. For example, the details of his conservation plan will include implementation of a real-time pricing program for "the largest customers."14 Real-time pricing will "not only protect California against shortages," but "also help reduce the cost of doing business for energy-intensive industries such as manufacturing."15

In addition, the Energy Policy Statement suggests increased emphasis on liquefied natural gas (LNG) as a fuel source. LNG "provides an opportunity to assure a reliable supply of natural gas," and "will create more natural gas capacity."16 Initiatives in this area would promote the goal of diversifying sources of natural gas, and help the state avoid any bottlenecks that develop in the gas transportation system.

The Schwarzenegger administration's detailed implementation plan is expected by the spring of 2004. None of these new initiatives are expected to represent a radical shift in policies. However, Schwarzenegger is committed to restoring confidence in government and improving the business climate, and at the same time taking steps to increase and diversify California's energy supply and improve the environment. Therefore, there is reason to be optimistic about California's energy future. At the same time, the flood of energy litigation is likely to subside so that perhaps in a year's time, all will once again be quiet on the Western front.

Endnotes

  1. Professor Sweeney's book, (Hoover Institution Press Publication, 2002), is one of the most comprehensive and digestible explanations of the events that led up to, and exacerbated, the California energy crisis.
  2. Other members of the working group include Ralph Cavanagh, senior attorney, NRDC; Severin Borenstein, director, University of California Energy Institute; Joe Desmond, president, Infotillity; Dan Emmett, an architect from Southern California who has focused on green buildings; Lenny Mendonca, managing director, McKinsey & Co.; Glenn Thomas, former chairman of the Pennsylvania Public Utilities Commission; and Dan Skopec, the liaison to the Schwarzenegger transition team.
  3. Rep. Ose and Skopec were actively connected to various Congressional hearings and proceedings involving the California energy crisis, including: "Assessing the CA Energy Crisis: How Did We Get To This Point, and Where Do We Go From Here?" 107th Cong. (2001); "FERC: Regulators in Deregulated Electricity Markets," 107th Cong. (2001); and "Energy: Maximizing Resources, Meeting Needs, Retaining Jobs," 107th Cong. (2002). Ose sponsored legislation aimed at increasing FERC's investigative and remedial powers over the energy industry.
  4. See Policy Statement at p. 9.
  5. See .
  6. See Article 6, "Qualified Departing Load CRS Exemptions," Section 1395, California Energy Commission (Dec. 31, 2003).
  7. Policy Statement at p. 9.
  8. See Policy Statement at pp. 9-10.
  9. , 267 F.3d 1042 (9th Cir. 2001).
  10. See http://www.energy.ca.gov/maps/siting_cases.html.
  11. (Dec. 18, 2003).
  12. See Policy Statement at p. 10.
  13. See Policy Statement at p. 13.
  14. See Policy Statement at p. 10.


Real-Time Price Study Update: Closing the Loop

The California Energy Commission recently released results of the Statewide Pricing Program (SPP) analysis performed by Charles River Associates (CRA). CRA found the program successfully caused significant peak-demand reductions.

The program included both time-of-use (TOU) and critical peak prices (CPP); TOU consisted of peak and off-peak rates, while CPP included peak, off-peak, and "super peak" rates that were dispatched 12 days during summer 2003. CRA's draft results are shown in the table below (final data may differ). CRA found California's customers had price elasticities, peak demand reductions, and peak usage reductions consistent with customers in other programs around the country. The SPP sample population is generally representative of the statewide population. However, the "CPP with automated response" group volunteered to be on a smart thermostat pilot program and may not be representative of the population as a whole. -Chris King, eMeter Corp.

Statewide Pricing Pilot Results-Residential
Performance Measure Average from
the Literature
California
SPP Result
Price elasticity of peak period energy usage (own-price effect) -0.30 CPP-F: -0.27
CPP-V: -0.53
TOU: -0.24
Peak demand reduction - TOU 20% 24%
Peak demand reduction - CPP
without automated response
24% 20%
Peak demand reduction - CPP
with automated response
44% 49%
Total usage reduction on weekdays
(conservation effect)
4% CPP-F: 6%
CPP-V: 28%
TOU: 9%
 

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