- The Washington Times - Monday, January 15, 2001

Silicon Valley needs electricity like people need water. Yet the residents there have refused to allow the construction nearby of the power plants and facilities needed to keep up with their growing demand for electricity.
As a result, the epicenter of the nation's technology-driven "new economy" like the rest of California faces the threat of power shortages in the next three years that could drain the lifeblood of the region's economic growth.
The power crunch is so serious that Intel Corp., the world's leading computer chip maker and one of California's most successful businesses, said last week that it will not expand any further in Silicon Valley because it has no assurance of future power supply.
California is in the midst of a power crisis that industry analysts say is largely of its own making and has significant implications for and lessons to be learned by the rest of the country.
Already, consumers around the nation are paying record high prices for the natural gas needed to heat their homes, partly because of soaring demand for the fuel from California utilities. Washington Gas customers last month paid nearly twice as much, $224.50 on average, as they did a year ago because of shortages brought on by the California crisis and unusually cold weather.
At a time of rapidly weakening economic growth around the nation, economists say the energy price shock and other economic disruptions emanating from the nation's largest state may be tripping the national economy into a recession.
And in a sign that the state's problems could quickly turn into a wider financial crisis, Wall Street got rattled Jan. 5 after major credit agencies warned of the impending bankruptcy of California's huge utilities unless the state or federal governments arrange a bailout. The down-draft in utility and bank stocks sent the Dow Jones Industrial Average plunging by 250 points.
The shock to already troubled markets prompted the Clinton administration to call state officials to Washington for continuing negotiations aimed at forging solutions to avert a crisis. Attending were California Gov. Gray Davis, federal energy regulators and leaders of the state's utilities and power generators.

Recession threat

Richard Berner, chief U.S. economist with Morgan Stanley Dean Witter in New York, said the crisis is well under way, however. California is leading the United States into a recession because of its failure to deal with the rapidly spreading crisis, he said.
"We worry about economic dislocations," he said, noting that the recession concern arises from the combined threat of power outages on the West Coast, a credit crunch for low-rated borrowers sparked by the utility crisis, and sharply higher natural gas prices that are taking a big bite out of consumers' spending power.
Energy-intensive businesses on the West Coast, from fertilizer and aluminum factories to farmers and dye makers, already have shut down this winter or face the likelihood of interruptions in their energy supplies in coming weeks as natural gas supplies dwindle and energy costs soar.
Faltering businesses have announced thousands of layoffs in the last month, including 1,850 at Southern California Edison Co., one of the two California utilities that are within weeks of bankruptcy because of a $12 billion mountain of debt they amassed mostly during the crisis that started last year.
"The energy woes menace growth," said Mr. Berner, with California likely to be hit the hardest because most of the problems are centered there.
California's two largest utilities, Edison and Pacific Gas & Electric, are on the verge of bankruptcy because the cost of wholesale power has far outstripped the rates that state regulators permit them to charge their 25 million consumer and business customers.
The utilities have warned they will have to turn out the lights and ration electricity unless the state legislature and regulators act soon to raise consumer rates or otherwise bail them out.
They made good on that threat last summer by imposing blackouts in the San Francisco Bay area. Again on Thursday, they announced a high-level emergency that enabled them to cut off power to some businesses and impose rolling blackouts.
A wide-scale power outage in California "would have monumental consequences for the U.S. economy," said Ward McCarthy, economist with Stone & McCarthy in Princeton, N.J.
Federal Reserve Chairman Alan Greenspan probably had an eye on the crisis in California when he ordered a surprise cut in interest rates Jan. 3, Mr. McCarthy said. The Fed cited the nationwide energy price crunch and a developing credit crunch as reasons for its pre-emptive strike against recession.
The Fed views the situation as especially volatile, Mr. McCarthy said, since downgrades by Wall Street credit agencies Jan. 4 cut off the utilities' sources of credit and left resolution of the crisis in the hands of politicians who have shown little appetite for making tough decisions.
Mr. Davis, the Democratic governor, and the state's lawmakers and regulators have granted only part of the stiff, 30 percent rate increases the utilities say they need to avoid bankruptcy. They have taken steps toward a state takeover of the power system but have not offered any financial plan to stave off bankruptcy.

State wants price caps

Mr. Davis and other state officials blame the crisis on the state's botched effort at deregulation since 1998 and "greedy" power generators, who they say are charging the utilities usurious rates on the spot market.
The cost of wholesale power last summer soared 270 percent over the previous year to as high as $324 per megawatt hour. That prompted state officials to call on the Federal Energy Regulatory Commission to put a cap on wholesale power prices throughout the West and disgorge what they consider ill-gotten profits at the generating facilities.
Mr. Davis has traveled to Washington several times seeking advice and assistance from Mr. Greenspan, President Clinton and others. While federal officials say they will not finance a bailout, Mr. Clinton showed his sympathy for the plight of the nation's most populous state by providing some temporary assistance in the past month.
After Mr. Davis appealed to Mr. Clinton personally for intervention Dec. 26, the Energy Department ordered Western power generators to supply electricity to the state's utilities, despite their inability to guarantee payment.
Last week, Energy Secretary Bill Richardson intervened even further, imposing a temporary cap of $64 per megawatt hour on the cost of the utilities' energy supplies. That put him at odds with the Federal Energy Regulatory Commission, which has opposed price caps as federal intrusion in the wholesale power market.
Administration officials in the negotiations appear to be trying to broker a compromise between Mr. Davis and federal regulators that would extend the wholesale price cap temporarily in exchange for long-term reforms in California's dysfunctional system and measures by the state to pull the utilities out of insolvency.
Mr. Davis said the negotiators made headway on a plan that would seal "attractive" wholesale power rates into long-term utility supply contracts a solution pushed by power generators. But that plan does not resolve the immediate question of financing the utilities' debt.

Supply crisis builds

Despite the emotional debate within California over the causes of the crisis, energy specialists are nearly unanimous about the source of the problem: the state for a decade has failed to build any new power-generating facilities to keep up with demand.
Stringent environmental rules have made it difficult to build and operate such facilities profitably, while "not-in-my-back-yard" sentiment has kept power generators out of key areas that are thirsty for power, such as Silicon Valley, where demand for electricity is expected to double in two years.
The drama playing out in California involves other sometimes complex factors, including the botched partial deregulation plan that allows spot markets to determine the price of wholesale power while consumer electricity rates remain frozen.
The region also has been suffering from a drought that has dried up usually available sources of hydroelectric power.
These factors all set in at a time in the late 1990s when demand for electricity was surging. Some analysts attribute the unexpectedly quick growth of power usage to the emergence of the Internet and other high-technology companies that until last year seemed oblivious to the fact that they were quickly running out of fuel.
"Silicon Valley is one of the biggest demand regions in the state, and they are probably the most at risk for generation problems," said Mike Zenker, a California utility specialist with Cambridge Energy Research Associates.
Since the crisis set in last year, Silicon Valley executives have tuned in to the problem and are working actively for a resolution, he said.
But the state's belated efforts to gin up supply by quickly approving the construction of six new power plants will not bear fruit for another two to three years, leaving the state's utility customers dangling without a safety net.
The entire West needs the equivalent of 40 new power plants to catch up with burgeoning demand, and power plants can't be built overnight, he stated.
The vilification of the energy industry by state politicians, meanwhile, has been counterproductive, Mr. Zenker said, noting that three investigations by federal and state regulators found no evidence of wrongdoing. The supposedly "corrupt" power generators are the same ones that must build the power plants and facilities the state needs.
Threats to "disgorge" the profits they need to finance the considerable expense of building the power plants has only discouraged construction, Mr. Zenker said, with one power generator recently citing "political risks" as a reason to avoid development in California.
"Frankly, what's gone on in the state in the last six months has only prolonged the problem and raised the cost for consumers," he said.
"The actions taken so far by regulators only put down hurdles in front of generators. Price caps, threats of forcing refunds of profits, threats to reregulate power generators all of those things create a very uncertain environment for people who are proposing to build power plants."
The state's stringent environmental rules and "nimby"-inspired restrictions already make building power plants there "a risky business," he said.
Most of California's existing power plants and all of those under construction are fired by natural gas, the cleanest burning fuel, to meet the state's strict clean-air standards and skirt opposition from local activists who don't want bigger, dirtier generating facilities nearby, he said.
Natural gas prices are much higher than those for coal or oil, so the result is that electricity rates already are 50 percent higher in California than they are elsewhere in the country.
But Mr. Zenker said that may not be for long, since the rest of the country is going down the same path as California with environmental and zoning restrictions that prevent anything but gas-fired plants from being built close to densely populated cities.

California leads the way

Ninety-five percent of the power plants being built around the country will be gas-fired and will compete for the already scarce supplies of natural gas needed to heat homes, ensuring that prices for the fuel will remain at least twice as high as they were a year ago, said economist David Wyss of Standard & Poor's DRI in Boston.
Like other economists, Mr. Wyss sees these high energy and electricity prices, and the powerful depressing effect they are having on consumers, as a reason to be worried about recession.
California politicians have sought to blame the state's rate deregulation plan, in place since 1998, for the soaring costs of power. But analysts say that is not the culprit. Americans for other reasons have been increasing their dependence on costly and scarce energy supplies.
"Deregulation is getting a bad name, and unfairly so," said Mr. Zenker, who noted that California's deregulation plan was never fully carried out and actually was rolled back last summer in the one jurisdiction that completely deregulated rates: San Diego.
San Diego utilities were able to uncap their consumer rates last summer after fulfilling certain requirements under the deregulation plan, but the sharp jump in electricity bills immediately afterward prompted a public outcry that led to the rollback.
Mr. Zenker said the problem with the deregulation plan was it was poorly designed and "resulted in a market structure that failed to build power plants before a supply crisis occurred."
One much-criticized aspect of the plan requires utilities to buy power on the high-priced spot market rather than locking in lower rates through long-term supply contracts. Federal and state negotiators are nearing agreement to reform that aspect of the plan, which has been shunned by other states.

Deregulation suspect

Still, the widely publicized crisis in California has caused a number of states to cancel or postpone deregulation plans until they are certain they won't have the same problems, including Georgia, Minnesota, Montana, North Carolina, Ohio, Illinois, Oklahoma, Arizona, New Mexico and Nevada, Mr. Zenker said.
Deregulation efforts also have lost steam because groups of business users that previously thought they would benefit from lower electricity rates now are not so sure after witnessing California's supply crisis, he said.
The state that has been most successful with deregulation Texas has made it much easier for power generators to build new plants and facilities and is facing no supply crisis, he said. Generators can bring new capacity on line in about two years in Texas, as opposed to six years in California, he said.
Consumers and politicians in California were led to believe that deregulation would result in lower rates, and that is why there has been such a backlash there, he said. When the law was enacted in 1996, energy supplies were cheap and plentiful, and no one had any reason to think prices would escalate sharply.
But, while wholesale prices are soaring because of shortages today, consumers in California are shielded from higher prices by the rate freezes, Mr. Zenker said. The result is that there is no incentive to conserve, and demand for electricity remains high, frustrating calls for conservation.
"The average consumer in California has experienced no tangible impact from this crisis. Their electricity rates have not changed and their lights have stayed on" despite numerous power-outage warnings from the utilities, Mr. Zenker said.
The biggest impact has been on customers outside California. Their electricity rates have skyrocketed, particularly in the areas where generators have been forced to sell power to California under the Clinton administration's emergency order.
Hydroelectric facilities in Washington and Oregon had to divert water that had been slated for their own states' needs to California last month, Mr. Zenker said.
"That's putting them in a critically tight situation. There's a limit to how long you can do that."


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