New Power Generation - Government Activity

Industry Standard, The, Sept 18, 2000 by Scott Harris

Deregulation seemed like a perfect way to streamline electricity markets -- and the Internet would help make it happen. That hope has dimmed.

WHEN CALIFORNIA TOOK THE lead in deregulating electrical power two years ago, Internet entrepreneurs rejoiced. It seemed like the perfect chance to marry marketplace economics and the Internet. "Electricity is the perfect e-commerce commodity' says Edward Cazalet, chairman of Automated Power Exchange, or APX, an online electricity market based in Santa Clara, Calif. "You can't do deregulation without the Internet."

Little wonder that this happy coupling also spawned retailers with names such as Utility.com and Go-Green.com, "virtual utilities" that own no power plants or power lines but sell juice all the same. Californians were promised that competition in the wholesale and retail markets would mean smaller bills and online bill payments.

And the rest of the country liked the idea; 25 states followed California in beginning electrical power restructuring.

But now the marriage is in need of some serious counseling. In San Diego the first city to unfreeze its prices - rates soon doubled and tripled [see story, page 58], triggering a consumer revolt and sending politicians and regulators scurrying to restabilize rates as power companies fend off accusations of gouging.

What went wrong?

Simply put, demand is straining supply. The booming economy is taxing power plants and the grid. And -- in an unfortunate irony -- the Internet itself, the vaunted "engine" of the new economy, appears to be a glutton for kilowatts.

And it's not just California's problem. The rates-run-amok are "throwing a monkey wrench into deregulation elsewhere," says Bill Swanton, an analyst of Internet commerce at AMR Research. And instead of Internet exchanges providing a perfect solution, Swanton says the fear is that "there is going to be a regulatory backlash."

But online boosters insist that deregulation hasn't gone far enough. "The dirty secret of restructuring," says Severin Borenstein, director of the University of California Energy Institute, "is that it is replacing old forms of regulation with new ones."

California, for instance, continues to enforce a price cap instead of allowing an unfettered free market. Its new system is built around the California Power Exchange, otherwise known as the CPX, a state-mandated nonprofit agency that largely controls the daily electricity auctions, much to the dismay of private online outfits like APX and Houston-based Altra Energy Technologies.

Under the state's electricity makeover, the three big utilities - Pacific Gas and Electric, Southern California Edison and San Diego Gas and Electric - no longer are in the business of producing power, but merely resell it to their local customers. These companies, however, aren't free to buy electricity wherever they choose. The state requires them to buy their power through the CPX. Although the rules have loosened a bit, the big three still buy 85 percent of their power through the CPX.

APX's Cazalet complains, "We compete for crumbs in the rest of the market."

Nobody expected that deregulation would be easy. Not long after Thomas Edison figured out how to harness the electron, the force was considered so important that it required public guidance in its promotion and control, be it a small municipal utility or a sprawling multistate creation like the Tennessee Valley Authority. Locality by locality, a complex regulatory patchwork evolved that today is difficult to unravel.

And then there are the laws of physics, which pose their own obstacles to deregulation. Electricity is produced and used instantaneously. And because there is no economical way to store electricity, prices are volatile. Ideally, regulation should smooth out price fluctuations while guarding against abuses by the utilities.

In the wake of California's restructuring of regulations, state and federal officials are investigating charges that major energy producers manipulated the CPX auction. In August, the auction cost was $166 per megawatt hour, up almost 500 percent from $28 in July 1999.

But it's hard to determine whether the hike was a result of shady dealings, deregulation, the increased demand generated by the booming economy or less visible forces. The cost of natural gas, for instance, has doubled, and air-pollution fees have soared. And the grid is notoriously vulnerable; when a forest fire took out a major power line in the Northwest, it cut off one of California's main access points to imported power.

Still, many observers blame deregulation. "A lot more firms are exercising their market power," Borenstein says. "They are driving up prices because they can.

Those price spikes have resulted in tighter price caps, something supporters of deregulation say wouldn't be necessary in California if lawmakers eliminated CPX's privileged position. In the CPX blind auction system, the utilities submit bids for the following day's juice while power providers submit asking prices. When high demand is expected, higher prices are submitted; the highest price accepted is then guaranteed for all producers for the next day's output.