California’s electricity network reliability pales in comparison to competitive states

Yesterday California experienced a Stage 1 alert , indicating that electricity operating reserve margins had dipped to below 7 percent. Nothing compared to 2000-2001, but still a signal for some concern about electricity network reliability.

As we approach this summer air conditioning season, I wanted to bring a recently-released analysis of California?s electricity outlook to your attention. The Bay Area Economic Foundation (BAEF) has released a study entitled “California is Still Coming Up Short on Electricity?, in which they address the ability of California?s electricity network to meet anticipated demand in the short, medium, and long run. They are not sanguine, but rather foresee supply shortfalls as early as 2006.

The reliability of the network and the ability of supply and demand to meet at sufficiently low electricity prices continues to be a challenge in California, and the BAEF study summarizes the challenges facing policymakers as ?inadequate infrastructure, an uncertain regulatory environment, a lack of incentives for consumers to conserve, and high retail electricity prices.? (p. 2) The report focuses on the importance of taking diverse approaches to improve network reliability, including infrastructure investment, generation investment, and integrated demand response to connect wholesale and retail markets with price signals. In fact, just last week the California PUC approved plans to upgrade Path 15, the notorious transmission bottleneck in the Bay Area, which is a good step.

The BAEF report emphasizes the role of regulatory uncertainty in reducing incentives for capital investment in California, a role that cannot be reiterated frequently enough. In analyzing the proposed additions to generation capacity (50 gigawatts proposed since 1998, with only 13 gigawatts likely to be built), the report indicates that California has a lower construction rate for proposed generation projects than other states that have implemented electricity restructuring. California?s recent construction rate has been 25 percent, while even in states that started with higher capacity relative to demand, such as Texas and New York, generation construction success rates are higher than California?s. Regulatory uncertainty in California has a variety of sources ? the denouement of the 2000-2001 crisis and the shadow of expensive energy contracts to pay back, the introduction of legislative proposals to re-regulate the industry in California, the prolonged siting and permitting process that makes building baseload plants extremely difficult (leading to a shift toward construction of peaking plants), and the persistence of retail and wholesale price regulations that make it almost impossible to earn a return on your peaking plant investment.

Instead of focusing entirely on California, the BAEF report compares California?s reliability situation with other states that have restructured their electricity industries (an exercise similar to one that I did in early 2001), and they reach an important, but not surprising, conclusion:

California is the only major restructured power market that faces this problem.(p. 16)

In fact, the Ohio Public Utilities Commission just released a report to the Ohio state legislature on the effects of Ohio?s restructuring in 2001 and 2002. In his transmittal letter to the General Assembly, PUCO Chairman Alan Schriber states that

Of the twenty-four states in the United States that have adopted electric choice, Ohio?s experience has been among the best. While it is difficult to argue that electric choice has been pervasive anywhere, I believe that under the circumstances, Ohio?s program has so far been a success.

Ohio?s report is similar to the competition report cards that the Texas PUC provides, the most recent having been released in February 2003. Both the Ohio and the Texas experience indicate that California?s continuing reliability concerns are an anomaly in states that have adopted electricity restructuring. The BAEF report also compares California unfavorably to the mid-Atlantic and the New England experiences.

California?s investment predicament is exacerbated by the complete and utter lack of market price signals. The lack of price signals to retail customers breaks the link between energy costs and prices to consumers. How, in such a situation, will customers see any incentives to conserve in peak periods? Other than the usual imploring statements from policymakers, that is. Consumers can and should be responsible for making power use choices that meet their needs, and the integration of wholesale and retail market competition is the most effective way to do so. Innovative suppliers should be free to choose approaches that would appeal to their customers, from direct retail access to a menu of contracts that enables customers to take on as much or as little price risk as they choose, with the appropriate prices for each option.

If market signals in California were not so distorted, and the degree of regulatory uncertainty was not so high, then profit opportunities in California would attract investment, even without the mandatory capacity reserve requirements that the BAEF report advocates. Such mandatory requirements are simply band-aids to cover the lack of true information transmission through price signals in integrated markets.

The BAEF report closes with recommendations for policymakers in California:
-link retail electricity prices to wholesale costs
-permit full retail choice, including direct access
-increase attention to transmission infrastructure siting and investment
-remove obstacles to customer distributed generation
-issue clearer mandates to agencies and improve decision-making consistency
-promote energy efficiency and resource diversity responsibly

These actions would improve the uncertain investment climate in California, to the benefit of customers and suppliers alike. But as it now stands, California is the only state that has passed restructuring in which electricity markets are not win-win propositions, because they are not allowed to be.