Lights Out as California Slammed by Power Shortage, High Prices

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Lights Out as California Slammed by Power Shortage, High Prices By Christopher Edmonds Special to TheStreet.com Originally posted at 8:06 AM ET 12/12/00 on RealMoney.com

It's shaping up to be a dark Christmas in California.

Just as temperatures were cooling and California's summer power crisis was supposed to be ending, it got a whole lot worse. As cooler-than-normal temperatures gripped the West Coast in early November, California was caught off guard as power and natural gas prices soared.

With electricity prices trading above the $250 per-megawatt-hour price cap originally imposed by the California Independent System Operator, or ISO -- the organization responsible for assuring the reliability of California's deregulated power markets -- the power deregulation debate once again is focused on the Golden State. Things got more tense last week as natural gas coming into California markets traded more than five times higher than prices elsewhere, sending power prices spiraling even higher.

Not only are prices high, power is scarce. While it was routine for the ISO to warn about possible power shortages during the summer heat, such warnings were expected to disappear as temperatures cooled and demand dropped. Instead, since Nov. 13, the ISO has issued 19 supply warnings, including its first ever Stage Three warning last Thursday, advising consumers that rolling blackouts were imminent. (Monday brought another Stage Two warning, advising industrial customers to curtail usage and pleading for consumer restraint during peak hours.)

The escalating power crisis has the potential to wreak havoc on the California economy. For example, last week Intel was poised to reduce its power use by 50% at its Folsom campus. And the company said it was planning for a complete blackout. The Los Angeles Times reported last week that many schools in California were curtailing power usage, some losing power altogether, leaving students in the dark.

Call it the Grinch Effect: The lights on the state Christmas tree in Sacramento will remain dark at the order of Gov. Gray Davis until the shortage subsides. The three investor-owned utilities in California -- PG&E (PCG:NYSE - news), Edison International (EIX:NYSE - news) and Sempra Energy (SRE:NYSE - news) -- have urged customers to avoid using Christmas lights until after 8 p.m., when power demand begins to decline. And an 80-year Los Angeles tradition, Christmas Tree Lane, may come to an end this year because Southern California Edison said it uses too much power.

The lack of power and rise in prices come from an unpleasant convergence: colder than normal temperatures; generation plant outages, both scheduled and unscheduled; environmental curtailments; and high gas prices. Last week alone, more than 11,000 megawatts of possible generation were off-line, a result of scheduled maintenance, unexpected breakdowns and, for some, a lack of emission credits to keep the plants running at full tilt. (Older plants, which generate more pollution, must either obtain additional emission credits or curtail generation once they meet annual emissions limits.)

"In a situation like this, it's unfortunate to see idle generation because of emission regulations," says Neil Stein, a power analyst with Credit Suisse First Boston. "It's clear the environmental folks aren't talking to the generation folks when they should be."

In all, nearly a quarter of California's generation has been affected. "In the past few weeks, the market has been deprived of about 25% of its normal generating capacity due to planned and unplanned plant outages," says Stein.

The dearth of native supply and the lack of power imports from other states -- combined with peak demand -- have come very close to tripping the supply breakers. Frigid weather in Oregon, Washington and other Western states forced generators in those states to use power locally instead of exporting it to meet California demand. "Power flow from outside of California has been reduced," says Stein. "That's also a result of reduced hydro-[electric] generation in the Northwest."

That leaves California with too much demand and too little supply, which, on its own means higher prices. Add gas prices consistently above $30 per million British Thermal Unit (MMBtu) and, regardless of how efficient the generator, power prices will soar. For example, while gas prices elsewhere in the country hovered just above $8/MMBtu, natural gas into California was selling for more than $50/MMBtu, with an average price of around $40/MMBtu. For the average generation plant in California (with a plant heat rate -- the rate of conversion of a Btu of gas into a megawatt hour (MWh) of electricity -- of between 10,000 and 12,000), producing a megawatt hour of electricity would cost more than $400.

Why are California gas prices different? There is no simple answer except to say that demand keeps tugging at prices. It can be argued that supply is more constrained in California because of a lack of pipeline capacity and available natural gas storage, but that doesn't explain prices 500% higher than the national average.

That leads most analysts to blame generators' inelastic demand for natural gas. "When you need it, you pay for it," says Dan Pickering, director of research at Simmons & Company, a Houston energy research boutique. "You have price-insensitive buyers who are prying it loose from other price-insensitive buyers, and you end up with a very high clearing price."

While Pickering doesn't claim recent California gas prices are sustainable, he thinks power generators have little choice but to pay the going rate, however high. "When you are a utility with load that you have to fire, and you can pass that cost along, you pay the price," he says. "You may take some heat for the [generation] costs but it's much less than the heat you'd take for not generating that power."

The California ISO appears to agree, at least in part, with the argument that generators have little control over fuel costs. Friday, after months of resisting arguments from generators that price caps on generation prices sold to California utilities were unfair, the ISO agreed to lift the firm $250/MWh price cap. It replaced the previous ceiling with a "soft" cap of $250/MWh, requiring generators to justify sales above the cap by providing data on costs associated with generation. The Federal Energy Regulatory Commission agreed to the changes late Friday.

Most analysts agree the move to remove the caps is the first step in the process of allowing the markets to resolve the pricing and supply problems in the California power markets.

"It's a favorable first step in providing some freedom to let the markets work," says Jay Dobson, director of utility research at Deutsche Bank. "Generators won't be stupid. They will bid reasonably into the market and stability will eventually result."

It will take more than a removal of price caps to bring order to the California markets. It will take a more rational approval process for generation projects, upgrades in the electric transmission grid and, ultimately, additional supply into the California market.

All that will take time, probably years. Until then, are there ways for investors to take advantage of the inefficiencies in the California power markets? We'll explore that issue next.

http://www.thestreet.com/comment/christopheredmonds/1208352.html



-- Martin Thompson (mthom1927@aol.com), December 13, 2000


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