Fatal Systems Error -- Lights Out in California!

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Fatal Systems Error -- Lights Out in California!

By Don Sussis

[May 1, 2001] California is the world's sixth largest economy and accounts for 13 % of the U.S. gross domestic product. In the last year, this economic engine, home to Silicon Valley, has seen as much as a 900 percent increase in wholesale energy prices. Businesses such as server farms that need uninterrupted power face daunting challenges. Rolling blackouts are costing companies hundreds of millions of dollars in lost revenue. And many high tech companies are now reluctant to expand in the Bear Republic.

Failed Deregulation Much of the problem stems from a very poor deregulation effort. In 1996, both houses of the state legislature (and supported by former Governor Pete Wilson) voted unanimously to deregulate the market for wholesale electricity. This made it feasible for producers to sell to utilities on the spot market. This proved to be a bottomless pit, especially since the plan only called for partial deregulation; it left retail rates capped.

The new law did not create a free market in retail prices. In most cases, consumers and businesses were given a fixed rate until April 2000 or beyond. There was no reason for conservation -- rates were low and fixed. Lights, ovens, stereos, computers, alarm systems, pools, water heaters, dishwashers, air conditioners, and all the other accoutrements of contemporary sophisticated life were left free to burn at minimal cost.

The result is that in the last eight months, utilities have spend $13 billion more to purchase electricity than they have been allowed to charge customers. This has led the leading suppliers from profitability to bankruptcy. Among those affected are Pacific Gas & Electric (PGE), Southern California Edison (SCE), and San Diego Gas & Electric.

When deregulation was being negotiated, profit hungry suppliers were only too happy to fix customer rates while allowing producer costs to fluctuate. This is because the price of petroleum was in a downward spiral due to, among other things, the financial crisis in Asia, which lowered worldwide demand. Oil was meagerly trading for as low as US$10 to $11 dollars per barrel. The greedy suppliers reasoned that they would be able to reap guaranteed profits by charging consumers at a rate that was well above that being charged to them.

But that formula unwound, as the price of oil and natural gas spiked. Demand exceeded supply and prices rose. This put direct suppliers in the position of paying more than they were able to charge. Among the beneficiaries have been Duke Energy of Charlotte, N.C., and Reliant Energy of Houston. They became the prime middlemen.

At the same time, the deregulation legislation that passed in sunny California did not allow the utilities to enter into long-term contracts with their suppliers. This left the state vulnerable to the volatility of the spot markets. To put it in the plainest of terms, California dismantled its power generating system without securing adequate power, which led to pricing excesses, blackouts, and inflationary costs -- an economic disaster.

The Price of the Error Sure enough, rising demand for power in the state met with limited supply. The price of a kilowatt-hour jumped from five cents in January 2000 to over 40 cents in December 2000. While consumers and businesses have been suffering, energy supply companies have been recording record profits. Duke Energy, for example, has seen quarterly revenue increase by well over $100 million.

The average price for wholesale electricity in California changed from around $25 per megawatt hour to almost $500 per megawatt hour at the beginning of 2001. And the state paid the price. The average price in California charged to its independent systems operator was $313; it was $74 in New England; $63 in New York, and $39 in Pennsylvania, New Jersey and Maryland, according to the Energy Information Administration.

California's energy crisis could magnify problems in the overall economy. It has certainly affected earnings at major technology companies, and the overall population of more than 34 million residents. If the major utilities default, then banks and credit institutions will feel an earthquake. And if the state takes over by floating a huge bond issue, the interest payments will surely increase taxes.

Environmental Concerns and Infrastructure Shortfalls Many Californians, to their credit, are concerned about the environment. But this has led them to fiercely oppose new power plant construction in the state. In fact, no new power plants have been built in the state during the last 10 years. They have created mountains of red tape to discourage new plants. In addition, they have added a tax to anyone seeking to build a new plant by taxing them for the "stranded assets" of old plants that were abandoned or sold cheaply by power generators under the 1966 deregulation plan.

There also exists in California, home to Hollywood, Silicon Valley and Wine Country, an elitist sentiment that plants should be built anywhere, but "not in my backyard." The poster child for this approach is the 600-megawatt plant proposed by Calpine Energy in the Coyote Valley, near San Jose. Many groups, including the Sierra Club voted in favor of the project. But Cisco Systems has lobbied vigorously against it because it would be an eyesore next to the industrial plant that they plan to build. Cisco is San Jose's largest employer.

To tell this story properly, there are many other reasons why the high price of energy is stangling California. Among the reasons is the lack of infrastructure investments, both in plants and electricity, and in natural gas transmission capability. This is evidenced by the loss of power that has been occurring in northern California, rather than statewide. The reason is partially explained by the difficulty of transporting energy into the area. But the blackouts are spreading. In late March, rolling blackouts spread to some 140 cities in southern California. A number of other factors have contributed the "fatal systems error" in California, too. Among them is a decline in hydroelectric power due to lower precipitation, a warm summer in 2000, and a cold winter. These cut supply but increased demand.

In New England, by comparison, new plants will shortly been on line to deliver 11,267 megawatts, which represents about 43 percent of existing power: its insurance against outages. But in California, which has greater power consumption, less than 5,000 megawatts of new capacity is projected to come on line by 2004. This is insufficient to meet needs. And the desire of environmentalists, bless them, have caused a greater dependence on natural gas -- just as the price for this commodity has been rising over the tops of giant redwoods.

Natural gas prices have increased four or five times over previous years, and still delivery in many areas, despite contracts, cannot be guaranteed. There has not been any significant improvement or added capacity to pipelines in double the years since DOS became Windows.

Great Success Is Also a Problem California's supercharged economy, led by Technology, has also caused a huge increase in demand. In 2000, the Golden State economy grew by a whopping 10 percent, on top of a 7.5 percent rate in 1999.

Oddly enough, the success of California's economy has caused a migration to other states where the cost of living is lower, housing is more affordable, and opportunities are less competitive. Increasing numbers of people are migrating into neighboring western states, such as Arizona and Washington. From an energy point of view, this is negative for California. Washington has much colder winters and Arizona has much warmer summers -- both put increasingly higher demand on energy resources, and leave less available for export.

To gauge this, Energy Ventures Analysis, Inc. in Arlington, Virginia, estimates that the air conditioning-dependent Arizona and the heat-dependent Washington consume 83 percent and 130 percent more electricity annually than California households. This puts additional pressure on producers and generating states to delivery energy. But it also bodes well for their profits -- despite the greater costs to the general economy -- which include inflation, poor earnings, cuts in capital spending, and recession.

Don Sussis, the E-Consultant Columnist, is a business and investment advisor. He is a member of the New York New Media Association Angel Investment Group and a speaker for California based Tec, a worldwide association of CEOs. His email is: dsussis@internet.com


-- Martin Thompson (mthom1927@aol.com), May 01, 2001


Sort of like a summary of whats been posted on GICC for the past year.

-- Martin Thompson (mthom1927@aol.com), May 01, 2001.

And can you or Paula show me exactly where this was a Y2K issue? Thank you.

-- Rob (celtic64@mindspring.com), May 02, 2001.

Dear Rob

Why do I have to prove anything to you? This forum covers many topics including y2k. If you would take the time to read 'about'at the top then maybe you might understand what this forum is for.


-- Martin Thompson (mthom1927@aol.com), May 02, 2001.

Go Martin go. Tell em like it is. Only an idiot can't see whats happening here. All of a sudden we have the lights going out, refineries on fire, man holes exploding, pipe lines exploding, shortages in the pharmaceutical industry, retail stores that have been in business for 100 years are CLOSING DOWN. Basically the cost of ALL sources of energy have shot through the roof, should I keep going. I think not. Once an idiot, always an idiot. KEEP UP THE GOOD WORK MARTIN. YOU’RE THE MAN!!!!!!!!!!!!!!!!!!!!!!!

-- NdewTyme (NdewTyme@NdewT.com), May 02, 2001.

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