See Spot Run

Maybe ElRoY can flesh this out for me.


Now amid all the hue and cry about the CA energy screwups, about how the evil companies suppliers screwed everyone, etc., there is one thing that hasn't been made exactly clear to me: why did the legislature and Gov. Wilson feel that relying on the spot market for energy needs was a good idea?


By their very nature spot markets are volatile, yet it seems that nobody realized that they were playing with fire in doing this. Now, am I to understand that groups like Enron actively lobbied for this form of "deregulation" in the honest belief that this was wise? The bizarre particulars (suppliers were paid the highest current bid? long term contracts were strongly discouraged? Are all of these people nuts?) can only be understood if the principles involved were drunk. I suppose all these idiot legislators believed the hype about ever-growing suppliers invading California and continually depressing prices, which would have been a bonanza for distributors like Edison (and in fact was for a while) since retail consumers were locked in rapaciously high rates. How ironic that this same locked-in rate doomed them when energy costs soared and they were left to buy at panic rates on the spot.


So, my impression is that there really weren't any thieves in the CA crisis (at least beyond the usual stuff) but rather the intellectual failure by everyone to understand that the birthday candles they'd lit were actually sticks of dynamite.

I think the "deregulation" in CA involved fixing the outgoing price to the consumer, but not the incoming price to the producer. There may have been reasons behind this, such as electricity sellers not wanting to compete to win customers on a price basis.


I remember, I lived in CA when they began "competing," and there was an ad on TV from some utility or other bragging how clean their energy was - and what good people they were - and that is why I should buy my indistinguishable electricity from them and not from somebody else. My instant thought was "By George, they must not be allowed to compete on a price basis - or else they wouldn't stretch for such a silly product differentiation!"


So, somehow, the electricity companies won the right to "compete" for customers - but the price structure was agreed upon in advance - and as such they created a system where they would then compete to bid for electricity to supply for the customers they had won, or something.


On the face of it, it seems so silly. But you can't deny the more general explanation that, whatever and whoever created the system they settled on, everybody thought he was getting a good deal. It may be tough to reconstruct, today, exactly what incentives and constraints the different parties were operating under at the time, and what their assumptions were.


I think the key to reconstructing it - without having to sepnd too much time on Google or at the library - may involve speculating as to why


1) utilities that were to compete were first forced to spin off some of their generating capacity, and


2) they weren't allowed to hedge with forwards, to some extent.


I guess we can imagine why the utilities wanted some sort of competition in any form. And I guess we can imagine why, sort of, they couldn't come to an agreement if wholesale electricity buyers were to compete with electricity generators. I guess the restrictions on forward contracts were to somehow ensure competition, and prevent, like...


Well, you picture it. Like you said, some idiot must have gotten it into his head that some nefarious activity would go on if, like, one company went and bought up all the forward electricity for CA delivery (remember, the grid apparently wasn't that flexible). Maybe the politicians thought the market could be cornered, or something, and the sellers figured the fixed rate would never fall below the spot?


I apologize, I really am an expert in bad economic thinking, but I always assumed the particulars of the CA situation must have been so bad as to be beneath even meriting exploration. I have failed.


eLROY

Remember, since the theoretical monopolies they teach you about in Econ 101 don't actually exist in the real world (and let's not debate this now), regulated so-called "monopolies" are really just licenses to fleece, withheld and doled out by politicians to businessmen. (Remember, they figured this out in the airline industry when they noticed that unregulated intrastate tickets between San Francisco and LA were significantly cheaper than "regulated" interstate tickets between Boston and New York.)


So, in California, the original assumption was that whatever price they bought the right to charge from the government was going to be a fleecing, only instead of doling out the rights to fleece in the Capitol building - or by the uncomfortably rigid existing structure - somehow they were going to compete for the rights to fleece. Somehow, the utilities must have thought that they would be able to get one over on one another like this, or that fleecing would somehow become better allocated and more optimized and efficient. And somehow, the government must have thought that, with everyone fighting over the fleecing they had handed out, they would end up with more money.


I think the presumption was that, if you picture the utilities as sort of middlemen between the consumers and the government - rather than as the generators being at the other side - that there was a guaranteed fleecing margin locked up there. And so the rules of the game were set that everybody had to buy at the same price - the spot - and nobody could generate his own electricity. This was not going to be a game of producing, or speculating - or competing - it was simply going to be a playground match over the fleecing itself.


It should have been so simple.


But then I guess when the people who won the "fleecing" rights started feeling the pain, the government just turned its back on them.


So, the so-called "competition" they set up for electricity in CA is illuminated when you understand that they were not viewing themselves as normal economic partcipants, competing to produce or acquire a product and sell it at a profit. They were simply to fight over a profit. Meaning, the source of the electricity, and whether it was at a lower price than the retail price, was never meant to be part of the game, somehow. And it was actually foreseen that it if ever became part of the game, that would ruin everything.


leroy

Also, it is very easy for most people to ignore how the rate structure will shape the evolution of demand.


I guess, in this case, the evolving electricity consumer was instructed that supply was infinite without a 1-cent increase in the price, and so inverse-rationing was the way to go.


Meaning, the assumption was that there would be infinite demand at the fleecing price - they could sell an unlimited quantity there - and that is what they got.


Or something like that!


Okay, now let's bore everyone with a debate over this asinine notion of a "natural monopoly." (I'm already laughing out loud to myself at just the thought(How do you spend your Sunday mornings?)


leroy

You didn't address the main point here. The reason why the rates were frozen was because PG&E and Edison had huge investments in generating, namely their nuclear plants. The terms of the deregulation required that the companies divest their generating, but who is going to buy nuclear plants for what they are worth??? They can sell their coal and gas fired plants no problem and get close to their investment out of them, but nuclear plants with their massive costs and even bigger potential liability are things no energy company will take on these days. So to help them recover those investments they set a fixed price which was higher than the cost of generating, but slightly lower than what they had been charging their customers. So the argument goes we fix the cost of power for a period of time during which the companies can recover their investments. During this time other utility companies can come in and offer power as well, but they have to charge this fixed rate. There was plenty of profit to be had, but who is going to change their power provider if there is no price competition? Easier just to keep your current power in. Only companies that bothered competing were those "environment-friendly" providers and they generally charged a surcharge above and beyond what the big companies did to those willing to pay for renewable resource energy. Notice that SDG&E, now Sempra, did not follow this scheme. They didn't have nuclear investments so they were basically not regulated in their pricing. Well CA goes into a huge growth spurt and the prevalence of computers that suck up a lot of energy creates some problems. Remember that CA has so many environmentalists blocking almost any power generator, that the lack of investment caused what were comfortable power supplies to start running short. All the "gougers" as Gray Davis likes to call them came into the market, they were the new energy generators that resulted from the divesture of the business by the 3 utility companies. They are unregulated power providers and they did what a smart businessman would do. They acted in ways to make demand even tighter at times and made serious loot off of it. Well these aren't regulated businesses like power companies, they are profit driven. They didn't have monopoly power because there are quite a few generators in the state, but the supply became so short they could just generate some of their capacity and make a lot more money than generate all their capacity and get more volume at much smaller prices. Anyways I digress...they played a big role in it too.


Back to the big 3. SDG&E/Sempra were jacking their prices up big-time. I was in SD the summer before the "crisis" and at that time people were bitching heavily about how the power company was screwing them. I heard bills had doubled, but all the utility had to do under their deregulated operation was just prove they weren't ripping the customers off, that power really cost this much to provide. At this point I raised the issue with my father, an Edison employee, and asked how can people in San Diego pay twice as much in one year and the people in the rest of Southern California actually get cheaper bills??? He said that it was a mess and that Edison's day of reckoning could be coming soon. Sure enough, the next spring and the blackouts began. Edison and PG&E, exposed purely to spot markets were in trouble. A double whammy of lack of resources and lack of money were just killing the business. The CA economy was at its peak at this time, just as the NASDAQ bubble was burst. The strong economy drew ever bigger numbers of migrating residents and the technology required to operate ever more ubiquitous computers, servers, infrastructure...it all added up to a big spike in demand. In SD people had big incentive to cut back on their energy, but in the rest of CA there was none until the blackouts began. Up to that point people were paying low bills and not bearing the consequences of short supply. Had they faced higher bills right away, most of the power disaster would have been avoided.


I remember the idiotic reaction of a lot of Californians not long after the crisis began. The power companies were getting killed, paying over 250% more for power on average than they were a year earlier. They begged for a rate increase, all of 9%! Like that would do much. Anyways they figured it was the best they could get, should be a slam dunk when you are facing huge cost differentials. Well the people affected were just outraged. The companies were lying, the companies were stealing, the companies couldn't expect us to pay such a HUGE increase. Stupidity I tell you, Californians are the absolute greatest at this, the whole we want our cake and eat it too theory. Like cutting a few thousand employees was going to make up all the difference in their costs. Meanwhile Gray Davis at first is agreeing with the public saying he doesn't think they should raise the rates. Fortunately he doesn't decide that, the PUC does and they finally agreed to raise the rates far too late and clearly too little. If they had acted quickly and doubled the rates, people would have concrete reason to cut down on their usage, the utilites would have been much more solvent and everything would have died down quickly. I know Davis loves playing both sides as you say Leroy, but herein is his biggest case of mismanagement where he lied to the public telling them there were ways to avoid paying the piper and in doing so and in having the agencies and people under his control fight rate hikes, he bungled his state into a much much much bigger mess than it had to be. In the end people in CA are paying much higher rates that they argued against because the bills that were run up had to be paid. This mistake he seems to be forgiven for by many of his voters, but it might be one of the biggest mistakes a governor of any state has ever made from a financial perspective. He put politics before economic reality, trying to be the guy "fighting" for the voters. All he had to do very early on was go have a meeting with the leaders of the 2 utilities and say we will make a deal. You can raise your rates very quickly and enough to pay for the differential, but you have to lower them if and when the crisis passes. Further he could have negotiated other concessions out of them for doing this. Not the easiest sell to his people, but most people would grudgingly have to accept it when they see the numbers. Further at this point they could have gotten out of exclusive spot market in the same negotiations. The long term supply contracts they would have bought at this point would have been far cheaper than the ones they ended up with.


Its hard to imagine Davis would have ever thought it would end up as it did, but his ignoring economic reality caused much of the problem. Spot markets and the companies that supplied them were part of the problem too. A smarter plan would have been to have the rates float for all three and then have a surcharge on bills to help recover the nuclear plant disposal issue. Over ten years that charge would have been a very small amount on each bill in a state with around 15 million households and countless businesses.