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Enron Mail |
CERA Alert: December 13, 2000
Title: California on the Brink CERA Knowledge Areas: Western Energy, N. American Power, N. American Gas CALIFORNIA ON THE BRINK The California Stalemate California moved closer to the brink of an outage today as concerns over credit-worthiness of buyers brought the possibility that generators would avoid selling to the California market. While numerous factors have contributed to the high cost of power incurred by California's utilities, the root cause of the current crisis is a lack of new generation. The current credit crisis and its threat to supplies could spark state action to address the situation. The collective efforts of all market participants should be focused on increasing generation capacity as quickly as possible. Western power prices have skyrocketed well beyond the record levels set this summer. Perhaps because frozen rates insulate the majority of California consumers and companies from tangible effects of the market crisis, regulators have been able to postpone meaningful market reforms and significant rate increases. The California Public Utilities Commission denied the requests of Pacific Gas & Electric and Southern California Edison to end their rate freezes, forcing these utilities at least temporarily to finance the costs of higher wholesale energy. This has created an unsustainable accumulation of costs and a loss of faith in the California market. The current credit crisis and the potential for blackouts may become the galvanizing events that provide state regulators with a public mandate to address the underlying structural problems in the industry. However, there is no guarantee that these regulatory actions will expedite an effective solution for customers and the industry as a whole. Wholesale and retail markets that emerge from regulatory intervention are likely to remain muddled. In the necessarily political process that will follow, it is possible that-as has largely been the case so far-the steps taken will fail to move the California power market toward a more enduring solution and will instead continue to mask the underlying structural flaws. In the six months since California's supply shortfall began plaguing Western markets, regulators have done little to address the underlying problem. Rather than addressing the cause of the supply shortage-establishing a market environment that encourages timely additions of new generating capacity and demand side responses-efforts are instead directed at trying to lay blame for the crisis and lessen the immediate financial impact on customers. Indeed, several actions taken thus far have served more to compound the problem by discouraging new power plant additions. These include price caps, repeated changes to market rules, attempts to seize generator profits, and a challenging siting and permitting process. Medicine Worse than the Illness Several years of electricity demand growth and low prices in California were accompanied by very few additions to the supply base. Regulators did not pay adequate attention to the looming supply shortfall. The void of consensus over the cause of the current crisis has instead been replaced by a series of bandaid remedies that address the symptoms, but not the cause, of California's electric market woes.* * Challenging siting and permitting. Despite state action to better coordinate the siting and permitting process for new power plants, power plant developers still face high hurdles. Local community opposition alone has struck down some key proposed facilities. * Price caps discourage investment. State and federal proposals to cap prices limit the attractiveness of the California wholesale power market, especially for developers who have the option of channeling scarce capital and equipment to more stable or more attractive markets outside the state. * Repeated rule changes. Frequent rule changes in the ISO markets (including the price caps) confound attempts by developers to estimate profits from new plant development. * Calls for refunds. Despite reports by the Power Exchange, the ISO, and the FERC that no pattern of abuse could be found from their examination of the California markets, state officials continue to accuse power providers of gaming the market. Calls by state officials for refunds of generator profits are a threat to new plant development. * Facility inspections. Recent inspections of power plants by state officials to verify that operators are honestly reporting the operational status of their generating units accentuates the atmosphere of mistrust. CERA's recent analysis suggests that merchant plant developers in the West are not guaranteed? to make a profit. Prospects of new plant profitability are affected by the timing and quantity of new plants, decommissioning of older units, demand growth, and numerous other difficult-to-forecast factors. California's regulatory actions only further cloud the assessment of financial viability and degrade the political environment for developers considering entering the state. Despite efforts by the California ISO to stimulate new capacity additions in the state with a special, limited-term capacity payment, CERA estimates that demand growth will continue to outstrip supply additions in the West in 2001. In addition, the existing siting and permitting process will prevent a sufficient quantity of capacity from entering the market until 2003 at the earliest. Therefore, three years remain before a sufficient quantity of capacity enters service to significantly dampen prices and decrease the risk of an outage. The Road to Recovery There are a number of actions that can be taken to help relieve the capacity shortfall: * Encourage new build. Supply must be part of the answer. This requires a series of steps that can help facilitate new supply build. While in principal some have been taken, such as new fast track approval, the success of these actions can only be measured by the build itself. For now, there is still not enough new supply coming on until 2003 to relieve supply tightness.? * Stabilize investment climate. Utilities must have assurance that they will ultimately be allowed to recover market costs for power. This provides the credit worthiness needed by sellers to produce energy and to stimulate new build. * Move toward more balanced utility supply portfolios. One of the reasons the pressure on customers has been so intense in California has been the absence (and even discouragement) of diverse supply portfolios among the utilities in the state-particularly for residential and small commercial customers. With the market at a peak, however, now is in one sense a sub-optimal time to move toward term contracting. Yet these contracts provide the foundation for a series of actions-including new supply build and demand side investments. If they end up above market, they will at least have achieved the desired effect of knocking down prices, a fact which by itself should provide sufficient justification for recovering the cost of these commitments. * Encourage market mechanisms that elicit a demand response. Although originally a feature of California's market design, most consumers are insulated from price spikes through capped or frozen retail rates. Exposing customers to at least some of the market price signals would encourage a demand response. * Encourage market mechanisms that dampen the "Boom Bust" characteristic of the market. Whether in the form of a capacity payment, a reserve requirement, or a minimum term portfolio requirement, the California power market needs to move to a structure that encourages investment in new capacity when the market is in balance rather than waiting for a shortage and price shock to elicit new investment. Such a structure can help dampen (but not eliminate) future price volatility. * Avoid continuously tinkering with the market. While the market does need to be restructured as described above, it also needs to be stable and reliable to encourage the development of new supply as well as a robust long-term contractual market for power in California. Continually tinkering with the market structure-such as the three times the price cap has been shifted since July-only serves to undermine confidence in the market. California needs to do its best to develop a long-term solution and then let the market run its course. * Allow for greater environmental flexibility. The state should explore a more balanced solution to emissions restrictions in the face of a supply shortfall that has been exacerbated by generators that cannot operate due to emissions restrictions. * Free PURPA power plants to generate. Relief should be granted to PURPA power plants that are operational, but are restricted by contract from operating to generate only power. **end** This CERA Alert will be available in PDF format within 24 hours. ********************************************************************** This electronic message and attachments, if any, contain information from Cambridge Energy Research Associates, Inc. (CERA) which is confidential and may be privileged. Unauthorized disclosure, copying, distribution or use of the contents of this message or any attachments, in whole or in part, is strictly prohibited. Terms of Use: http://www.cera.com/tos.html Questions/Comments: webmaster@cera.com Copyright 2000. Cambridge Energy Research Associates
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