California's electricity crisis continues. This interview with Professor Robert Michaels was published in Utility Week.
California Dreaming
Dateline 10 March 2001
California has been living on borrowed time for 15 years according to Michaels. ‘We have assumed that the rest of the Western states would permanently have surplus power to sell us’. But the other Western states have rapidly growing populations. In any case, there is a limit to the quantity of power that California can practically import – most people place it at around 30% - so neighbouring states could not meet permanently growing demand. This year imports have actually fallen, as other states have needed the capacity for their own use.
Michaels believes that the only practical way to solve the short-term problem is higher retail prices: “only higher demand sensitivity can reduce the spikes”. He is reluctant to speculate as to how much prices will have to rise, as demand for energy is notoriously inelastic, but points out that when the San Diego utility temporarily adopted market pricing, prices roughly doubled. That experiment was ended by a taxpayer funded bail out. “That isn’t practical on a state-wide basis, it would be too expensive. In any case, if consumers are insulated from the higher prices they are insulated from the incentive to economise. Only higher retail prices will choke off demand”.
If lifting the regulations which have imposed a price freeze since 1996 is the short-term solution it is extra generating capacity that will aid in the long-term. “Again this is a problem of over-regulation. It is an administrative matter which the state executive can implement without the need for legislation”. California has seen no significant new capacity since the 1980s, even though the population has been growing rapidly and the economy has been booming. The average age of California’s generating plant is 30 years.
Some new capacity is due to come on line this year, but only some 2,000 Megawatts, when peak consumption is 43,000 MW. “It is this growth in peak demand that legislators failed to foresee”. The new capacity already planned is, according to Michaels, “only the beginning of what is required”.
All the planned new generating capacity is gas-fired, and Michaels does not expect that to change any time soon: “Gas is the only type of capacity you can reasonably build in California at the moment”. The state imports hydro, nuclear and coal generated electricity, but, although coal could be economically imported to the state, coal-fired power stations would fail the state’s rigorous emissions standards. Natural gas has about 20% of the market, but that is rising, and will probably carry on doing so.
Gas is imported to California from West Texas, New Mexico and Western Canada. The pipelines from Texas and New Mexico are close to being fully subscribed and the Western Canadian suppliers have recently opened a new market in Illinois, so supplies may require increased pipeline capacity. Michaels does not see Mexico as a realistic prospect for supplying California’s gas unless the country liberalises its own energy markets. “Even the new government is unlikely to privatise the petroleum industry, and that is what would be required for it to become swift enough to meet this need”.
Another advantage of natural gas is that it is principally used in California for space heating, so peak demand is in the winter. The prevalence of air-conditioning systems means that peak demand for electricity is in the summer so there is an obvious fit.
Rising prices for consumers will plainly be politically painful. But it is not necessarily any easier to put the burden on business. “Credible threats to relocate out of the state could be a potent weapon. Intel has already said it is unwilling to expand in California, which must be painful for them, as their main customers and suppliers are all in Silicon Valley, so that is where most of the skilled workforce on which they rely are based.
But businesses are already feeling a lot of pain. “Interruptible contracts used to offer considerable savings and interruptions only perhaps twice a year. Now interruptions can be daily, and businesses want to transfer to firm service agreements, but the Public Utilities Commission won’t allow it. Theoretically, a customer on an interruptible contract should not have more than 100 hours in the year without power, but some customers are brushing that limit already, before the end of January”.
Michaels is not optimistic that the state will take the necessary action to solve the problem: “The Governor [Gray Davis, a Democrat elected in 1998] has said he never wants to see price rises. But then, he has said he never wants to see utilities going bankrupt either. The only way to square that is to provide some sort of tax-funded subsidy – and that will not address the excess demand. If you can’t choke off demand and you can’t increase supply the problem will not go away. Anyone who thinks that they will is dreaming. I think the Governor is receiving a serious education in the operation of power markets”.
The plans on the table from state legislators vary from the state taking over the utilities’ debts to the state itself entering the generating market. “There is an impetus towards socialising the utilities”. The state’s Republican opposition seems nervous of advocating higher prices and market reforms and lacks visible leaders.
One Republican who has taken a very practical stand is the Mayor of Los Angeles, Richard Riordan. LA’s municipal utility is not governed by the same regulations as the private utilities and does not have the same disparity between supply and demand. “Riordan has offered to build new plants and supply power to the rest of the state”.
If the regulations which freeze consumer prices and prevent new capacity remain in place California’s problems are unlikely to be eased: “Essentially, the state will keep bleeding”.
Quentin Langley is a British based PR consultant and writer and an occasional lecturer at the Pacific Research Institute for Public Policy in San Francisco (http://www.pacificresearch.org/).
Professor Robert Michaels earned his bachelor’s degree at the prestigious economics department of the University of Chicago, home to Milton Friedman and more Nobel laureates than any other university. He read his doctorate at the University of California in Los Angeles and has been a Professor at the California State University, Fullerton, since 1978. He is an Affiliate Consultant, Tabors, Caramanis & Associates, Cambridge, Massachusetts, having previously worked with other consulting firms in Los Angeles and Arlington, Virginia. He is a Resident Scholar at the Center for Advancement of Energy Markets and an Adjunct Scholar at the Institute for Energy Research and the Cato Institute. In 1986 and 1987 he was an advisor on electricity privatisation to the government of New Zealand.
A biography and selected articles by Professor Michaels can be found at: http://sbaeweb.fullerton.edu/rmichaels/
Copyright © Quentin Langley 10 March 2001