California Leaders Gain Support for Power Price Controls

April 17, 2001

California Leaders Gain Support for Power Price Controls

By John Woolfolk

With little hope left of containing runaway power costs this summer, California's leaders are calling as never before for regional price controls, sparking the biggest debate over energy market intervention since the 1970s.

The Bush administration, key federal regulators and most Western states oppose price caps, arguing controls just make things worse by discouraging needed conservation and power plant construction.

But resistance is weakening as pressure grows to staunch a spreading crisis. Last week, three Western states softened their opposition to price caps and one federal regulator offered qualified support.

"The worm may be turning a little bit," said Sen. Dianne Feinstein, D-Calif., who is co-sponsoring a bill this week with with Republican Sen. Gordon Smith of Oregon calling for a temporary Western cost-based price cap. "This situation has run amok."

Wholesale power prices continue to soar as state efforts to contain them fall short. California is on pace to spend $70 billion on electricity this year -- 10 times the cost two years ago, and well above the state's $50 billion K-12 education budget. Similar prices are punishing Oregon and Washington, where a drought has drained hydro-electric power supplies.

State officials are appealing to Washington because only the federal government has authority to cap wholesale power prices and to oversee interstate electricity trade.

In recent years, federal regulators have reluctantly capped prices in some local markets, including California. But never have they applied such controls as broadly as the entire Western grid, which spans 14 states and parts of Canada and Mexico. That alone makes the outcome of such a move hard to predict.

"All the ramifications would be unknown," said Dennis Eyre, executive director of the Western Systems Coordinating Council, which oversees the grid.

Price caps have been controversial since the 1970s, when they were blamed for gas shortages and fuel lines that still haunt many on Capitol Hill. While reasons for those shortages are complex, most economists agree price controls at least contributed to the problems.

"In some cases it was more profitable to sell your oil than to make it into gas," said Severin Borenstein, director of the University of California Energy Institute.

Those crises helped spawn deregulation in the 1980s. Reaganomics swept the country with a creed that energy markets freed of government controls would produce lower consumer prices. Debates over lifting controls on oil and natural gas raged. But feared runaway costs never materialized when controls lifted.

As electricity markets began deregulating in the late 1990s, officials viewed locally imposed price caps as a necessary crutch to protect consumers during the transition.

Authorities experimented with several price caps in California, but they failed to tame prices. Because the cap only applied to sales within the California grid, authorities noted troubling side-effects. Neighboring states, also plagued by shortages but not subject to the cap, could outbid California.

With needed power flowing out of the state, California's grid operators often were forced to abandon their price limits in last-minute buys to avert blackouts. With such rules in place, power companies aware that the state would pay any price in an emergency could manipulate the market to their advantage.

Falling price caps seemed to have no bearing on power costs, said Lorenzo Kristov, market design manager for the California Independent System Operator, which oversees the state's main power grid.

The price cap fell last summer from $750 a megawatt hour to $500 and then $250. But the average cost of electricity rose from $125 a megawatt hour last September to $161 in November, Kristov said.

In December, authorities attempted to correct the problem with a new "soft cap" of first $250 and then $150. Under the new rule, companies could bid higher if they showed a need for the price. With demand exceeding supply, prices soared, averaging more than $300 ever since.

The ineffectiveness of a California-only cap and the meteoric rise in Western prices has fueled cries for a regional limit.

Joining West Coast leaders in support are California's major utilities, Pacific Gas & Electric and Southern California Edison, the state power grid operator.

But other Western states remain opposed. Siding with power generators, they argue that price spikes send market "signals" for consumers to cut back demand and power companies to build more plants.

A price cap still faces long odds in Washington. President George Bush has made clear his distaste for such measures, and the head of the Federal Energy Regulatory Commission, Curt Hebert, is a free-market enthusiast who staunchly opposes price controls.

Hebert says a regional price cap would be cumbersome and ineffective because federal regulators don't have authority over government-run utilities, including Los Angeles Department of Water and Power, Bonneville Power Administration and Canada's BC Hydro. Federal regulators would have authority over only about half of power sales into California.

Even experts are divided on caps.

Berkeley's Borenstein says that with runaway prices threatening economic catastrophe in California, a limited regional cost-based price cap is needed. Designed correctly, it could protect consumers while allowing reasonable but not excessive profit, he said.

"I think we should have a price cap and it has to be done in a careful and thoughtful way by people who actually understand how markets work," Borenstein said. "Not by ideologues on one side or the other who think price caps are always the right thing to do or never the right thing to do."

Others say California should press for another solution.

Frank Wolak, a Stanford University economist and market analyst for the grid operator, says regulators instead should force generators to sell 70 percent of their power to the state in cheap, cost-based contracts. Generators then could sell the rest of their power on the pricey daily spot markets with no limits, he said.

That would protect most of California's supply, while allowing generators to profit from excessive use, Wolak said.

A regional price cap, Wolak said, would give power companies little incentive to sell to California during shortages.

"I think it would certainly help us in terms of the cost," Wolak said. "But if we want to keep the lights on in California, we have to be willing to pay what it costs."