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The California energy crisis

The California energy crisis. Introduction (Wolak March ‘01) Wholesale: averaged $33 MWH in 1999, $116 MWH in 2000, $310MWH Jan 2001. Natural gas $3-$4 mm btu in late 1990s $10 nationally & $56.54 S Cal Dec 2000 April 6,2001 PG&E, bankrupt with debts of $9 billion. Deregulated market.

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The California energy crisis

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  1. The California energy crisis • Introduction (Wolak March ‘01) • Wholesale: averaged $33 MWH in 1999, $116 MWH in 2000, $310MWH Jan 2001. • Natural gas $3-$4 mm btu in late 1990s • $10 nationally & $56.54 S Cal Dec 2000 • April 6,2001 PG&E, bankrupt with debts of $9 billion. • Deregulated market

  2. Investigate cause • Describe old regulated structure • Initial regulated structure • Evolution of the crisis and underlying causes • Mitigation plans • Lessons

  3. Old system • Deregulation began in 1995. • Before this, C-O-S regulation of vertically integrated utilities • Generation, transmission, distribution, retail. • Equivalent of public ownership • Based on idea of natural monopoly • Regulation to set “just and reasonable” rates • Public Utility Commission, Federal Energy Regulatory Commission (FERC)

  4. Problems with Old • Technical, economic, with treatment of depreciation • Very costly • No incentive to reduce costs, innovate, increase efficiency, guaranteed return, promotes cost-padding, unwise investment • Green energy, cost overruns in nuclear

  5. Goals of deregulation • Competition in generation • No natural monopoly here • Increases efficiency, lowers prices, makes better use of existing facilities, gives better signals to generators re new investment • Competition in retail • Consumer choice, innovative packaging of energy products, lower prices, less waste.

  6. Deregulation program • Generation separated, power plants auctioned • Utilities allowed to recover $28 bill re. nuclear and green • Retail tariffs reduced by 10% and frozen till 31.3.02 or until debt paid • PG&E and SCE never paid off. San Diego G&E did.

  7. Institutions • Cal PX receives price and quantity offers from generators and bids from buyers • No long-term arrangements allowed. All day-of or day-ahead. • Cal-Independent System Operator: non-profit, role to avoid blackouts, make sure the system works, buy at any price

  8. Experience • 1998 & 1999 excess capacity, wholesale prices declined, retail fixed, profit of utilities increased, some debt paid off. SDG&E paid off all debt, retail no longer fixed • 2000 demand increased (20%?) • Result as discussed. Wholesale price increased, retail fixed • PG&E bankrupt, SDG&E customers faced bills up to 20 times higher 2.7 cents to 52 cents kWh

  9. What happened? • Supply and demand or market power? • Supply restricted by the deregulation program • No new power plants, new entrants lumbered with past costs of incumbents, for fairness • Still uncertainty re future regulations/prices restricts new entrants

  10. Market power • Also evidence of market power • Unverifiable forced outages • Generators purchasing gas at high prices through affiliates • Under mediation whether wholesale prices were “just and reasonable”

  11. Proposals • Price caps, soft and hard • Voluntary/compulsory forward contracts • Re-regulation of prices

  12. Subsequently • Natural gas prices in July ‘01 $3/mmbtu NYME, about $4/mmbtu Cal. • Temperate weather, increased conservation, increased gas production, slowing economy. • FERC June 19, power emergency in California sets price caps in all western states. Cost of production in marginal plant, was $90MWH.

  13. 2001 • Some suppliers would not sell, increasing emergency • FERC and generators in mediation. FERC claimed $9 bill. Generators offered $1 bill.

  14. My view • Bad legislation • Markets create incentives • True scarcity, high prices give signals to consumers to reduce consumption and producers to increase production (long run) • Here consumers were insulated and producers would not invest for uncertainty. • Result, more scarcity.

  15. My view • Here the incentives the system created were to increase profit by using the faults in the system, like income tax in many countries. • Example: price cap avoidance by selling into other markets, reducing supply to increase price.

  16. Lessons • Markets often work better than planned economies because the players innovate in ways that cannot be anticipated by the planners. • Deregulation should be designed to capture the benefits of this innovation rather than to give an incentive to avoid the rules.

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