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The Unexpected Hero in a Deregulated Electricity Market

September 10, 2000|Steven P. Erie and Robert V. Phillips | Steven P. Erie is director of UC San Diego's urban studies and planning program and a senior consultant to the L.A. County Economic Development Corporation. Robert V. Phillips is a former general manager of the Department of Water and Power

SAN DIEGO — What a difference four years make for Department of Water and Power customers. With passage of electricity deregulation in 1996, an uncompetitive DWP clung to life. Unable to pay down its $4-billion-plus power-generation debt and saddled with high rates for large business customers, it faced the prospect of a death spiral if it entered a deregulated marketplace. Commercial customers threatened to flee to lower-cost energy suppliers, while residential customers could be forced to pay large fixed costs. As a result, the DWP shunned deregulation.

Yet, by this summer, as San Diego Gas & Electric's ratepayers, the first to be exposed to market forces, faced a doubling, even tripling of their electric bills, the DWP's 3.8 million customers basked in low rates and a large power surplus. More remarkable, the DWP is even being touted today as a model for proposed municipal utilities in cities hard-hit by escalating electricity-rate increases.

What accounts for this startling turnaround? While current management deserves credit, the DWP's position also is a product of longer-term policy and investment decisions. Since its creation nearly 100 years ago, the department has made low-cost water-and-power reliability its policy cornerstone. Ezra F. Scattergood, founder of the DWP's power system, relentlessly pursued cheap hydroelectric power--nearly all from Hoover Dam--and by 1940, L.A. boasted the nation's lowest power rates. Yet, with postwar population and industrial growth, new and more expensive ways had to be found to meet burgeoning demand.

Starting in the 1970s, stringent state air-quality regulations, which eliminated fossil-fuel-fired plants in California, created the need for large, expensive power stations in Utah and Arizona. The DWP's new power came from four large, steam-generating plants in the L.A. Basin, partnerships in out-of-state coal-fired and nuclear plants, an Intertie connection to the energy-rich Pacific Northwest and the peak-load Castaic pump storage facility. As a result, the DWP accumulated nearly 7,000 dependable megawatts of generation, well above this summer's peak demand of 5,300 megawatts.

For the DWP to have entered the deregulated marketplace early on, it needed to pay off the large debt created by its investments in distant energy sources and offer competitive rates for large business customers. Under deregulation, debt relief came at the cost of reduced reliability. Investor-owned utilities such as Southern California Edison could pay off debts like the San Onofre nuclear power plant with a transitional surcharge added to ratepayers' bills. But participating utilities were forced to sell their power plants so that transmission and generation lay in separate hands.

The DWP's decision to pass on deregulation's guarantee of debt relief was risky. While municipal utilities were given the option of fully entering the marketplace in 2002, there was little evidence that the DWP could unilaterally pay off its huge debt since its revenue in part was used to fund other projects, like Mayor Richard Riordan's police buildup. While the city's elected officials approved residential rates 20% below private-utility charges, they balked at lowering rates for large businesses that were higher than for rival utilities. Because big businesses would be the first to enter the deregulated marketplace, many believed the DWP would have to be privatized to be competitive.

Yet, since 1996, the debt of the "uncompetitive" DWP has been halved, and the agency plans to be debt-free within two years. It now sells surplus power to other utilities, accelerating debt payoff. Adding 960 megawatts of capacity over the past several years by restarting mothballed plants, the DWP, in its just-approved 10-year, $1.7-billion capital program, will provide 2,900 megawatts of new generating power. As the state's investor-owned utilities and their ratepayers face a doubling or more of energy prices until new plants come on line, the department plans to offer a 5% rate reduction by 2002. Armed with low rates and a large surplus, it is vigorously promoting alternative-energy sources.

The department's current management deserves some credit for the turnaround. DWP general manager David Freeman has adroitly used that deregulated market for surplus sales and debt relief. Forging an alliance with the department's largest labor union, Freeman has wrung concessions from a labor-friendly City Council. Freeman also engineered the sale of the DWP's share of a poorly performing plant--the Mohave facility--while planning upgrades of cleaner plants in the L.A. Basin that will significantly add to the department's energy reserves.

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