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Want More Power? Build We Must

January 23, 2001|MICHAEL ZENKER and DANIEL YERGIN | Michael Zenker is a director of and Daniel Yergin is chairman of Cambridge Energy Research Associates

The California power crisis represents a "dangerous failure," as Gov. Gray Davis put it, but not the one normally cited. Rather, it is the failure of an idea--that the surplus generating capacity in the state would last forever.

The architects of California's partial deregulation were not focused on adding new supplies. They were concerned about four things: lowering rates, providing customers the choice of power suppliers, giving utilities the ability to recover their past costs and providing a reliable power system for consumers and businesses. They failed to anticipate that none of this would work if the wholesale market--on which they would ultimately have to depend for electricity--responded dramatically to a supply shortfall.

Deregulation in other states, such as Massachusetts and Texas, is more successful because these states made it possible and profitable to build new power plants. This is in stark contrast to California, where a crisis was inevitable because the prices remained below what it cost new plants to produce electricity.

Compounding the problem were several things, starting with California's open-ended environmental review process. While other states have a checklist approach--once you've gone through the list, you can proceed with building a plant--the process in this state seems to go on almost forever.

In addition, major population centers, including Los Angeles and San Francisco, have air quality standards that limit the amount of electricity that can be produced in those regions. And, again at the local level, community opposition to new construction has thwarted plans to build new plants.

More than 40 new power facilities are now proposed for California. An aggressive push to permit and construct half of these would solve the current supply crisis, allowing power prices to fall dramatically.

California began the 1990s with a surplus of generating capacity. But supplies have not kept up with demand. California's economy grew by a phenomenal 32% in the past five years, fueling a 24% increase in the consumption of electricity in that same period. Yet no new plants have been built in the last 10 years. Growth in consumption has nearly exhausted supplies, pushing the oldest, least efficient, most expensive plants into nearly continuous operation.

Conservation can help. But simply saying that word does not make it happen. It takes time, and it is hard to achieve without prices that reflect supply and demand.

As it is, California's system has created a no man's land, trapping the state's utilities between high wholesale prices and regulated, frozen retail rates. Over the past six months, California's utilities have been paying more than 13 cents per kilowatt-hour to buy electricity from the wholesale market while charging their customers an average of 6 to 7 cents. As a result, the utilities have hemorrhaged billions of dollars over just a few months.

This situation is untenable and unsustainable, as the near bankruptcy of the state's two largest utilities makes clear. Despite the urging by federal regulators, California's Public Utilities Commission has turned aside proposals to get costs and prices back into a rational balance. But even raising consumer prices--which might resolve the bankruptcy problem--won't resolve the crisis unless the state finds new supply sources.

The easiest political response is go backward. But re-regulating the industry or placing the grid under state control risks prolonging the supply crisis by contorting the economics, driving away investment and discouraging conservation.

At this moment of crisis, it would be a great loss to the citizens of the state if the search for villains overwhelmed the quest for reasonable solutions. It's worth learning from other states, which have successfully attracted new supplies and are now enjoying the benefits of electric industry deregulation.

California initiated the deregulation effort to achieve important goals for consumers and businesses. None of these goals have been met. If California is to get out of this fix, it needs to immediately expedite the permitting and construction of new power plants.

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