The New Energy Crunch

By John Greenwald

According to the laws of Mother Nature, electricity follows the path of least resistance. Mother apparently hasn't been hanging around California recently, where last week rolling blackouts spread darkness at noon across some of the richest cropland, most complex high-tech factories and busiest streets in America.

The blackouts were the latest and most painful phase of a statewide energy crisis that has been years in the making and continues to worsen, triggered by a spectacularly twisted and shortsighted deregulation plan. It has enraged consumers and businessmen even as it has pushed California's two largest utilities toward bankruptcy. It threatens to undermine the state's $1.3 trillion economy, the sixth largest on Earth, and rock the U.S. overall as it struggles to avoid a recession.

The crisis is also part of a nationwide winter of energy discontent in which natural-gas rates have soared to their highest level in 15 years, and that ever lovable cartel, OPEC, has slashed its oil output again to keep prices up. California's woes are testing everyone from Governor Gray Davis, a moderate Democrat seen as presidential timber, to George W. Bush, who last week stiffed Davis' request for federal aid to the staggering utilities.

At the same time, California has cast its shadow over ambitious deregulation plans being launched in such states as Oklahoma, Nevada and Arkansas (see following stories). Says Daniel Yergin, chairman of Cambridge Energy Research Associates: "The California crisis puts questions about our entire energy infrastructure front and center."

The state's largely self-inflicted energy wounds are rich in irony. A deregulation plan that was supposed to cut electric rates has instead more than tripled what some California consumers pay and has proved powerless to slow a tenfold increase in the state's wholesale prices. And instead of pulling regulators out of the utility business, the plan has plunged Sacramento and Washington ever more deeply into it. Last week Davis, who has called the deregulation plan a "colossal and dangerous failure" while also railing against "out-of-state profiteers," signed an emergency order that empowers the state's water-resources department to spend $400 million to buy electricity--a measure that could keep supplies at adequate levels for a few days at best.

Small wonder that California seethes with anger and accusations as furious consumers, power suppliers, legislators and regulators point fingers at one another. "Consumers are being asked to conserve on power, but suppliers are unwilling to give up a shred of their profits," complains Susan Weisberg, a San Francisco editor whose home office went dark for more than an hour last Thursday. In Sacramento, Republican state representative Keith Richman, a practicing physician, accuses Davis of Hamlet-like indecisiveness as the crisis worsened. "If I had stood by and watched one of my patients decline without taking action," Richman says, "I would be sued for malpractice and have had my license revoked. And I would have deserved it."

The entire mess flows not only from a deregulation plan that did not live up to the word deregulation but also from California's failure to complete a single large power plant over the past 10 years, even as Silicon Valley boomed and the state economy expanded 34%. "This is virtually a crisis by design," says Yergin. "At the heart of the problem in California is the lack of new construction."

Ironically, new construction was one of the aims in 1995 when the state, whose environmental laws make it a utility builder's nemesis, launched the nation's first and most sweeping electric deregulation plan. Enthusiastically endorsing the scheme were utilities, lawmakers and environmental and consumer-advocate groups. The goal enunciated by Republican Governor Pete Wilson was to bust up the monopolies held by utilities like Pacific Gas & Electric and Southern California Edison (SCE). They in turn would be free to purchase and market power in the state as well as to pursue business elsewhere. PG&E, for instance, owns 30 plants outside California.

Conversely, out-of-state operators were supposed to flock to California. These new competitors would help bring down electric rates that were among the highest in the country. "To be charitable," Wilson told TIME last week, "no one fully foresaw the dimensions of the increase in demand."

In sum, California dismantled its private power-generating industry without securing adequate power supplies. The Big Three utilities, which in addition to PG&E and SCE include San Diego Gas & Electric, sold off plants to outsiders like Duke Energy of Charlotte, N.C., and Reliant Energy of Houston and became middlemen. But the state wouldn't allow these new intermediaries to enter long-term purchasing agreements for fear they would be locked into fixed-price contracts as prices dropped. Their purchases had to be made on the so-called spot--or cash--market, and prices were low at the time.

The utilities willingly accepted this limitation, as well as a rate freeze until 2002. "The public utilities thought that it was just a splendid idea to be able to buy wholesale in a free market and turn around and sell at a capped rate to consumers," says Wilson, "because for a long time, at least, they would enjoy the ability to make a profit doing so." But they were gambling that they could wheel and deal their way through the marketplace without exposure to price swings.

They lost. In fact, the utilities rolled snake eyes time and time again. While the state's appetite for electricity was growing fast, its generating capacity was getting no bigger. Today California imports about 25% of its juice from neighbors in the Southwest and Pacific Northwest--a link that has frayed with the growing demand in those areas. Nor did anyone foresee a spike in rates for natural gas, which fires about half of California's generating plants and can account for more than half of the price of electricity. Then, as the rising demand for power met its restricted supply, the wholesale price of energy jumped from less than 5[cents] per kW-h in January 2000 to nearly 40[cents] per kW-h last December.

The results were catastrophic. Unable to pass along rising costs to homes and businesses, PG&E and SCE piled up losses and owed more than $12 billion to their banks and power providers. The utilities defaulted on some loans last week and refused to pay bills, creating a showdown with their bankers and power suppliers. Either group, in fact, could have forced the utilities into bankruptcy.

With the California utilities so shaky, it was hardly surprising that some generating companies were reluctant to supply them with more power. To keep the juice flowing, outgoing Energy Secretary Bill Richardson last month ordered suppliers to keep selling to California--a demand that rankles. "Suppliers such as ourselves are being forced to assume [the utilities'] credit risk with no promise of payment," says Steve Letbetter, CEO of Reliant Energy in Houston. "This is unreasonable and unfair and cannot be allowed to continue."

Nonetheless, the business has been highly profitable. Just last week Duke Energy reported a hefty $284 million in fourth-quarter earnings--compared with a $189 million loss last year--thanks in no small part to California's soaring wholesale prices.

Those earnings could continue to rise, since the state remains woefully short of generating capacity. California's power demand has grown nearly 25% since 1995, far in excess of the state's relatively small additions to capacity. (By contrast, Texas has built 22 new plants since 1995, with 15 more scheduled to come online within a year.) That forces California's Independent System Operator (ISO), which manages the power grid, to find some 6,000 megawatts a day outside the state.

The poster child for the frustrations that power companies face is the proposed 600-megawatt Coyote Valley generator that Calpine Corp. wants to build in San Jose, in the heart of Silicon Valley. The facility would light 600,000 homes in a region that experienced blackouts last week, but the San Jose City Council vetoed the project in November, even though groups ranging from the Sierra Club to the N.A.A.C.P. supported it. But the plant faced opposition from Cisco Systems, the leading producer of high-speed fiber-optic networks, which happens to be San Jose's largest employer. Cisco argued that the power plant would be an eyesore next to an industrial park that the company plans to build for 20,000 employees.

Such hostility helps explain why blueprints for generators keep gathering dust while California's energy crisis deepens. Proposals for 44 plants representing 22,600 megawatts of generating capacity are currently before California regulatory bodies. But only a handful are likely to come online before 2003. "California has a very cumbersome siting process," says Michael Zenker, a director of Cambridge Energy Research Associates. "It's long and gives opponents a good chance of defeating any plan." To make matters worse, some 40% of the state's capacity comes from facilities built more than 30 years ago, making them prone to equipment problems.

Given the lack of slack in the California power grid, it didn't take much to tip a swath of the state from Bakersfield to the Oregon border into blackouts last week--nor will that be the last such episode. "There's a good possibility that over the next couple of weeks there will be another day or two of blackouts," says Kellan Fluckiger, the chief operations officer of the California ISO. "And unless we have an unbelievably cool summer this year, there will be afternoons when we will have rolling outages again too."

Compounding the problems last week was a shortage of rain and snow in the Pacific Northwest, which depleted hydroelectric plants of the water they need to generate exportable power. Off the California grid went some 3,000 available megawatts. Meanwhile, a combination of routine maintenance and unexpected shutdowns in California took an additional 11,000 megawatts of capacity offline. In Morro Bay, on the state's scenic central coast, Duke Energy had to shut a 163-megawatt unit for two hours last Wednesday after the turbine began to vibrate and emit a loud, piercing sound.

With power from the Pacific Northwest slowed to a trickle, Northern California was further squeezed by bottlenecks in crucial supply lines--known as Path 15--that run through the state's Central Valley. The constraint--described by one expert as an "L.A.-freeway-type logjam"--placed the northern half of the state in a vise that made blackouts virtually inevitable. "We had some spare capacity, and we offered everything we had in the morning," says S. David Freeman, general manager of the Los Angeles Department of Water & Power, a municipal utility that opted out of the statewide deregulation scheme. "But we couldn't get all our power up there, so we could only offer limited help at first."

For Fluckiger, managing a rolling blackout calls for a jockey's nerves and instincts. The trouble starts when power supplies threaten to dip below the grid's projected hourly needs, which are arrayed on a bank of computers. Weather is typically the main factor. "A degree or two," Fluckiger says, "can make all the difference." And since supply and demand can shift rapidly, Fluckiger and his managers may have just moments to clinch a deal or notify utilities that they must cut their power. The companies then decide which areas to black out and use radio and TV to give their customers a 10- to 15-min. warning. When shortages persist for more than an hour, the utilities darken another area.

While all that may sound surgically precise, the results were naturally disquieting. At the San Francisco Zoo last week, members of the staff had to rush 150 cichlids--an endangered species of fish from Madagascar--to the warmth of the zoo hospital, lest they perish in chilling water. At the same time, seven West African gorillas found themselves trapped for 90 min. in their night quarters when the outage made it impossible to open the hydraulic doors of their cage. If the apes were irate, some San Franciscans may have been even more irascible. "I'm angry not just with the [utility] company but with the politicians who started all this," says Lawrence Mitchell, who feared for the inventory inside his darkened ice cream parlor. "I don't know what they were thinking." The crisis caused shutdowns and layoffs across the state. A Miller brewery near Los Angeles, which was spared blackouts, nonetheless shifted its production to Texas because of uncertainties about power.

The crisis showed no signs of easing last week. Wilson thinks that Governor Davis should use emergency powers to suspend tortuous regulations and start building plants pronto. And the ex-Governor calls for temporary power sources, perhaps sited on barges, to be rushed into service. Failing that, California's 34 million residents may soon hear calls for conservation reminiscent of the energy crises of the 1970s. "People go into their houses and turn on seven light bulbs, five computers, three TVs, and they're cooking dinner while the clothes dryer is running," Fluckiger says, with just a touch of exaggeration. "If they waited until after 8 p.m. to use some of those things and turned off some lights and a TV, it would have a major impact."

So would a less convoluted approach to deregulating an essential public service. But as Californians adjust their thermostats and turn off those lights burning in the basement, the lesson to the rest of the U.S. last week was pretty basic: a marketplace that is only partly free is a prescription for complete disaster.

--With reporting by David S. Jackson and Jeffrey Ressner/Los Angeles and Cathy Booth Thomas/Dallas

With reporting by David S. Jackson and Jeffrey Ressner/Los Angeles and Cathy Booth Thomas/Dallas