|December 11, 2000
California Energy Officials
Price-Cap System, in a
By REBECCA SMITH
Staff Reporter of THE WALL STREET JOURNAL
California grid officials unexpectedly abandoned
their main tool for managing prices after it
proved incapable of reining in runaway energy
costs. Instead of capping bids at $250 per
megawatt hour, they will now accept electricity
at any price so long as suppliers can prove it is
justified by production costs.
The unilateral move by the California
Independent System Operator, or ISO, came at
the end of a chaotic week in which energy
prices spiraled out of control and the world's
seventh-largest economy was threatened by
blackouts. Originally meant to have a small role
in the state's deregulated market, the ISO, which
guarantees electricity reliability, has lately found
itself buying as much as one-third of the power
consumed daily. In order to do so, the ISO has
paid ever-higher prices for last-minute power
purchases. On Monday, it spent $5 million. By
Friday, the figure had climbed to $81 million.
Generators, which already had 30% of the
state's power plants down for repairs after
running them hard all summer, offered
progressively less power to a computerized
day-ahead market run by a state-sanctioned
auction. They held back thousands of
megawatts, offering the juice to the ISO only if
prices got high enough. That put the ISO in the
position of having to beg and haggle for power,
despite the fact that actual demand wasn't
"My people were making phone deals -- 10 to
15 an hour -- when I needed them running the
grid," said Terry Winter, ISO chief executive.
"We had a gun to our head."
In the end, the ISO took the rogue action of
abandoning its "hard price cap" of $250. It did
so without advance approval of its governing
board, Gov. Gray Davis or even the Federal
Energy Regulatory Commission, to which the
ISO reports. Nevertheless, the four-member
commission concurred with the move, at least
temporarily, noting the "extraordinary
circumstances occurring in California." The
energy commission is expected to issue on
Wednesday an important order on what is to be
done with the California problem.
Mr. Winter said he got tired of waiting around
as politicians and bureaucrats debated a fix for
California's broken energy market, which saw
prices soar to record levels even before last
week and which has put the state's main utilities
at risk of eventual insolvency. "I wanted some
accountability for these outrageous costs," Mr.
Gov. Davis, who has come under fire from
consumer groups for the sharply rising energy
costs, immediately lambasted the ISO for what
he called an "outrageous assault" on consumers.
Gov. Davis, who favors a $100 price cap -- a
level that generators say is below their
operating costs -- threatened to "dismantle" the
ISO in retaliation.
Generators and traders, on the other hand, said
that by freeing up prices, the ISO is actually
doing what is necessary to make sure the
market works. They argue a better match of
supply and demand should eventually bring
down prices. "Price caps distort the market,"
says Kenneth Lay, chairman of Enron Corp., the
nation's largest energy trader.
Even if that is the case, relief may not come
quickly. A cold snap is increasing electrical
demand throughout much of the West, soaking
up juice that otherwise could be available to
California. What's more, the price of natural gas
-- the fuel for many power plants -- has shot up
to unprecedented highs recently. Natural-gas
prices, at $2 to $3 per million British thermal
units a year ago, are now trading on the spot
market at around $40 to $60, by far the highest
level in the country.
The ISO action, though, should give the
organization some breathing room. By
promising generators they can offer energy at
more than $250 per megawatt hour and not
have their bids rejected outright, the ISO saw
the amount of juice offered on Friday jump
from nearly zero to 3,000 megawatts, giving it
the biggest cushion it had all week. Some of the
offers came in below $250.
By Sunday, more trading had shifted back into
the day-ahead market run by a sister
organization, the California Power Exchange.
But that pushed up its average price for power
to be delivered Monday to a record $611.80 per
megawatt hour, nearly one and a half times the
prior daily high.
That price run-up may reflect the fact that the
ISO, in its emergency market, now is forcing
suppliers to provide "appropriate cost
information" to the energy commission and state
officials when they offer power at prices above
$250 per megawatt hour. The daily auction has
no such requirement. When emergencies are
declared, the ISO also is asserting the right to
fine generators who refuse to provide power.
The change in the pricing system is a risky one
because generators may be able to justify
sky-high prices because of their natural-gas
purchases. There are only a handful of
generators serving California, and some buy
their natural gas from affiliate companies,
opening the door to sweetheart deals. "There's
no arms-length relationship between the gas
and electric companies," say Harvey Morris, an
attorney at the state Public Utilities Commission
who has filed an action against El Paso Energy,
owner of a major gas pipeline serving
California, alleging that contractual
arrangements between its units have driven up
gas prices. El Paso denies that is the case.
Under traditional cost-based regulation, such
arrangements weren't allowed. Electric
generators -- utilities -- were required to show
they bought their gas at reasonable prices.
Today, they are allowed to buy gas from anyone
and at any price because the assumption was
that a competitive electricity market would
make it impossible for them to pass through
Energy experts say that the ISO's actions will
only have a positive effect if the energy
commission sets standards for permissible costs
and then audits generators and traders
Write to Rebecca Smith at