Two Comments on TQE #7: The California Energy Crisis
In none of the subjects that I write about am I an expert. I tell my students I am a "Jack of all countries and master of none." Any one of us can be an expert in only one or maybe two things, yet we have to be political beings in all things. So I read as many experts as I can understand and try to interpret them to my students. I teach a course at the University of Colorado called "Global Issues," which is the source of these Letters.
Every once in a while, an expert will answer me and point out the obvious: that he or she knows more about that particular subject than I do. Two have done that for California electricity, Karen Street and Dick Bellin. Their messages can be presented fairly only if I reproduce them in full. For non-expert messages, I excerpt from the long ones to give the reader the flavor without making the Letter too long.
In fact, I am not convinced by either of these experts. Each says that electricity is so complex that it must be regulated, at least in part. So is the world economy. I believe the very complexity is what requires competition each pair of transactors making decisions at the margin. But of course, as I tell my students, you make up your own mind.
Sincerely your friend,
Comment by Karen Street
Berkeley, California, Friends Meeting
First, let me thank Jack for the opportunity to participate in a Friends' discussion on an important topic. Discussions help us understand the issues; they help us understand our own values.
I have been writing about and leading discussions on energy and environmental issues for several years, but have only recently begun reading about the specifics of California deregulation of electricity production. You can find more of my ideas at the Friends Energy Project. Or you can read some of my sources, especially the University of California Energy Institute.
The first part will respond to Jack's assertion that deregulation is part of the answer. The last part will list some of the questions in energy policy.
Are the problems of deregulation the utilities' fault?
California newspapers, much more than Californians, blame local utilities, as if they initiated deregulation in California, as if the PG&E parent company should subsidize California. Rather, we the voters elected people who fed back to us our dreams.
Are the extreme prices the wholesalers' fault? Economists generally consider that wholesalers are obligated to make large profits for their shareholders.
The explanation of why almost no power plants were built in the late 1980s and early to mid-90s is complicated. Much of the blame belongs to the California Public Utilities Commission, which failed to be responsive to utility requests. Once the deregulation process had begun, no one wanted to initiate new plants while the rules were unclear, and no one in California was responsible for determining power needs.
California's electric problems today are the fault of the U.S. and state governments, and the dreams they were pandering to.
Is electricity ready to be deregulated?
While it is true that it is now practical to ship electricity hundreds of miles, it is not necessarily true that a competitive market for electricity is in place, or can be set up, or should be set up.
Is there a competitive market? Some producers can sell easily to part of California, for example, but not to other parts, because of limits on transmission lines. Nor is it only the Not-In-My-BackYard syndrome [NIMBY] that prevented the construction of new transmission lines: the advantages of competition may not be sufficient to pay the high price and environmental costs of the new lines, though transmission capability should be improved. If California could buy from anyone, why not buy cheap, plentiful Texas electricity?
Can there be a competitive market? Possibly, though not all commodities are so marketed. First, though, electricity users need real-time meters, to know how much their electricity costs. Real-time meters should be integrated into the distribution system as rapidly as feasible, but this will still take years. Governor Davis agreed April 19 to a $31M program to extend real-time metering to sites with more than 200 kw use; currently only sites using more than 500 kw have real-time metering.
Should we set up a competitive market? The most important question, what is a good energy policy, will be discussed at the end of this response. A good energy policy is concerned with more than pricing
How much will Californians pay for electricity in 2001?
There are many estimates being put out without clear explanations. On top of that, no one really knows. This is my attempt to explain others' attempts at estimating the magnitude of the debacle.
Californians used to pay PG&E and other utilities an average of 13 cent/kwh, a minimum of 10 cent/kwh, for electricity. Some of this covered distribution costs, some accelerated payments on nuclear plants and renewables contracts, some production costs. Productions costs were considered to be high, and deregulation was instituted to bring production costs to well below 5 cent/kwh; it was thought that the price would be less than 3 cent/kwh in the short-term. This was sufficient incentive to encourage a large number of proposals for power plants, more than sufficient for electricity needs.
Per capita use in California is half of the per capita use in the West, partly because so many live near the coast, and partly because of "aggressive" encouragement of efficiency (one can only assume that the term aggressive is applied by people who are comparing California to even weaker promotion in other states).
Wholesale electricity (does not count other costs) was priced at more than 17 cent/kwh in March, a low-use month. Wholesale electricity cost almost 35 cent/kwh in December. The average wholesale price for 2001 may be 30 - 40 cent/kwh.
California is expected to pay about $70B to wholesale producers of electricity this year, more than $2,000 per capita, about 6 - 7% of the Gross State Product. California still has billions of dollars, hundreds of dollars per capita, in unrecovered costs from 2000, costs which will be paid. When OPEC increases led to oil prices that were 2% of U.S. GDP, a recession resulted.
Are wholesalers charging too much?
Californians should be paying higher wholesale costs for electricity as hydroelectric power is down this year, and natural gas prices have risen (prices increased so much in California that it triggered an investigation). Also, we can legitimately be charged scarcity prices. But this is only a part of the increase in wholesale prices.
Electricity wholesalers are making enormous profits as they "exercise market Power". The Federal Energy Regulatory Commission refuses to cap wholesale rates (they made a minor change in that policy this week). FERC is lawyer heavy, and economist and energy scientist light, and is in disagreement with most of the economics community, which feels that such a high profit for wholesalers is unnecessary. See University of California Energy Institute for discussion of capping rates.
Capping wholesale rates will not decrease supply or competition, unless the rates are set lower than anyone recommends. Remember, an anticipated price of less than 3 cent/kwh (plus a few cents for distribution) in the short-term was sufficient to encourage large numbers of applications for new natural gas plants. (Natural gas plants will produce power averaging about 4.5 cent/kwh over their lifetime, assuming that the price of natural gas behaves as Department of Energy predicts. This price will be higher if anticipated carbon taxes are imposed.)
Today's rates do not affect plans for new power plants; rather, they put money in the pockets of the people who bought power plants from California utilities.
Are Californians paying enough for electricity?
Californians do not pay enough in our bills, nor will we under the Davis/California Public Utilities Commission proposals: rates will not reflect the true price. As a result, we demonstrate little interest in reducing consumption. The price increases that the California Public Utilities Commission and Governor Davis announced are not sufficient to prevent rolling blackouts this summer.
Jack is correct: we pay less than the full cost of energy. The U.S. military subsidizes oil, for example. The health and environmental costs for fossil fuel electricity were estimated by ExternE (a research project of the European Union) in 1997 to be as much as 19 cent/kwh, and might be considerably higher if evaluated today. For wind, photovoltaic (solar), and nuclear power, these were calculated at 0.5 cent/kwh or less. For gasoline and diesel fuel, health and environmental costs were evaluated to be as much as $4 and $30/gallon respectively.
None of the profits are being used to compensate society for the health and environmental costs. Even if retail rates reflected the high wholesale rate in California, the true costs would not be paid.
We will pay in California, directly when we pay our bills, or indirectly with taxes and bonds. California will also pay with higher prices, lost jobs, and reduced funding for schools and other social necessities. The entire U.S. is likely to suffer economically.
What should the price of electricity be?
University of California Energy Institute and other institutions consider how much profit they think fair for wholesale electricity,
Jack points out that when the wholesale price of electricity is too low, more expensive technologies with lower health and environmental costs have difficulty competing. Again, the price of electricity should be raised to reflect its costs to society. A surcharge is needed to help subsidize research on tomorrow's energy, both because today's sources will not be sufficient tomorrow, and because fossil fuel use must be significantly curtailed.
Jack says that if the price of energy is increased, we will find ourselves spending more on energy in the short-term. Surprisingly, this is not necessarily true in the long-term. According to Scenarios for a Clean Energy Future (a 5-national lab report), a $50/ton California tax (0.5 - 1.3 cent/kwh for fossil fuel electricity and 12.5 cent/gallon for gasoline) is part of a package estimated to reduce total energy costs 18% over business-as-usual by 2020, as people begin to buy more efficient cars and appliances that should have been bought anyway. People often don't make good energy decisions regarding efficiency unless the price of energy is high enough. Note that this tax charges us only a part of the cost of the greenhouse gases, and charges us nothing for fossil fuel pollution; also, business-as-usual predicts an increase in per capita spending as average use and the price of energy both increase.
The proposed $50/ton California tax could pay a part of the cost of preparing for the great environmental changes that will occur in the 21st century, and for the consequences. Climate change will cost the United States significantly, as we prepare for natural disasters and recover from them, as the cost of clean water and migration increase. Imagine the costs of electricity, as a typical July day in the Southeast, now 105 degrees F heat index, including humidity, may increase to 130 degrees F by the end of the century. And while U.S. energy use will cost the U.S. money, lives, and aggravation in the 21st century, U.S. energy use is expected to be devastating to much of the developing world. [see note below]
Some method needs to be found so that energy users pay the health and environmental costs to society. ExternE proposes a tax on each source, while American energy scientists propose a small carbon tax. Most people in energy policy recommend beginning soon or immediately.
We agree that the poor need to be protected by society. It would be better to do this in a well thought out package rather than individual programs. But for energy, additional help could come with a subsidy of high capital cost items, such as insulation. These often have a short payback time which may not be obvious to someone for whom a $10 light bulb is a large expense.
What are the questions in energy policy?
This is the question that has been left too long.
Deregulation was intended to solve the problems of electricity prices, which some considered too high in some areas of the country. But the problems of energy are more than high or low prices, more than rolling blackouts.
John Holdren (Science, February 9, 2001, p. 945, "Meeting the Energy Challenge") speaks for much of the energy community when he says, "Neither complete reregulation nor complete deregulation of energy markets is the answer. Capturing the cost savings available from the appropriate play of market forces in the energy sector is too appealing a proposition to abandon. But energy is too burdened with public-goods dimensions (including national security, environmental sustainability, the macroeconomic ramifications of reliability, and society's commitment to meet the basic needs of its poorest members) to allow complete deregulation. The directions for addressing our short-term energy challenges are easier to describe than designing and implementing the details will be. But more daunting still are the energy challenges looming in the longer term. These include providing a sustainable energy basis for maintaining prosperity where it already exists and achieving it where it does not, limiting dependence on imported oil, reducing the risks from greenhouse gas-induced climate change, and minimizing the contributions of nuclear energy to nuclear weapons dangers.
"Meeting these challenges will require increased efforts to maximize the capabilities and minimize the liabilities of the full array of energy options: improvements in end-use energy efficiency in vehicles, residences, and industries; renewable energy sources; advanced fossil fuel and nuclear fission technologies; and nuclear fusion. There is no silver bullet in this array nor are there any that we can be confident we can do without. Current levels of public and private investment in energy R&D and demonstration are not remotely commensurate with the long-term challenges and opportunities, either in the United States or in any other country. U.S. federal expenditures on applied energy technology R&D are about what they were, in real terms, just before the oil price shock of 1973-74, although today's economy is more than twice as large. U.S. private sector investments in energy R&D have been falling since the mid-1980s.
"Strengthening R&D is only part of the answer. Incentives must also be strengthened for deploying a wider array of the most attractive options from the menu available at any given time. And increased international cooperation in energy innovation is warranted, because U.S. and other countries' economic, environmental, and security interests are served thereby. Although markets have a large role to play in all this, the government must also be involved. The large public benefits attending the right choices and the large public costs attending the wrong ones require it."
I believe that the states have been given power to make too many decisions. Perhaps the U.S. government should take more responsibility, given the national and international implications of the answers. Most certainly, we need more state and U.S. control than exists under deregulation if we are to have any chance of solving today's energy problems.
Note: Everyone who uses energy should read about the effects of our choices. For more on the changes that the U.S. and the world will see in the 21st century, see The Regional Impacts of Climate Change: An Assessment of Vulnerability and the U.S. National Assessments, including The Potential Consequences of Climate Variability and Change.
Comment by Dick Bellin
Washington, DC, Friends Meeting
Jack, your analysis and opinion of the "energy crisis" neglects some important considerations.
First of all, by way of background, I am more than just a concerned but not-very-well-informed "consumer." My entire career was spent in the utility industry. I worked as a power systems planning engineer for almost 10 years, as a rate analyst within a utility for 5 years, and then as a consultant in cost analysis and rate design for over 20 years. I have testified numerous times before Federal, State, and Canadian Provincial regulatory commissions as an expert witness. I carry a Professional Engineer license from the State of New York. While I don't claim to know everything, I think I know quite a bit about this situation.
First of all, as you have stated, the production and delivery of electricity is extremely complicated much more so than natural gas, and certainly much more so that almost any other commodity we purchase. The generation of electricity in turbines and the flow of electricity in transmission and distribution lines is governed by well-known physics and engineering principles- principles which cannot be changed by either legislators or economists. Not only does there have to be adequate generating capacity on line at every moment in time, but the network of transmission and distribution lines must also be adequate. For almost a century, utility engineers have co-ordinated the installation and operation of generating and transmission facilities in recent years through large-scale regional power pools so that all elements of the system worked together. The sizing and siting of generators included analysis and necessary reinforcement of the transmission system. Generating units were dispatched in accordance with incremental cost of operation rather than selling price, which insured the lowest overall cost of power all the time. In spite of a few major lapses particularly the two Northeast blackouts the power systems in North America have worked remarkably well to provide highly reliable energy at reasonable prices.
I recognize fully that the pricing principles which have been followed average historic costs including not much more than bare bones cost-of-capital may have encouraged overcapacity, discouraged conservation, and perhaps slowed the development of alternative technologies. However, solutions to these problems were being addressed within the regulatory context. I fully agree with you that, all other things being equal (the economist's principle of ceterus paribus), free and open competition is better than government-imposed regulations. But all other things are not equal.
I disagree that "conditions are different now." The only reason smaller plants are more economical is our collective refusal to permit the construction of larger plants. And our failure to increase the production of natural gas to fuel these plants means that even these smaller facilities have become uneconomical. As Karen Street will tell you, nuclear power is the best answer to our energy problem for the foreseeable future, but given the irrational objections and fears so many have, I do not hold much hope of implementing this solution.
Furthermore, the only part of the system which has been deregulated is production. Transmission and distribution facilities still come under regulatory jurisdiction. The failure to address the technically complicated and politically volatile problems of providing adequate transmission facilities is even more worrisome than the problems of generation However, as long as the right of Eminent Domain exists, I don't see any alternative to regulation. While the NIMBYs and the BANANAs have done too good a job of delaying and/or preventing these necessary facilities from being built, it might be far worse if utilities had no such right. So complete deregulation doesn't seem possible, and partial deregulation seems to be worse than none at all.
I have concluded from all of this that we had a very good if not perfect system which "wasn't broke, so we broke it!"
Needless to say I could write much more, but this is enough.
Dick Bellin, Friends Meeting of Washington (DC)
Karen Street said, "People often don't make good energy decisions regarding efficiency unless the price of energy is high enough."
Energy is not anything special. It is just one of a number of commodities that make life more palatable. It costs what it costs, and there is no intrinsic reason to conserve it. Friends may wish to conserve energy in the short term because they feel that the price of energy does not include the pollution it creates. But that is a problem of regulation; not anything particular to energy.
Russ Nelson, St. Lawrence Valley (NY) Friends Meeting.
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