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Corporate Research E-Letter No. 12, May  2001

by Mafruza Khan

As the California energy crisis continues unresolved against the backdrop of President Bush's energy plan, the other Western states have been feeling its impact in many ways. The situation has prompted Western governors and other politicians to join forces to think of the problem as a regional one with serious implications for the entire nation. Earlier in the year, governors from nine Western states met at the Western Governors' Association's energy conference with short-term solutions to their state's electricity shortages and long-term strategies for coping with increasing demand. Declaring that the economy of the entire West was at stake, Governors John Kitzhaber of Oregon and Dirk Kempthorn of Idaho took the lead to call for a regional energy plan that would promote conservation, increase reliance on renewable resources, cap wholesale electricity prices and increase production without sacrificing environmental quality.

Besides their economic connection, the Western states are connected by the infrastructure of the Western Power Grid, which distributes power to 11 states and two Canadian provinces. High prices in one part of the West ultimately translate into higher prices throughout the region. The arrangement that the Pacific Northwest has generally had with California is that, in the summer when demand is high in California but low in the other states, California imports electricity produced by the 30 federal dams in Idaho, Oregon, Washington and western Montana. In winter, when loads are higher in the Northwest, California sends power up to the region. The Bonneville Power Administration (BPA), a federal agency, based in Portland, markets about 50 percent of this power. (Others include the Western Area Power Administration.)

BPA was created in 1937 to market the power from dams built during the Depression to aid economic development in the then-isolated region. Until recently, BPA had been sending California electricity in an exchange arrangement that returned to the Northwest 2 megawatts of power for every megawatt delivered. BPA owns 80 percent of the region's transmission lines, more than 15,000 miles, and sells power to 18 customers in the state that include, nine rural cooperatives, seven municipalities, the Bureau of Reclamation and Idaho Power Company. The agency produces 40 percent of the electricity in the Northwest.

Power connections and price surges in the region:

When the energy crisis in California continued into the winter of last year and earlier this year, the Northwestern states were under order by the Federal government to send approximately 2,700 megawatts of power down to California. This caused them to draw down the water behind the reservoirs, which had an impact on the available power in the region, and reversed the flow of electricity from these states to California during winter. The prolonged drought in the Northwest, the second worst since 1929, compounded the existing problems created by deregulation, price gouging, and high demand by creating a shortfall in the expected supply of hydroelectric power. Experts told the Senate Energy and Natural Resources Committee in February that a combination of unusually dry weather and emergency orders to ship power south in the winter had shaken Northwest utilities, forcing them to raise rates to deal with the unprecedented market conditions. BPA announced that it would raise prices 60 to 90 percent over the following year. This would have a broad impact on the region's economy, which was dependent on cheap, reliable energy. In Washington, Takoma Public Utilities instituted a 50 percent surcharge, making it more expensive to heat buildings and keep lights on. The Northwest Power Planning Council, which oversees electricity policy in Washington, Oregon, Idaho and Montana, predicted that rates for Idaho Power Company consumers might go up by 24 percent. Utah Power and Light proposed a 19 percent increase and Vancouver, Washington ratepayers were hit with a 20 percent hike.

The Federal Energy Commission's April decision to cap electricity prices whenever supplies fall to within 7.5 percent of demand may offer some respite to consumers and utility companies. But the Golden State incurred the wrath of its neighboring states when it proposed in April that it would cut off electricity deliveries from California to other Western states when rolling blackouts threaten. The plan requires approval from federal regulators before it can be put into effect. Under the plan, California's power grid operator could declare a power emergency and then ban electricity exports scheduled by in-state generators. The California Independent System Operator would set price controls for all generators operating within the state and require outside market providers planning selling electricity into the state to honor the limits. "California is trying to wall itself from the rest of the West," said Ron Eachus, chairman of the Oregon Public Utilities Commission. "Allowing California to embargo energy and cease being a cooperative participant in the Western market would have a chilling effect on these efforts in our region," said Arizona Governor Jane D. Hull.

Everyone wants some easy money:

California's crisis is the result of multiple factors, including a flawed deregulation bill that created circumstances conducive for price gouging, unfavorable weather, flawed demand and supply projections and a spike in natural gas prices. The Federal Energy Regulatory Commission (FERC) has indicated that it may order some refunds because of price gouging by out of state companies like Enron, Duke Energy, Reliant Energy and Dynergy, most of which are headed by major contributors to President Bush's various political campaigns. Duke Energy laid its cards on the table in early May by publicly releasing a plan for the California energy crisis on the day that reports hit the newspapers of secret contacts with the governor's office by Duke officials seeking to end investigations into alleged price gouging. Duke, the North Carolina-based energy giant that is heavily involved in the high-priced California power market, issued a statement outlining a three-year plan in which the company offered to build new power plants, enter into long-term supply contracts with the state and "share the financial pain of the troubled market." In exchange, Duke said it sought some non-specific changes in environmental and siting regulations along with "resolution of all pending lawsuits and investigations into the company's pricing activities."

Such problems are not limited to power generators alone. Consider the practice of Northwest aluminum producers that were getting energy at below-market rates from BPA. Instead of using it for their operations, they have been reselling it in the high-price, high-demand market environment at 10 or 20 times what they have been paying. Concerned parties have said that BPA should exercise its legal authority to halt such contracts. Estimated profits from resale are: Kaiser, $426 million; Goldendale/Northwest, $344 million; Columbia Falls, $292 million; Alcoa, $210 million; Longview, $173 million; Atofina, 4 million; Oremet, $2.5 million; and Vanalco, $900,000.

Currently, BPA has agreed to provide 11,000 megawatts of power to its customers when its new contracts kick in October 1, but it has 8,000 megawatts available to sell. The aluminum companies, which, unlike public utilities, have no legal claim to BPA power, have contracts for 1,500 megawatts. As part of BPA's response to the shortage, the agency has urged operators of the region's aluminum smelters to agree to keep their operations closed for the next two years while the electricity market stabilizes. During the two-year shutdown period BPA would provide funding for employee compensation to minimize the impacts on local communities and make additional payments to compensate local governments for lost tax revenue. Only one company, Alcoa Inc., said that it had signed an agreement with BPA to shut down its Intalco aluminum smelter at Ferndale, which employed 900 workers. Aluminum smelters provide 8,000 jobs in the region and support another 20,000 indirectly.

Energy, jobs and the regional economy:

The aluminum industry is not the only sector losing jobs and incomes. Unlike California, about 80 percent of the energy in the Northwest is generated by hydroelectric power. The coincidence of the California energy crisis with the drought in the Northwest is draining an estimated $1.5 billion out of the regional economy. A recent study by the Office of Financial Management estimated that without more conservation or power generation Washington could lose $1.7 billion worth of disposable income to out-of-state energy suppliers and lose 43,000 jobs. The study also documents that electricity price increases are forcing many Washington families into food banks for the first time. By December 2000 astronomical power costs had already forced some companies in Montana, Washington and Oregon to curtail production and lay off employees. These included the Columbia Falls Aluminum Company and Montana Resources in Butte. According to the AFL-CIO, more than 1,000 Montana jobs have been lost to higher electric prices. This includes 330 mining jobs and 150 paper mill jobs. Other victims include copper mine workers in the Southwest.

Many technology firms that set up shop along the I-5 corridor because they expected to have access to cheap energy have had to shut down. Low-tech industries have also been hit. In Bellingham, Washington, Georgia-Pacific announced that it would shut down its pulp mill and chemical plant because it could not afford the electricity it needed. The 420 workers at the plant and mill will receive two months' pay and severance packages. Georgia-Pacific is also considering closing its adjoining tissue paper plant, which employs about 330 workers. According to the Bellingham-Whatcom County Chamber of Commerce, the decision would cost the local economy $45 million to $50 million a year, including pay, benefits and charitable contributions. The Chamber expects the state to provide tax breaks as incentives for major employers to try and fill the void.

Water is the lifeblood of the Northwest. Industry, agriculture, fisheries, recreation, forestry and electricity all depend on it. Washington and Oregon are struggling to manage their competing water needs while keeping the power turbines spinning. Fifth generation apple growers have gone bankrupt as energy prices have soared along with a sharp decline in the price of apples. The BPA has also warned that it cannot divert water away from its hydroelectric turbines to aid migration of endangered salmon. Under a federal plan to meet the Endangered Species Act, BPA is required to divert water from its power turbines and spill it over the dams to help flush young salmon downriver during their migration. It also holds water in reservoirs for at the time salmon need it most. (Young salmon are washed by high river flows to the ocean; they do not swim there.) Without these measures most of the young salmon will not survive the low flows. It is hard to put a dollar on the fish since they are a fundamental part of life for Native Americans in the region. Under treaties signed with the federal government in 1855, Native Americans have rights to continue fishing for salmon along the Columbia River. If the fish become extinct, reparations would cost the federal government an estimated $12 billion. Even as it sacrifices water intended for fish, BPA has said that it will still have to raise rates.

Surviving a crisis - best and worst practices in the making:

The right way to restore stability and reliability in the Western energy market is, needless to say, a hotly contested issue. These range from extreme supply sided solutions to more balanced approaches that consider the different aspects of a complex problem both in the short and in the long run. Demand management can be a significant chunk of the solution. Since restructuring, the utilities' energy conservation efforts have been less than stellar. In California, more than $200 million collected from ratepayers for energy conservation programs remain unspent. The California Energy Commission projects that if energy efficiency programs designed and managed by investor-owned utilities had retained the momentum of the early 1990s, there would have been no blackouts. In the late 1990s, when electricity was plentiful, BPA dismantled its $200 million a year energy conservation program. Many utilities followed similar measures. Seattle City Light was virtually alone in keeping its conservation investment, which saved ratepayers millions of dollars in power purchases last winter.

A March 2000 report by the Rand Corporation estimates that on an average, low-income households spend eight percent of their income on electricity; in very poor households it may be as high as 23 percent of income. According to utility filings, there was $44.4 million in unspent electricity and natural gas funds for low-income energy efficiency programs administered by PG&E in 2000 (in addition to another $8.4 million they chose not to spend). Southern California Edison and San Diego Gas and Electric filed testimony opposing a proposal to expand energy efficiency programs for low-income populations until a needs assessment is completed. The assessment was authorized in 1996 but has yet to be started. Much of the state's $700 million in funding earmarked for conservation would flow through the utilities, in spite of their track record, another tribute to the clout of investor-owned utilities.

Programs that offer incentives for businesses that curtail demand, such as the Portland General Electric's deep market rate discounts, have already proved to be successful. PacifiCorp, Oregon's second largest utility, suggests finding large customers willing to use less power and paying households to install energy efficient appliances. In a variation of buy-back programs, Portland General Electric and PacifiCorp have signed large industrial customers onto a plan that pays the customer to reduce electricity use during emergencies or when wholesale prices spike. Seattle City Light is testing a program that sets a high rate during the times of day electricity use generally peaks and a low rate when electricity use is low with the intent of bringing down and stabilizing electricity use. If the pilot project works, the utility hopes to have the program, known as "coincident peak pricing," in effect by next winter and eventually worked into a broad range of rate designs. The Oregon Public Utilities Commission has ordered Portland General Electric and PacifiCorp to offer a similar time-of-use pricing structure to customers by fall. Puget Sound Energy in Washington has advanced load management programs that allow customers to monitor energy use daily through the use of sophisticated software and technologies.

The political response from the Western states have included an agreement to introduce bipartisan legislation to restore stability in the Western energy market by directing the Federal Energy Commission to impose a just and reasonable wholesale rate cap which can be load-differentiated based on demand and supply or cost-of-service based rates.

Meanwhile, the energy crisis and the skyrocketing price of gas are sparking renewed interest in coal, nuclear power and other contested sources of energy. As one commentator has suggested, "The principal change under way today in energy politics is the growing role of independent generators. Some private generators, particularly those that rely on renewable energy fuels, continue to serve the public interest. Other large wholesale producers and companies that purchased utility fossil fuel assets, firms such as Duke, Reliant and Dynergy, now exercise the type of market power once commanded by utility monopolies. Clearly, this latter group of power producers may not serve anyone but their own corporate bottom line."