Mr. Chairman and members of the Committee, my
name is Judy Martz and I am Governor of the Big Sky State of
Montana. I appreciate the interest this Committee has shown in
the struggles of Western states to deal with an electricity
crisis.
We are here to discuss "The Role of the Federal Energy
Regulatory Commission Associated with the Restructuring of
Energy Industries." However, the real issue seems to be:
"What went wrong in California and could it happen anywhere
else?"
Let me try to answer this question. The facts show that the
primary responsibility for the electricity crisis in the West
lies with the State of California. A series of mistakes made by
the State, and a failure by the State to take corrective action
once problems first arose more than a year ago, led directly to
this crisis.
This crisis could have been avoided if California had taken
timely action. Instead of acting, the State has unfortunately
engaged in a prolonged exercise of blame shifting.
I don’t say this to be disagreeable. I say this from the
perspective of a State that has been hurt by the California
electricity crisis. I also say this to make sure that other
States do not make the same series of mistakes California made
in recent years.
Montana has been hit hard as a result of the California
electricity crisis. Montana industrials that gambled on
declining future power prices have been hit hard hurt by with
the resulting power prices.
We have seen several closures in Montana, a state whose
economic base cannot afford to lose a single job. But, bWhile
ecause since we are tied into the western grid, any excess
energy is pulled to other states and we face higher rates
ourselves.
Industries that choose to shop for energy found their
traditionally low rates of about $30 per megawatt rise to as
high as $300. Much of the pain that my State and others have
felt could have been avoided if California had not shied away
from taking tough decisions when they were called for last year.
Let’s review how we got where we are today. California was
the first State to open its retail electricity markets to
competition in 1996, with Pennsylvania following quickly on its
heels. The California electricity law is often described as
"deregulation" but it was nothing of the kind.
California did not deregulate electricity markets, but merely
exchanged one set of State regulatory rules for another –
which led to disaster. We did better in Montana.
The 1996 law had a number of unusual elements.
It forced California utilities to divest much of their
electricity generation. It required utilities to rely completely
on volatile spot markets to buy all their power, something no
other State did. It also imposed regulatory rules governing spot
market sales that increased wholesale market prices. It froze
retail rates.
One provision missing from the 1996 law was
reform of the State siting law. California’s siting law is the
most burdensome in the world. It can take up to seven years to
build a power plant in California, and the average period is 4.5
years – nearly twice the average in Texas.
This was a crucial mistake, since California
retained a siting process suitable for long-term planning by
regulated utilities with 10 or 20 year planning horizons, but
completely unsuitable for a competitive market where independent
power producers build virtually all power plants using much
shorter planning horizons.
The failure to address siting reform was a major
mistake. Independent power producers moved quickly to meeting
California’s growing electricity demand, filing applications
to build 14,000 megawatts of new generation beginning in 1997.
Because of the failed State siting process, none of these power
plants are operating yet. Montana did not make the same mistake.
We revised our siting laws to exempt generation facilities.
It is important to note that the supply shortage in
California did not occur overnight. It developed over a
five-year period when electricity demand rose by 6,300
megawatts. Incredibly, over this same period, electric
generating capacity in California actually declined.
As I indicated earlier, California took a big gamble by
forcing its utilities to buy all their power through volatile
spot markets. It took an even bigger gamble not ensuring that
electricity supplies were adequate to meet the needs of
consumers and businesses. It does not take a panel of economists
to know that supply shortages and spot markets are not a good
combination. They produce the sky-high prices that California
and the West have been paying for the past year.
California has had price caps for wholesale power sales since
1998. Last year, California experimented with four different
price caps: a hard cap of $750 per megawatt-hour (under a hard
cap no sale may take place above the capped price), a hard cap
of $500, a hard cap of $250, and a soft cap of $150.
This year, FERC changed tacks, approving price mitigation
that reflects gas costs and other costs. That approach seems to
be working, and FERC earlier this week expanded the scope of its
price mitigation plan.
Price caps exacerbated California’s supply problems last
year. Since the caps did not apply to Western markets in-State
power producers often chose to sell electricity outside
California at price higher than the hard cap. As a result, power
exports from California rose 85 percent and California’s
electricity supply fell by 3,000 megawatts.
By the end of the year, when the hard cap had been lowered to
$250, the price cap was seriously exacerbating California’s
electricity supply problem, since prices in uncapped markets had
risen to more than $400.
Ultimately, California asked to lift the price cap on the
grounds that it was causing serious supply problems. On December
8, 2000, the California ISO filed an emergency petition to waive
the $250 hard cap, which FERC approved. At their request, FERC
set a soft cap.
Price caps last year also did not control high prices. Each
time price caps were lowered, average monthly prices rose. The
experience last year showed that price caps failed to control
high prices, and exacerbated supply problems.
The lesson California apparently drew from the failure of
price caps last year was to expand the scope of price caps to
encompass the entire West, notwithstanding the opposition
expressed by 8 of the 11 governors in the region.
The main cause of the California electricity crisis is a
supply shortage. It is the State’s responsibility, not the
Federal government’s, to license power plants. It has been
clear for a long time the State siting process is broken.
Although it has made cosmetic changes, the State has shied away
from making meaningful reforms to the siting process.
The secondary cause of high prices is the disastrous
regulatory rules imposed on the electricity market by the State.
Unfortunately, the State has simply refused to act in a timely
and effective manner. The California electricity crisis in large
part is the result of inaction over a crucial nine-month period
after the price spikes and supply shortages began in May 2000.
This inaction forfeited the last chance to prevent a crisis.
State rules barred California utilities from recovering
wholesale power costs from retail rates, forcing utilities to
buy power at 30 cents per kilowatt-hour and resell it for 3
cents. It was those rules – imposed by the State of California
– that destroyed the financial health of the utilities and
drove Pacific Gas & Electric (PG&E) into bankruptcy.
If the State had allowed cost recovery, the utilities’
credit would not have been destroyed, PG&E would not have
gone bankrupt, and the State would not be spending its surplus
buying electricity and bailing out the very utilities’ whose
credit it destroyed. The bankruptcy of PG&E could have been
avoided if the State had allowed cost recovery.
Perhaps the most serious mistake made by the State was
forcing the California utilities to rely entirely on the
volatile spot market for all their power, even after wholesale
prices had risen ten-fold. If the Governor had allowed the
utilities to enter into bilateral contracts last year,
electricity prices would be a fraction of what they are now.
Last summer, Duke Energy offered to sell San Diego Gas &
Electric power for $55 per megawatt-hour, a fraction of today’s
cost. However, the California Public Utilities Commission forced
the utilities to continue relying on the spot market. The end
result: instead of paying $55, utilities paid average monthly
prices exceeding $300.
The State only recognized the need for bilateral contracts
after the financial health of the utilities was destroyed, and
the State assumed the burden of buying power for Californians.
Once the State was paying the bills it realized reliance on
volatile spot markets was foolish, and began to enter into
bilateral contracts.
Ironically, the contract prices California has announced –
and much of this remains secret – indicate they agreed to pay
up to three times higher than what Duke Energy offered last
year.
The State’s indecision on raising retail rates was another
major mistake -- one that led to higher rate increases than were
necessary. Last fall, the utilities requested a modest rate
increase. The State refused to consider this proposal, which
directly led to the PG&E bankruptcy. In the end, the State
ended up approving a much larger rate increase than was
necessary if it had acted in a timely and effective manner.
Nine months after the beginning of this crisis, Governor
Davis began to take action. In February, he announced an
emergency plan to build 5,000 megawatts of new generation by
July 1. According to recent reports, only 1,300 megawatts of
plants that were under construction before his announcement will
be available on that date.
Governor Davis announced a conservation plan to lower demand
by 3,000 megawatts. I understand that plan also is falling
short, and may produce less than 1,000 megawatts in demand
savings. The Governor’s plan to restore the financial health
of Southern California Edison appears to be languishing in the
State legislature. I am glad the State is taking this action,
but regret they only acted in response to a crisis, instead of
trying to prevent one.
Threats by the Governor and others to seize power plants and
impose punitive taxes, which we did not ultimately do in
Montana, will discourage what is needed most: investment in new
generation. California has seen at least two power plants put on
hold because of uncertainty about regulatory stability in
California. As one power company put it: "I have more
confidence in regulatory stability in Brazil than I do in
California."
