TCS Daily

Reliant Energy's Perkins Sees Supply and Demand as Best Laws for Weathering Californias Energy Crisis

By James K. Glassman - June 11, 2001 12:00 AM

Posted June 20, 2001

Reliant Energy's Perkins Sees Supply and Demand as Best Laws for Weathering California's Energy Crisis

Life on the edge of darkness in California has led the state's highest officials to lash out at the very companies stretching to keep power flowing. Reliant Energy Inc. of Houston has been one such target. Although it enjoys just about 5% of the Golden State's supply of electric power, Reliant drew attention last month with one price quote approaching $2,000 per megawatt-hour.

But, as Reliant Energy Wholesale Group President and Chief Operating Officer Joe Bob Perkins recently told Tech Central Station Host James K. Glassman in an interview, the jaw-dropping price applied to a very limited supply and was an "economic signal to save that [supply] for the most critical times."

Adjustments have since been made, and earlier this week the Federal Energy Regulatory Commission enlarged its role in Western U.S. wholesale power markets. Perkins, though, cautions, "There is no silver bullet, and those people that are looking for a single silver bullet to solve the problem are going to be quite frustrated."

James K. Glassman: Your company has attracted a lot of headlines for charging up to $1,900 for a megawatt hour of power and that's certainly a natural for the news. But what's the story behind that?

Joe Bob Perkins: Well, and it's an old story, Jim, but let me explain what happened there and explain the steps we've taken since then. The $1,900 per megawatt-hour was for a very small emergency unit. We compared that unit to an emergency canteen to be used in a trek across the desert. We're not yet in the hot summer trek across the desert, but the ISO [Independent System Operator] called on that canteen. Now the people we were working with, over a period of time, knew that that $1,900 price was a warning on the canteen that said, "Don't use except in dire need." That was the economic signal to save that for the most critical times. At the same time, with all of the discussion that occurred around that bid, when it was taken probably prematurely, we have voluntarily reduced our price in the hope that the local air quality boards and the Governor's office efforts will remove restrictions from this limited-run hour unit and make it available during emergencies. Otherwise, it can only run eight or nine days a year, and it's only got four or five days left. And we haven't even got to summer.

Glassman: Many people think that the actual supplier of power is the same company that sends them their monthly bills. Could you just explain your company's niche in the power marketplace?

Perkins: Reliant Energy entered the California wholesale market in 1998 when that wholesale market was deregulated. We sell power to retail companies that then provide the power and bill to a residential customer.

Since we entered that market in 1998, we've been very focused on trying to make that market work, but we're just a wholesale participant. Up to this point in time, the primary retail participants have been the local utilities, to whom we had previously sold much of our power. They are the ones who provide the bill that you were asking about to the consumers.

Reliant`s Role In The California Market

Glassman: Now where do you get your power?

Perkins: We produce it from generating facilities that we purchased. We have five plants in California, 3,800 megawatts. Megawatts are the units that describe the amount of electricity that can be generated. We're only about five percent of the market in California. That's how that 3,800 megawatts translates. So in many ways, we're a small player. But we're a small player that's focused on trying to provide solutions for the people in California on the supply side as well as on the demand side. On the supply side, we've set records for output from these 30- to 50-year old plants that we acquired, running them in 2000, two and a half times more than the historical average prior to our acquisition. We've also offered a large portion of our capacity at what everybody would view as a very low price, two cents per kilowatt-hour for a five-year contract where the purchaser of that capacity would supply the natural gas. What that price highlights is that if you exclude fuel, our prices are still quite low.

On the demand side, we have worked across all of the Western states and with federal officials to try to create an effective voluntary load curtailment program for the benefit of consumers all across the Western United States. It's really not to our benefit. That is an effort that's still ongoing, and I hope we'll see results soon.

Glassman: Now do you sell power to other states?

Perkins: Yes we do.

Glassman: From California?

Perkins: On occasion, but what I was really referring to, is we have portfolios of plants in many other regions of the United States.

Glassman: Now you talked about voluntary load curtailment program, but in fact you really put a high premium on price signals for curtailing or increasing the use of power, right?

Perkins: We are big proponents of an open and free market as the best way to affect both supply and demand. Having the correct price signals tells people when to build plants and maintain them and keep them running. And it also tells customers when to reduce load or change the time of day that they might be using it. That is the best way of improving a supply-demand problem, and that's what we have in California is a supply-demand problem.

Previous FERC Involvement Discouraged Supply

Glassman: And that's why you filed an emergency motion with FERC -- which is the federal regulatory agency here -- to halt the price caps that recently took effect?

Perkins: Yes, the April 29th order was an order that imposed what are very stringent cost-based price caps on the market during emergency periods of time. We've filed for them to drop, or at the very least, at least amend them to avoid sending even more confusing signals to the market. The order, as it currently exists, creates misleading signals, it depletes power from peaking plants. It eliminates price signals for retail customers and most importantly, it discourages supply from coming from out-of-state generators.

Glassman: So, what is FERC's overall approach, aside from these price caps?

Perkins: FERC has been very actively involved in trying to regulate the wholesale market, which is their role. They've been unable to effect the changes in the retail market that need to occur to help fix the problem in California. That's a California PUC [Public Utility Commission] responsibility. But since 1998, I've heard charges that FERC has been ignoring this, they have implemented five cost-control price cap orders. In fact, the California market has been under price caps since the summer of 1998 in one form or another, all the way to the present.

"[T]hose people that are looking for a single silver bullet to solve the problem are going to be quite frustrated."

Glassman: So how do you see the situation resolving itself? What is the answer in California?

Perkins: There is no silver bullet, and those people that are looking for a single silver bullet to solve the problem are going to be quite frustrated. It is a supply and demand problem, and what we have to do is take an open and free-market approach to solving both supply -- building new generation in the state. That's desperately needed. Getting the most out of those plants that are already there. And there's reducing demand, sending economic signals that cause economically based conservation. Over the last five years, robust economic growth in California has caused energy demand to increase 28% or 29%. During that same period of time there was not a single bit of supply added to the market. In fact, there was a slight reduction in the overall amount of supply, due to plant de-ratings. That decrease in the supply-demand balance meant that California was a very fragile, large net importer, importing 25% to 30% of its energy. What it was importing was primarily excess hydro from other Western states.

Glassman: Because of drought?

Perkins: Because of drought, lack of snowfall, and record low hydro levels behind dams in all of these Western states and Canada. When that dried up there wasn't excess to be imported into California; California was in a very tight supply-demand situation and had to pay higher prices for its power. That situation was compounded by a huge increase in natural gas prices over the same period of time.

Glassman: Now could it be argued that the state is holding its residents' power supply hostage to environmental regulations?

Perkins: I think that during this period of intense supply-demand imbalance, that the environmental regulations could be eased in the near term to allow supply to catch up to demand.

California`s Choices

Glassman: And how would that be done?

Perkins: Those are California choices. There have been studies that show that if those choices were made, you could still end up with a cleaner environment by bringing in more clean, state-of-the-art, gas-fired generation, building it quickly, and replacing some of the older, less efficient higher emissions units.

Glassman: So a small spike in pollution would be temporary, and then new plants would be built?

Perkins: Exactly. This would involve letting those that are already on the ground and have been restricted to only eight or nine days running time -- for example -- let them run more often and during emergency stages. They're already there. Their reduced amount of run hours allowed has been part of the plan to reduce overall emissions. But these are tradeoffs that Californians will have to think about. We will comply with whatever regulations are there, but we do encourage trying to avoid blackouts and the high economic cost associated with those.

Glassman: Now you say that you will comply with whatever regulations are there, but what do you see happening if the state imposes a windfall profits tax or takes over the generation itself, or both?

Perkins: I'm glad you asked that question, Jim. We're very concerned about the business environment being created in California, because we have to add supply in California. The discussion of windfall profits taxes, plant seizures, state control of plant operations, the ability to only recover costs or do worse can chill the investment in supply that is so needed in California, to help the California consumers. That investment occurs from companies like Reliant, but any of those companies are subject to the oversight of an independent board of directors who will sit there and ask the question, "Is this the best place for us to be investing limited capital? And what are the risks?"

Glassman: And Reliant has, how many plants do you have around the country?

Perkins: We have over 20 plants around the country in unregulated markets. The California portfolio -- five plants and 3,800 megawatts -- is about one-third of our overall portfolio. We also have large portfolios in the Pennsylvania, New Jersey, Maryland area, and a pretty significant portfolio in the Florida area, as well as smaller plants located in the mid-continent.

"California, as some people have put it, partially deregulated. It deregulated to wholesale but did not align and create an effective retail deregulation."

Glassman: Now you say these are unregulated areas, and, of course, some people would say what California has done is deregulation. What's the difference between operating in, say, Pennsylvania and in California?

Perkins: California, as some people have put it, partially deregulated. It deregulated to wholesale but did not align and create an effective retail deregulation. There were flaws in its overall market structure. The primary flaw I'd like to point out is this over-reliance on a spot market, number one. And the failure to align retail rates with wholesale rates, number two. When we look at successful deregulated models, we can point to the Pennsylvania area. We can even point to Texas where our markets deregulate January 1, 2002. But we have already encouraged significant new generation to be built in 2000 and 2001. If California had built either one of those years worth of generation that Texas had, it wouldn't be in a supply shortage now.

Glassman: You bring up the issue of the spot market, the California plan did not allow the utility companies to purchase power on a long-term basis, As far as you're concerned as a power supplier, would you rather sell on a long-term basis? What is the market like on a long-term versus short-term basis?

Perkins: In the summer of 1998, just months after we had acquired our first plants, we were arguing for allowing the utilities to purchase energy in capacity under long-term contracts. We support that and supported it publicly in front of the ISO. That's the way markets should work.

Our efforts, along with other people's efforts to try to make a more sustainable market structure, were ignored. It's unfortunate. If you compare it with the Pennsylvania market, for example, less than 15% of the power is transacting in that just-in-time, today or tomorrow market. In California, almost all of it, 85%, was transacting in the just-in-time, today or tomorrow market. That creates higher price volatility. Term contracts smooth that volatility and create price stability. Now lately, the Governor and the California Department of Water Resources have been trying to "term up" [solidify] contracts. That is a good thing for the overall market stability. We should not confuse term contracts, though, with changing the supply-demand situation. The supply-demand situation is still critical.

"Many of the actions that need to be taken need to be taken by California."

Glassman: Let me just ask you, actually, two more questions. Is there any positive role that the federal government can play here?

Perkins: The federal government has been playing a role from the FERC side as the appropriate wholesale regulator. I know that legislators are looking at how they can facilitate things like improved environmental legislation consistent with California's wishes. The FERC can help by encouraging this load reduction program that I was describing. Many of the actions that need to be taken need to be taken by California. There's also an important role for a Regional Transmission Organization. California is not an isolated market; it's part of the overall Western market.

And it's California's independent system operator that has, in fact, taken on some protectionist rules that make the market in the West less efficient. If other Western states retaliated, we would have a much worse situation.

Glassman: As far as the situation is concerned, what is the range of blackout scenarios that are being forecast for this summer, and how could the state's actions affect them?

Perkins: I have read published reports estimating the amount of blackouts this summer, beginning in the hundreds of hours and going to multiple hundreds of hours. The biggest uncertainties will be weather and the amount of precipitation. The actions that can be taken from this point forward to affect supply and demand are really very limited. We can't do much at all to increase the amount of supply. We can take actions today to affect demand. The conservation programs that Californians are trying to do right now, without even getting economic signals, are to be applauded. And more aggressive economically led load reduction efforts are necessary in California and across the West to help the situation.

Glassman: But isn't the best way to affect demand through price signals?

Perkins: Absolutely, that's why I said economically focused load reduction. We're starting to see an increase in retail rates. Most residential consumers will feel that but as many as 40% won't see that. They're just now getting those bills. There have been studies saying that you have to get bills for a couple of months at higher prices before you're taking positive action. We believe that price signals -- in an open and free market sending signals to both supply and demand -- are the most effective way to solve supply and demand issues. When you distort those price signals, you get people to act in the wrong way. The price caps, for example, are sending price signals that are even below the cost of generation -- some generators -- and what California will be paying for that energy. That will send a signal to a generator outside of California that maybe it shouldn't work hard to keep that plant up or take on risk to be able to sell electricity to California. That's reducing the amount of available imports.

Glassman: Well I really appreciate your time, Mr. Perkins. This really provides our viewers with the kind of information they need.

Perkins: Thank you, Jim. We welcome the opportunity to try to get to a dialogue of solutions -- solutions for supply and solutions for demand.

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