TCS Daily

Enron's Electric Shock

By Duane D. Freese - June 17, 2002 12:00 AM

Like a bad relative, Enron keeps popping up in the worst places at the worst times.

Even as reform efforts spawned by Enron in accounting and corporate governance languish, reform of the nation's energy markets falters as well. Brash energy traders in an infant industry make an easy target.

The feeling generated by Enron memos released by the Federal Energy Regulatory Commission and from California is that the price spikes in California's energy market in 1999, 2000 and 2001 - where wholesale prices topped $1,000 a megawatt hour (Mwh) compared with average prices of about $20 Mwh this year -- were primarily the result of manipulation by traders rather than actual market conditions in the state.

The documents show energy traders, not only at Enron but others, attempting to game the loopholes in California's partially deregulated system. The traders arbitraged pricing differences between California's market for electricity and those in other states and between the prices set for supplying energy and those for relieving congestion on the state's electrical grid, among many other things.

As one memo called Death Star explained: "Enron gets paid for moving energy to relieve congestion without actually moving any energy or relieving any congestion."

Considering the possibility that California really was paying a lot of money for a lot of nothing, it is little wonder both the state government and federal power suppliers, such as Bonneville, which paid hefty premiums for future power supplies, now are seeking to have their contracts broken. If prices set in them in large part resulted from Enron committing a gigantic market fraud, they argue, why should the victims of the fraud pay?

Only the question of whether there was any actual fraud hasn't been settled. California's Independent Systems Operator that runs its power grid claims, for example, that there actually was congestion in the state's grid warranting payments to suppliers to divert their supplies.

Still, the suspicion of manipulation runs deep, and doesn't end with the Golden State. In Texas, home base to Enron, the public utility commission has fined Enron Power Marketing Inc. for engaging with other companies in overestimating energy demand last August, claiming that caused price spikes in the wholesale electricity market benefiting them.

In its letter to Enron, the Texas PUC put the problem created by Enron's action plainly: "By its actions, EPMI endangered the future of a competitive electricity market that is in its infancy. EPMI's behavior diminished confidence in the market at a time when it was vulnerable and threatened its ability to develop into a mature and workably competitive market."

And Pat Wood, whose oversight of electricity deregulation in Texas led his former governor and current President George W. Bush to appoint him to head FERC, is expressing reservations, too. As Laura Cohn of Business Week noted, the the free-market oriented former head of Texas' PUC abruptly changed course on June 4 by threatening to have FERC set the prices for energy rather than leave them to energy trading markets.

FERC itself as June began threatened to revoke the trading licenses of four energy merchants for not fully cooperating with FERC's investigation into price manipulations.

All of this could grind deregulation of electricity markets to a halt, thus limiting consumer choices and leaving in place an inefficient production, transmission and delivery system for that most necessary of all resources for a high-tech economy. A New York Times survey of state utility commissioners last year found three quarters intended to halt deregulation efforts, and nothing has happened to change that picture.

Luckily, for the moment, the deregulatory pause won't stymie economic recovery.

As Paul Joskow of MIT told a conference on electricity restructuring and competition at the American Enterprise Institute on the same day Wood threatened to impose price controls, there's been a vast increase in investment in new generating capacity since FERC in 1996 finally implemented the Energy Policy Act of 1992. By ordering open and equal access to state and local utilities' transmission lines so all electricity producers, FERC spurred growth in the market between states for wholesale electricity sales, and thus encouraged investment in new generating capacity from non-utilities.

The good news for consumers is that this will bring 55,000 Mega watts of new power into service this year, making it 100,000 Mw added since 1998. While less than 3% of total supply, that increase marks a sharp improvement over the early 1990s when no additional production was brought online despite sharply rising energy usage.

While pundits such as the Sacramento Bee's editorial board caution consumers to "beware of the regulator or politician who preaches the beauty of the energy marketplace as an efficient balancer of supply and demand," consumers in many of the other states where modest deregulation has taken place have been rewarded. Illinois, Pennsylvania, Massachusetts, New York, New Jersey and Texas have all experienced lower retail prices, Joskow noted. Most existing problems, he said, are "caused primarily by transmission congestion" and problems with networks, not supply.

But that generally optimistic short-term view could change quickly. The economic growth of 1999 increased electricity demand that year alone by 88,000 Mw nationwide, according to the Energy Information Administration. And with values of existing energy trading firms plummeting, the question is where will the investment in new generating capacity come to meet future demand? Investors, according to Joskow, are looking for greater certainty on their investments, while the backing away from deregulation by regulators and legislators, and the uncertainty created by the shenanigans of Enron, hardly promote investor confidence.

What could create that certainty, and at the same time prevent the kind of arbitraging in wholesale rates that Enron appears to have engaged in, would be the creation of a truly national wholesale energy market to replace the 50 state power systems, and numerous municipal power systems that now exist.

As Joskow notes, the "let a thousand flowers bloom" approach of letting states lead the way to competitive, efficient electricity markets simply won't work.

Electricity is the same everywhere. And it suffers the same drawbacks everywhere. It is a use it or lose it commodity that can't easily or affordably be stored.

States that individually attempt to match supply to demand must create an oversupply of generating capacity to make sure they have enough electricity at peak times and in case of power plant failures. That is inefficient.

And as California learned, a limited market for trading electricity can bring about huge price spikes - especially when there is no ability to manage demand other than closing off portions of the grid.

States working together, as has occurred in the Northeast, in which most states have committed to some form of electricity restructuring, can do better as they can take advantage of oversupplies in neighboring or nearby states in case of shortfalls.

But nothing is more efficient than a national market, a market in which electricity generators in the West while residents there are still asleep can send power to the East, and generators in the East as its workers go home can send power to the West.

Creating a national market, though, requires a national vision and a national plan to get there. And unfortunately every time Enron pops up in the news, lawmakers and regulators lose their focus on the nation's electricity needs and wallow instead in scandal.

It takes three to five years to bring a generating facility on line, but only a moment to kill financing for one. If leaders don't focus on bringing more power on line soon, Enron's biggest electric shock will be when we are all left in the dark.



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