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Fred Keeley
Speaker Pro-Tem, California State Assembly (D-27th District)
Many, many years ago, when the federal government decided that deregulation of virtually every regulated part of our economy was virtuous in and of itself – whether that was airlines, trucking or phones or electricity – that there was an inherent value and virtue in the notion of deregulation and restructuring of industries, in the case of electricity, California was a willing partner.
At the time the governor, and at least one house of the legislature, was willing to believe that was in and of itself a value worth pursuing. In the mid-1990s, California paid about 20 percent more at the retail level for electricity than most of the rest of the country.
So the argument was: If we deregulate and restructure the electricity industry in California, and inject into it genuine competition, what will result is a drop in prices at the retail level.
The basic idea was to take investor-owned utilities and say, "PG&E, you no longer get a monopoly in your service area. However, the government will no longer regulate many of your activities. Other folks will come in and compete in your service area for your customers, and that competition will drive down the cost of electricity and the pricing of it at the retail level."
Before I got to the legislature, the governor and the legislature passed Assembly Bill 1890. They said, "We will move from the regulated monopoly to this unregulated environment, but there needs to be a transition." You can't do it overnight because these utilities have been promised, through actions at the Public Utilities Commission, that investments that they made in everything from power plants to pick-up trucks would be guaranteed a rate of return for that investment, and the ability to amortize over many, many years. That was embedded in the rate structure.
So if the state wants to say, "We're going to stop doing business that way and start doing it a new way, where they are no longer regulated but there is real competition," then somehow the utilities need to get paid for that contract that they entered into with the state. That's the concept of stranded costs.
The state said, "We will sell bonds to finance, and get those stranded costs on the other side of the line so that you can move to real competition." As the state and the utilities started moving through that process, the Public Utilities Commission said, in order to get actual competition, "We're also going to have the utilities sell off at least half of their generation assets."
That was where the first really serious error took place. The California Public Utilities Commission did not require the utility to have a deal with the buyer to sell the electricity back on a long-term, fixed-cost contract at low rates.
When that happens in enough instances, the utility is then in the position of having to buy power from the plant that it used to own. It used to cost them a penny or so to generate that electricity, and they used to get about 3.5 cents. Now, that same product costs them 30, 40, 50 cents a kilowatt-hour to buy from the same power plant that they used to own.
Think of the amount of power we use in the state of California as a pie. About a third of that pie is generation that is still owned to this day by the utilities. In PG&E's case, they own hydroelectric facilities and a couple of gas-fired generation facilities, one in Hunter's Point, one in Humboldt.
Another third of the power comes from what are called "qualified facility contracts," a vestige of the oil crisis back in the 1970s and 1980s when the federal government said it would be a good idea to lessen our dependence on foreign oil: one of the ways to do that is to encourage renewable sources of energy.
So there is a requirement that a qualified facility – a wind, a solar, a biomass, or co-generation facility that qualifies – the utility is required to buy their electricity.
It's that other third that began to break the backs of the utilities financially. That is the third of the utility pie that they used to own, in terms of generation, that they sold off, and are now out there buying in the wholesale market.
Things weren't always so bad. There was a period of time between 1996, when the deregulation and restructuring law went into place, and about the year 2000, when things went upside down.
How did it go from something that worked pretty well, even at the front end of deregulation, to the point where it didn't go so well at all? Not having those power-purchase agreements was the first problem.
The second problem is that the federal government decided to deregulate natural gas. Natural gas is the fuel for almost half of all the energy that we use in California. As natural gas prices began to spike, the price of electricity accordingly went up – that is, the cost of electricity for those that have to buy it on the wholesale market.
We haven't experienced in Northern California the real brunt of what's going on in electricity. When you open up your utility bill, and you practically faint, almost all of that is on the "G" side of PG&E: It's on the gas side, which is unregulated. What you are reading in the paper is all about the electricity crisis, and what you are experiencing in your bill is the crisis in natural gas.
The reason we don't experience the problem in electricity yet, from a pricing point of view at the retail level, is because in 1996, when we refinanced the utilities' deal with the Public Utilities Commission; we also financed a 10 percent rate reduction and froze rates at the retail level that were 10 percent below what they started at in 1996. That has insulated us from the actual real-life experience of the procurement cost of buying electricity.
In San Diego last summer, they got to experience the free market in real time. Southern California Edison was able to pay off the stranded costs and lift the price cap, and prices went up 300 percent.
The promise in 1996 was if you deregulate and restructure, prices will go down on average 20 percent, and in the real world they went up 300 percent. Businesses closed that will never open again. There was a level of public concern that verged on anarchy.
We tried to solve that problem by giving every rate payer in San Diego a credit card, in essence, to finance that experience, and we're going to have to figure out how to solve it in real terms as we move along. What's happening in Northern California and throughout the state today is that the utilities were buying a product, a third of their power, in the unregulated wholesale market at 30, 40, 50 cents a kilowatt-hour, and selling it to you and me in the PG&E service area for 6.7 cents a kilowatt-hour, and they were eating the difference.
They incurred billions of dollars in debt. There is more than one side to that story, because at the front end of this, when things were working well, the utilities were making billions of dollars off this deal. In 1996, 1997, 1998, gas prices hadn't spiked, they hadn't sold off all their generation facilities, and things were working well. As they sold them off and gas prices went up, they turned upside down.
What did they do when things were going well? They took most of the moneyup to the parent company, and they then engaged in buying power plants in other states. Just as Duke Energy used to be a company in the Carolinas, now PG&E is a company back East. Just as Florida Power & Light used to be there and is now here, Southern California Edison is back East and in foreign countries, buying power plants.
These folks are competitors with each other, and one of the reasons prices have gone up so much is because the people that our local California-based, investor-owned utilities are going to have to compete with in the next 10 - 50 years are Duke, Enron, Dynegy, and Southern and Williams – are the companies right now that PG&E and Edison and Sempra have to buy from.
In essence, they've got them where they want them. Those companies have got the regulated utilities buying in an unregulated wholesale market and selling in a regulated retail market. That's the fiscal reality of what is going on.
Faced with that, the utilities have said, "We're on the verge of going bankrupt, we don't see how we can make this thing work, and we need the state to help us out." The initial response from the legislature was, "We don't remember you being in here when you were making billions of dollars, asking us how it is you can share that with the ratepayers. But now that you are losing billions of dollars, you want to come in here and ask how to share the pain with the ratepayers."
It's a classic example of what happens in Sacramento: privatize the profits, socialize the problems. In that mode of socializing the problem, they are in front of us asking for help. Now the first reaction is, "Help thyself, parent companies; help the children companies that are your regulated utility.
Take some of those billions of dollars and send it back down." You know what they've said? "No, we're not going to do that." And, in fine two-year-old fashion, "You can't make us." And they're right; we cannot make them do that. There is no legal mechanism to make them do that. So take it off the table, and we all have to get over it.
But what we are left with is the fact that these utilities may go bankrupt. Some people say, "So what?" Here is the answer: If they go bankrupt, a federal bankruptcy judge and a federal bankruptcy trustee and a federal bankruptcy court – a creditors committee – is in charge of solving this problem. They have only one task, and that is to take care of the creditors. They cannot under federal law concern themselves with the consumers and the ratepayers. They have to concern themselves solely with the creditors; that is a very bad place for all of us to be, and to try to hope that things are going to work out well for us. So we have an interest in resolving this issue outside of the bankruptcy venue.
Next issue: The governor has said, "Thou shalt solve this problem without raising rates. So if you send me a bill that raises rates to solve the problem, I'll veto it." What we are going through now is an exercise of putting ourselves in the strangest public policy contortions imaginable to create the fiction that we can solve this without a rate increase. I will tell you, sort of like Walter Mondale did at the convention in 1984 – and you know what happened to him, and it will probably happen to me: There is a rate increase in your future to solve this problem.
Now, having said that, what can we do to make it as small as possible? To believe that you can solve this within the context of the existing rates is to believe in the energy fairy: It just can't happen. Here's why it can't happen: the existing rates support native generation, qualified facility contracts, and buying power on the wholesale market.
In the new world order, we are going to ask them to support native generation, qualified facility contracts, purchasing power on the wholesale market, resolving the debt of the utilities, and buying some assets from the utilities. We're going to take something that used to support three big burdens and carry five big burdens; it can't be done.
Now, we can minimize it, and the way we will minimize it is we will stretch out solving this problem over time. It will be done in terms of long-term financing. Let me go through the architecture of where we are trying to go. First, stop the bleeding of the utilities; it doesn't matter if you like them or not, what has to happen to get this under control financially is to stop the bleeding.
That's why we passed Assembly Bill 1X and said that the one-third of the power that the utilities were out there trying to buy on the spot market – because they couldn't enter into long-term contracts, because they had lost all their credit worthiness and no one would sell them electricity at any price – instead, on a long-term basis, the state, as a credit-worthy entity, will engage in long-term contracts.
That's the first part, which will drive down the cost of the overall product, and we will stretch that out over time by issuing revenue bonds to solve that problem.
Part two, we will take the second third of the power equation, which is the qualified facility contracts, which used to be fairly affordable, and have now risen to about 15, 16, 17 cents a kilowatt-hour; we're driving that down through negotiations with the 650 qualified facility contractors and the three public utilities throughout the state. We have a bill to take that 17 cents a kilowatt-hour and squeeze enough cost out of that to get it down around 8 or 9 cents a kilowatt-hour.
Next, the governor, principally, is in negotiations with the utilities to agree on what is their actual debt. That has been a long and healthy and vigorous debate, because they say it's one thing and we say it's another. They say it's higher, we say it's lower, as you might imagine. Once we fix that, we will then know what we're trying to solve. In order to solve that debt problem we'll do two things: one, buy an asset from them.
The flavor of the week right now is the transmission system. I don't think that's the best asset we can acquire; the best asset we can acquire is the hydroelectric system, for a wide variety of reasons, and I will lose that battle.
Who will win that battle are advocates of buying the transmission system. The transmission system will be purchased; they will use the difference between the sale price and the book value and apply that towards their debt – that will still leave several billion dollars. That several billion dollars in debt will be retired, authorizing them to issue corporate bonds, and create something called a dedicated rate component within your rates to pay off those corporate bonds.
Those two things together will solve their debt. We will try to make as long an experience as possible so that in any given day or kilowatt-hour or monthly bill it is as small as possible. But I don't believe that you can get all of that done without raising rates in the PG&E service area and the Southern California Edison service area and the Sempra service area.
Once we get through that, all we have done is solve the financial problem, because what we are experiencing this winter is a financial problem. What we're going to experience this summer is a real supply and demand problem. The way you know the difference is that every time we put money on the table, the blackouts stop. That's how you know it's a financial problem.
This summer we're going to have, if we don't do some really good, smart things in the next 102 days, a supply and demand gap that won't be able to be solved no matter how much you are willing to pay for electricity. It won't matter how much money you put on the table; you can't fill it because it simply isn't available. Why is that? In part, it's because we've grown at five or six hundred-thousand people a year in the state of California; it's in part because of the change of usage patterns, regarding each of us as individuals and about our culture in California in general.
Even though we are one of the lowest in per-capita use of electricity, there are so many of us, and that number continues to grow. That places a great burden on the system. And the system has not grown much.
Contrary to some belief, the supply-side has grown somewhat, but the demand-side has far outstripped the growth in supply. So we do have to increase supply. The best thing we can do this summer – the fastest, most effective, least cost per kilowatt-hour thing we can do – is decrease the demand side.
I don't think we should ask people to swelter during the summer and freeze during the winter in order to solve this problem, because the only people who didn't ask for deregulation are consumers.
The people who wanted deregulation were the utilities, the large utility users, the generators of electricity; it was a whole range of people, but it was not the residential user, and most commercial users didn't ask for it.
So we can't say you are going to have to suffer to do this, but what we should do instead is have a very thoughtful, targeted program of decreasing demand through capital outlay in a wide variety of ways, and increase supply quickly but not by sacrificing environmental quality in the process.
There is a myth that the reason we haven't added supply in sufficient quantity in California is because of all those doggone environmental regulations. Now, I am an unapologetic environmentalist, which is why I get my hackles up when that argument is made. It is made in every economic crisis the state of California faces.
Almost inevitably two things happen when there is an economic crisis: We find a group of people – last time it was Latinos to blame for it – and we try to blame environmental regulations.
This time, fortunately, we are not blaming individual groups of people for it, and instead, some people are trying to blame environmental regulations. It simply isn't borne out by any facts. Environmental regulations in California have nothing to do with the lack of growth and supply. The utilities fought every effort to add supply in the state of California at the time that they didn't want the competition.
Secondly, there are only two things you need to build a power plant: You need a fuel supply contract, and a power-purchase agreement with somebody to buy the power once you do it. You get those two things; you can build a power plant.
If you go to the California Energy Commission and ask them to look at their last ten years' worth of records of applications, what you find out is that largely the reason power plants didn't move forward – some did, and some have been brought online – is because of business decisions: competition fighting them, couldn't get the power contract, couldn't get the fuel contract, couldn't sell the contract on a long-term basis.
What we need to fix this thing, not only for the summer but for the long-term, is to add more supply in California. But don't think of that as saying, "That means we're going to have a Moss Landing Power Plant on every corner." We are much wiser than that as people. What we can do is distributed generation.
Every time there is a critical mass of commercial development that goes in place, distributed generation can be done at that site. With Mr. Simitian's help, and others in the Assembly and in the Senate, and with the governor, we are taking and tearing down the barriers that used to exist in the old world order of investor-owned monopoly utilities who fought every effort for people to get off the grid.
Now that we the people of the State of California buy one-third of the power out in the wholesale market, we're tearing down every barrier imaginable so that we can get people off the grid. Get distributed generation; get photovoltaic on every roof we possibly can.
Here's how you know it's going to work: One-third of the power in the state of California currently comes from those sources. It comes from those sources in a way that they have had to fight and scrape and battle every twist and turn all the time to make it happen. Our future is in that direction.
If we can do things by way of capital outlay to increase the efficiency of public buildings, public schools, private residences and commercial establishments, and we're thoughtful and careful about our own individual use of electricity, we will get through this summer.
If we use distributed generation and PV and others to get through this summer, and use that as the model to build on a much longer, much more comprehensive way of getting over the next 18 to 36 months to bring the supply and demand into balance, we're going to turn out just fine.
