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Jeffrey Skilling
Chief Executive Officer, Enron Corporation
Consumers in California are angry, and they should be - prices shouldn't be what they are in California for a number of reasons. I think you'll still be angry when I'm finished, but I hope that you'll have a better idea about what to be angry about. I'm angry about it as well. Electricity markets are an important part of what's going on in California and they are not functioning the way they should.
Electricity is one of the most unusual commodities on the world because you can't store it; imbalances of supply and demand are very hard to fix in the short term.
Over two or three years, imbalances can easily be cleared by building new facilities or reducing demand. Amory Lovins is an articulate spokesman for ways to conserve electricity. They can be done cost effectively and quickly, but they can't happen over night.
In the short term, prices are very volatile because of that. But this is not unusual. In Ohio, in the summer of 1998, electricity prices ran along typical, historic relationships when supply is in excess of demand: around $15-20 a million megawatt hours. But because it got very hot in Ohio, and because there was an imbalance of supply and demand - prices shot through the roof, going up to over $2,000 a megawatt hour. It was the same story in 1999.
Every single wholesale market for electricity that's deregulated has experienced high volatility. The same phenomenon happened in New South Wales in Australia: high prices followed by a correction. Price spikes led to significant increases in supplies - new power plants - and to declines in demand. Things start tailing off, and prices stay low.
The price spikes of 1998 and 1999 drew on new capacity, and prices today in Ohio are under $20 a megawatt hour, from once being $7,000.
So there are two different markets. The short-term market for electricity is highly volatile; it's the nature of the commodity. The long-term market for electricity is, in fact, a typical commodity market, where supply and demand clear at reasonable prices if you have a market in place. This is natural. Why are we having so many problems in California? Ohio didn't melt down like California melted down. What's different about California is that there was a marketplace that was not designed by the marketplace, but by regulators in California.
In 1994 and 1995, when they were designing the marketplace for power, there was the supposed deregulation of a lot of electricity prices in California. The CPUC (California Public Utilities Commission) put forth a model for that marketplace that was originally called POOLCO - a state-mandated, monopoly marketplace for day-ahead power. To add nitroglycerin to a bad idea, they mandated three other factors as part of the supposed deregulation of the power markets.
First, they required that all purchases of power by California utilities be conducted on this volatile, day-ahead market. Second, they prohibited any term contracting or hedging of those prices in the long-term market. And third, they mandated that utilities had to devast the vast majority of their generating assets to doubly insure that there were no term contracts that were associated with these longer term, lower prices for power. Because of these rules, the power consumers in the state of California were thrown to the mercy of the spot market.
On a chart showing actual power prices in California, the blue line reflects very high volatility, very high prices. The red line is the forward market. If you wanted a contract for power in the year 2004, 2005 that little red line reflects the prices at which you could contract for that power. Prices are very low in the future and probably reflect natural supply and demand intersections in the marketplace.
That's the marketplace that every other utility in the world conducts business on. They don't conduct business in the spot market. This is not coming to other parts of the country. This is a unique feature of the structure of the marketplace that was setup in the state of California. The percentage of power that PG&E and SoCal Edison had under some form of term contracting mechanism - either ownership of the facilities or term contract for power - is only about 40%. So 60% of the power was at the whim of the very volatile spot market, where a significant portion of supplies were contracted for under term contracts, to dampen out some of that volatility.
Why was this the structure of the marketplace? I came to California in 1994-1995, testifying in front of the CPUC, and the terms I used were, "This is ludicrous." That this was setting the state up for high and capricious prices. It's in the testimony; we told everybody that. We operate in these markets, we know how they operate. We know about the volatility.
It was done in the name of regulatory efficiency. If all transactions were forced into a single monopoly marketplace, it would be simpler for the regulators to monitor utility purchases. There would be no confusion about having to compare term structures of contracts, or locational differentials, nor would there be any confusion about various contractual terms and conditions being compared for regulatory passthrough.
They created a flawed marketplace in the name of regulatory expediency. It is fundamentally a different marketplace for electricity than anywhere else in the world: period. The only other marketplace that was even close was the UK's, but they have completely restructured theirs in the last six months to focus more on term purchases in the marketplace.
Price spikes happen; that's the nature of the beast. But when they happen in California, under this type of a structure, the outcome is calamitous. When spot prices went up to $7,500 in Ohio, less than 2% of the consumers needs were purchased in that market. The high spot price was a non-event, except for power suppliers who rushed into the market to build new generation. Within two years those price spikes were gone. In California, on the other hand, virtually every electron was purchased in this volatile spot market. When spot market prices rose, the price for every electron went up, which is problem we've got in California today. I agree - it is a catastrophe. Californians who paid about 7 billion dollars for power in 1999 may pay about 50 billion or more in the year 2001.
The governor has declared a state of emergency. One utility is bankrupt. Another is teetering on the edge of bankruptcy. It's logical to want to blame somebody; you didn't ask for higher prices, blackouts or bankrupt utilities. It wasn't the consumers' fault and it is not the governor's fault; he was dealt a very difficult hand. The governor could have done some things sooner and faster to help respond to it, but I don't blame him for the fundamental problem. The fundamental problem was built into the system by the regulators in the mid-1990's. It also is the generators and power marketers' fault, though politicians would have you believe that out-of-state power companies are also to blame.
We're from Texas - we're evil. Only 13% of the power consumed in California is generated by Texas companies. The vast majority of dollars being paid for high power prices are going to state-owned generation companies - municipal generation companies in California or in contiguous states. You'll see it [in a report out] tomorrow.
We testified and pointed out the problems, but the regulators pushed forward with the market structure that is now in place. The irony of this is that California is now turning to the regulators to solve the problem. The market is messed up, and now we're going to trust them to fix it?
This isn't the first time the regulators have screwed up. They decided to change the marketplace in 1995 and 1996 as they had so thoroughly messed up the marketplace prior to that. In 1995 California was saddled with the highest power prices in the nation; it was the proud owner of the incredibly expensive and dangerous White Elephant Nuclear Power Plants, and had a stranded cost base of over $10-12 billion. All of that was in the interest of supposedly just and reasonable prices.
If you had an open, competitive market place without restrictions I guarantee you the prices to consumers in California would have been significantly lower and will be significantly lower in the future. But let's get past the blame. What can be done to fix the problem?
We've got to get the State of California out of the power buying business. We're just creating another problem for ourselves in the future. If you look at what's happened already, a lot of power contracts have been let. Those power contracts are already well out of the money because prices are coming down. As new supplies come online, as demand is reduced, as prices go up. You have to increase supply in the State of California. There is enormous opportunity for demand decreases and cost, but you're also going to need some additional supply.
You're not going to encourage companies to come to the state and invest in generation if you threaten them with seizures of plants and criminal investigations for how you're running the plants. You'll probably drive investment out of the state.
To decrease demand California must get prices right so that consumers - especially big consumers - have financial incentives to save. A simple thing like real-time pricing would make a big difference. If people saw the difference in price between 3 o'clock or 4 o'clock in the afternoon compared to 3 o'clock or 4 o'clock in the middle of the night, you'd see big shifts of demand. More efficient timing would fit better with the generation resources within the state. Give price signals to the consumers because they will respond. Give them the incentives to conserve.
A solution must be made to the credit worthiness problems of the big utilities. You want to get the utilities back in the business - they're the professionals, they know how to run this business, we've got to fix PG&E, we've got to fix SoCal Edison.
California needs to get deregulation right as does the rest of the country. Structure markets in the way that markets can operate. Give the markets the chance to have effect and the markets will have an effect, because markets are powerful and they work. Markets do respond.
People say that Enron is making a ton of money - that this is a great thing for Enron. I started building this business back in the late 1980s. We built a business from scratch by providing value to our customers. They don't have to come to us: we don't have a monopoly.
Our stock price is half of where it was seven or eight months ago. This thing in California has been bad for everyone. If we had anything to do with this then we are the stupidest people in the world. I'd give anything to turn back the clock and get the marketplace right.
