Energy Issue For Emphasis

 

Interview with Severin Borenstein

On May 20, 2002, the League of Women Voters California Energy Committee interviewed Severin Borenstein, Director of the University of California Energy Institute. The objective of the interview was to get Mr. Borenstein's view on the California energy crisis, and his vision for the future. Below are selected excerpts from that interview.

Question: What do you see as the cause of the Energy Crisis?

Borenstein: "The paper I suggested to you, the 'The Trouble with Electricity Markets,' goes through the problems you run into when you try to run an electricity market where the demand doesn't respond when prices go up. You have demand that is completely fixed - the only thing that drives demand is weather, not prices, or the market interaction. And [you have] supply that at low levels is just fine, but when you start getting hot days gets very tight. As a result, supply and demand can easily get out of balance. Even if nobody was trying to drive prices up, the natural competitive structure of the market would cause price spikes . . .

"And then there's a second problem which people also didn't seem to foresee which is not only do prices go up just because the market gets tight, but it also puts sellers in a stronger position to . . . exercise market power. That is, drive prices further up by either withholding power from the market, or threatening to withhold it. And threatening is done in this case by bidding the power in at very high prices and saying, 'we'll sell it, but only if the price goes to a certain level.'

"The combination of those two effects causes prices to get very high when the market gets tight. In the summer of 2000 the market got very tight, and it was tight during more hours than in previous years and that both naturally drove up prices, due to the natural competitive interaction, and it put sellers in a stronger position to exercise market power. . . . .

"So a solution to the problem that California missed . . . . was to have long term contracts so the utilities were not as vulnerable to the spot price fluctuations . . .

"The other big mistake that has been made, and continues to be made, is the way we price electricity to final consumers. We charge the same price all the time whether it's a hot summer afternoon, or the middle of the night. Even with industrial and commercial consumers, we charge prices that only vary essentially peak and off-peak. So they can't tell the difference between a hot summer afternoon and a mild summer afternoon, and the prices can be 10 times higher on a hot summer afternoon. So we've set up a pricing system that doesn't give people incentives to conserve when we really need them to conserve.

"What we've done instead for 75 years is we've set a price that's the same all the time and then we've just built so much capacity to make sure that we can meet the peak demands. [We did that] instead of saying, 'Well, at peak times prices are going to go up. [Raising prices at peak times] isn't going to cause people to turn off their air conditioner. But it might cause people (we're talking about industrial and commercial customers), to change their air conditioning setting from 70 degrees to 72 degrees, or 74 degrees, which has a huge effect on the demand of the system.' If we did that we'd have to build far fewer power plants."

Question: With real-time pricing you need two way communication with prices indicated to the customer and the usage indicated back. What triggers the customer to reduce usage?

Borenstein: "This is what computers are for. We're not talking about putting this in your house, we're talking about putting this in commercial buildings. All the technology exists. These meters exist, . . . [and] what's been used so far is a telephone line . . . Now all that does is read the price every 10 or 15 minutes and when the price goes above $200 a MWh, 20 cents a kWh, it automatically sets the air-conditioner up a couple degrees. If it goes above $500 a MWh it automatically sets it up a couple more degrees. That's all we're talking about."

Question: Are we talking about just thermostat control?

Borenstein: "There are lots of things you can do, lighting [and thermostat control] are two big ones . . ."

Question: It wouldn't be used with household appliances?

Borenstein: "You could do it for all of those things, but I think that's not where you start. To give you an idea, the state of California spent $35 million to put [real-time] meters in last year to all of the facilities for which their peak demand is 200 kWs or above . . . A typical house peaks at 3 kWs, if you have air-conditioning maybe 4 kWs. So this is the equivalent peak demand of 50-70 houses; a big office building for instance . . . Per meter these guys are really big users . . ."

Question: Have we seen results from this?

Borenstein: "No, the PUC has never passed a real-time tariff. It's not enough to put the meter in; you've got to actually use it . . .

"But what you're avoiding with real-time pricing is rolling black-outs, price spikes and having to build power plants in everybody's backyard. Not only does this make more economic sense than the alternative, environmentally this makes a tremendous amount of sense. Because you know the way we got through last summer, and we will get through this summer; in both cases it's in part because they're giving waivers to the most heavily polluting power plants. These are the real old smokers, and they're giving them waivers to run as much as they want because everybody's worried about black outs. Well, given the alternative that's probably the right thing to do, but it would make a whole lot more sense to give commercial/industrial customers a price incentive to curtail their consumption at peak times. . . . We just stalled out on this. The Governor claimed he was all for it; the tax-payers of CA spent $35 million putting in the meters; the PUC stalled out on this."

Question: In the electricity market do there need to be extra protections against market power?

Borenstein: "There need to be extra protections, but the first line of defense needs to be that consumers see the prices, so there is some demand elasticity. We should still have price caps, but we should not be relying on price caps. Also, if you have long term contracts then sellers have much less incentive to try to [exercise market power] . . . "

Question: Could you summarize for us your vision of the best market structure?

Borenstein: "I think there are a lot of issues still to be resolved, but I think eventually the right place to get to is a competitive wholesale market--which means nobody owns too much of the capacity, and you've got to be very careful about that . . . Where there are competitive retail providers for signing long term contracts. You'd still have a default provider of some sort, but the default provider would not offer flat pricing. Even for residential you should at least put them on Time-of-Use (TOU) pricing, so there is peak and off-peak--at least get people to do their laundry at night during the summer. But the most important thing is that they not offer flat pricing, or even TOU pricing, to commercial and industrial customers. If they want to stick with the default provider then they should be paying the real-time wholesale prices. If they want they can go to somebody else that will give them some insurance aspect to it--that is they'll sell them a hedge against the real-time price variation. I think that there would be a lot of companies that would want that hedge.

"But, what California did instead was we offered commercial/industrial customers flat pricing or TOU, and implicitly a guarantee that if prices got out of control we wouldn't make them pay. That was the real killer. Everyone knew that no matter what happened in the wholesale market they were never going to get stuck with more than this flat retail price. And so nobody went to alternative providers, or they did it in a way that actually sort of ripped off the state. They went to them and then as soon as the price went up they switched back [to the utility]."

Question: Which is Loretta Lynch's reason for not supporting a core/non-core model.

Borenstein: "That's not a reason for not supporting a non-core model. You just have to have an exit fee. Sure, you can go buy from whomever you want but you don't get out of your part of the commitment on the long term contracts just by ditching us . . . "

Question: Do you think that the market could grow with the exit fee in place?

Borenstein: "Absolutely. It's sort of economic math that says if [other retailers] can't give them a better deal with the exit fee in place then there's no economic reason for these people to be switching. They shouldn't be switching just to get out of paying their share of [the DWR] overpriced contracts. Because that's not an efficient reason to leave, that's just dumping the cost onto somebody else. They should be leaving if they can actually, holding constant that liability, get a better deal. Then they should leave. I think there's some value that can be brought to commercial/industrial customers from other retailers and if there is, they'll leave. But you should not be measuring the success of deregulation by how many leave. You should be measuring its success by how efficient the market operates. And maybe an efficient outcome is that these customers stay with the utility, but they're now on real-time pricing."

Question: My biggest concern with that vision is that it relies on FERC managing market power.

Borenstein: "It doesn't, in a way. There are pieces of it that rely on FERC managing market power, but if you were to have the long term contracts and have the real-time pricing, it's much less critical. You're counting much less on FERC. But yeah, it does rely on FERC to have some more sense; even FERC is learning ... I think they now have a better understanding of the problems with firms owning too much of the generation, and problems with firms being able to exercise market power, and I think they will do something. But no, I wouldn't say we should leave ourselves open to that. Real-time pricing and long term contracts will make us much less vulnerable to that."

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Prior to our meeting, Prof. Borenstein recommended several articles he has written. These articles are:

There are also a number of other related papers listed at http://www.ucei.org/Recent_Presentations/recent_present.html