The California electricity crisis, also known
as the Western U.S. Energy Crisis of 2000 and 2001, was a situation in which the United
States state of California had a shortage of electricity supply caused by market manipulations,
illegal shutdowns of pipelines by the Texas energy consortium Enron, and capped retail
electricity prices. The state suffered from multiple large-scale blackouts, one of the
state’s largest energy companies collapsed, and the economic fall-out greatly harmed Governor
Gray Davis’s standing. Drought, delays in approval of new power plants,
and market manipulation decreased supply. This caused an 800% increase in wholesale
prices from April 2000 to December 2000. In addition, rolling blackouts adversely affected
many businesses dependent upon a reliable supply of electricity, and inconvenienced
a large number of retail consumers. California had an installed generating capacity
of 45GW. At the time of the blackouts, demand was 28GW. A demand supply gap was created
by energy companies, mainly Enron, to create an artificial shortage. Energy traders took
power plants offline for maintenance in days of peak demand to increase the price. Traders
were thus able to sell power at premium prices, sometimes up to a factor of 20 times its normal
value. Because the state government had a cap on retail electricity charges, this market
manipulation squeezed the industry’s revenue margins, causing the bankruptcy of Pacific
Gas and Electric Company and near bankruptcy of Southern California Edison in early 2001.
The financial crisis was possible because of partial deregulation legislation instituted
in 1996 by the California Legislature and Governor Pete Wilson. Enron took advantage
of this deregulation and was involved in economic withholding and inflated price bidding in
California’s spot markets. The crisis cost between $40 to $45 billion. Causes
Market manipulation As the FERC report concluded, market manipulation
was only possible as a result of the complex market design produced by the process of partial
deregulation. Manipulation strategies were known to energy traders under names such as
“Fat Boy”, “Death Star”, “Forney Perpetual Loop”, “Ricochet”, “Ping Pong”, “Black Widow”,
“Big Foot”, “Red Congo”, “Cong Catcher” and “Get Shorty”. Some of these have been extensively
investigated and described in reports. Megawatt laundering is the term, analogous
to money laundering, coined to describe the process of obscuring the true origins of specific
quantities of electricity being sold on the energy market. The California energy market
allowed for energy companies to charge higher prices for electricity produced out-of-state.
It was therefore advantageous to make it appear that electricity was being generated somewhere
other than California. Overscheduling is a term used in describing
the manipulation of capacity available for the transportation of electricity along power
lines. Power lines have a defined maximum load. Lines must be booked in advance for
transporting bought-and-sold quantities of electricity. “Overscheduling” means a deliberate
reservation of more line usage than is actually required and can create the appearance that
the power lines are congested. Overscheduling was one of the building blocks of a number
of scams. For example, the Death Star group of scams played on the market rules which
required the state to pay “congestion fees” to alleviate congestion on major power lines.
“Congestion fees” were a variety of financial incentives aimed at ensuring power providers
solved the congestion problem. But in the Death Star scenario, the congestion was entirely
illusory and the congestion fees would therefore simply increase profits.
In a letter sent from David Fabian to Senator Boxer in 2002, it was alleged that:
“There is a single connection between northern and southern California’s power grids. I heard
that Enron traders purposely overbooked that line, then caused others to need it. Next,
by California’s free-market rules, Enron was allowed to price-gouge at will.”
Effects of partial deregulation Part of California’s deregulation process,
which was promoted as a means of increasing competition, involved the partial divestiture
in March 1998 of electricity generation stations by the incumbent utilities, who were still
responsible for electricity distribution and were competing with independents in the retail
market. A total of 40% of installed capacity – 20 gigawatts – was sold to what were called
“independent power producers.” These included Mirant, Reliant, Williams, Dynegy, and AES.
The utilities were then required to buy their electricity from the newly created day-ahead
only market, the California Power Exchange. Utilities were precluded from entering into
longer-term agreements that would have allowed them to hedge their energy purchases and mitigate
day-to-day swings in prices due to transient supply disruptions and demand spikes from
hot weather. Then, in 2000, wholesale prices were deregulated,
but retail prices were regulated for the incumbents as part of a deal with the regulator, allowing
the incumbent utilities to recover the cost of assets that would be stranded as a result
of greater competition, based on the expectation that “frozen” rates would remain higher than
wholesale prices. This assumption remained true from April 1998 through May 2000.
Energy deregulation put the three companies that distribute electricity into a tough situation.
Energy deregulation policy froze or capped the existing price of energy that the three
energy distributors could charge. Deregulating the producers of energy did not lower the
cost of energy. Deregulation did not encourage new producers to create more power and drive
down prices. Instead, with increasing demand for electricity, the producers of energy charged
more for electricity. The producers used moments of spike energy production to inflate the
price of energy. In January 2001, energy producers began shutting down plants to increase prices.
When electricity wholesale prices exceeded retail prices, end user demand was unaffected,
but the incumbent utility companies still had to purchase power, albeit at a loss. This
allowed independent producers to manipulate prices in the electricity market by withholding
electricity generation, arbitraging the price between internal generation and imported power,
and causing artificial transmission constraints. This was a procedure referred to as “gaming
the market.” In economic terms, the incumbents who were still subject to retail price caps
were faced with inelastic demand. They were unable to pass the higher prices on to consumers
without approval from the public utilities commission. The affected incumbents were Southern
California Edison and Pacific Gas & Electric. Pro-privatization advocates insist the cause
of the problem was that the regulator still held too much control over the market, and
true market processes were stymied – whereas opponents of deregulation assert that the
fully regulated system had worked for 40 years without blackouts.
Government price caps By keeping the consumer price of electricity
artificially low, the California government discouraged citizens from practicing conservation.
In February 2001, California governor Gray Davis stated, “Believe me, if I wanted to
raise rates I could have solved this problem in 20 minutes.”
Energy price regulation incentivized suppliers to ration their electricity supply rather
than expand production. The resulting scarcity created opportunities for market manipulation
by energy speculators. State lawmakers expected the price of electricity
to decrease due to the resulting competition; hence they capped the price of electricity
at the pre-deregulation level. Since they also saw it as imperative that the supply
of electricity remain uninterrupted, utility companies were required by law to buy electricity
from spot markets at uncapped prices when faced with imminent power shortages.
When the electricity demand in California rose, utilities had no financial incentive
to expand production, as long term prices were capped. Instead, wholesalers such as
Enron manipulated the market to force utility companies into daily spot markets for short
term gain. For example, in a market technique known as megawatt laundering, wholesalers
bought up electricity in California at below cap price to sell out of state, creating shortages.
In some instances, wholesalers scheduled power transmission to create congestion and drive
up prices. After extensive investigation The Federal
Energy Regulatory Commission substantially agreed in 2003:
“…supply-demand imbalance, flawed market design and inconsistent rules made possible
significant market manipulation as delineated in final investigation report. Without underlying
market dysfunction, attempts to manipulate the market would not be successful.”
“…many trading strategies employed by Enron and other companies violated the anti-gaming
provisions…” “Electricity prices in California’s spot
markets were affected by economic withholding and inflated price bidding, in violation of
tariff anti-gaming provisions.” The major flaw of the deregulation scheme
was that it was an incomplete deregulation – that is, “middleman” utility distributors
continued to be regulated and forced to charge fixed prices, and continued to have limited
choice in terms of electricity providers. Other, less catastrophic energy deregulation
schemes, such as Pennsylvania’s, have generally deregulated utilities but kept the providers
regulated, or deregulated both. New regulations
In the mid-90’s, under Republican Governor Pete Wilson, California began changing the
electricity industry. Democratic State Senator Steve Peace, was the Chairman of the Senate
Committee on Energy at the time and is often credited as “the father of deregulation” .
The author of the bill was Senator Jim Brulte, a Republican from Rancho Cucamonga . Wilson
admitted publicly that defects in the deregulation system would need fixing by “the next governor”. The new rules called for the Investor Owned
Utilities, or IOUs, to sell off a significant part of their electricity generation to wholly
private, unregulated companies such as AES, Reliant, and Enron. The buyers of those power
plants then became the wholesalers from which the IOUs needed to buy the electricity that
they used to own themselves. While the selling of power plants to private
companies was labeled “deregulation”, in fact Steve Peace and the California legislature
expected that there would be regulation by the FERC which would prevent manipulation.
The FERC’s job, in theory, is to regulate and enforce federal law, preventing market
manipulation and price manipulation of energy markets. When called upon to regulate the
out-of-state privateers which were clearly manipulating the California energy market,
the FERC hardly reacted at all and did not take serious action against Enron, Reliant,
or any other privateers. FERC’s resources are in fact quite sparse in comparison to
their entrusted task of policing the energy market. Lobbying by private companies may
also have slowed down regulation and enforcement. Supply and demand
California’s population increased by 13% during the 1990s. The state did not build any new
major power plants during that time, although existing in-state power plants were expanded
and power output was increased nearly 30% from 1990 to 2001.
California’s utilities came to depend in part on the import of excess hydroelectricity from
the Pacific Northwest states of Oregon and Washington. California’s clean air standards
favored in-state electricity generation which burned natural gas because of its lower emissions,
as opposed to coal whose emissions are more toxic and contain more pollutants.
In the summer of 2001 a drought in the northwest states reduced the amount of hydroelectric
power available to California. Though at no point during the crisis was California’s sum
of actual electric-generating capacity plus out-of-state supply less than demand, California’s
energy reserves were low enough that during peak hours the private industry which owned
power-generating plants could effectively hold the State hostage by shutting down their
plants for “maintenance” in order to manipulate supply and demand. These critical shutdowns
often occurred for no other reason than to force California’s electricity grid managers
into a position where they would be forced to purchase electricity on the “spot market”,
where private generators could charge astronomical rates. Even though these rates were semi-regulated
and tied to the price of natural gas, the companies controlled the supply of natural
gas as well. Manipulation by the industry of natural gas prices resulted in higher electricity
rates that could be charged under the semi-regulations. In addition, the energy companies took advantage
of California’s electrical infrastructure weakness. The main line which allowed electricity
to travel from the north to the south, Path 15, had not been improved for many years and
became a major bottleneck point which limited the amount of power that could be sent south
to 3,900 MW. Without the manipulation by energy companies, this bottleneck was not problematic,
but the effects of the bottleneck compounded the price manipulation by hamstringing energy
grid managers in their ability to transport electricity from one area to another. With
a smaller pool of generators available to draw from in each area, managers were forced
to work in two markets to buy energy, both of which were being manipulated by the energy
companies. The International Energy Agency estimates
that a 5% lowering of demand would result in a 50% price reduction during the peak hours
of the California electricity crisis in 2000/2001. With better demand response the market also
becomes more resilient to intentional withdrawal of offers from the supply side.
Some key events Rolling blackouts affecting 97,000 customers
hit the San Francisco Bay area on June 14, 2000, and San Diego Gas & Electric Company
filed a complaint alleging market manipulation by some energy producers in August 2000. On
December 7, 2000, suffering from low supply and idled power plants, the California Independent
System Operator, which manages the California power grid, declared the first statewide Stage
3 power alert, meaning power reserves were below 3 percent. Rolling blackouts were avoided
when the state halted two large state and federal water pumps to conserve electricity.
Most notable, the city of Los Angeles was unaffected by the crisis because government-owned
public utilities in California were exempt from the deregulation legislation and sold
their excess power to private utilities in the state during the crises that enabled much
of the greater Los Angeles area to suffer only rolling brown-outs rather than long term
black outs suffered in other parts of the state.
On December 15, 2000, the Federal Energy Regulatory Commission rejected California’s request for
a wholesale rate cap for California, instead approving a “flexible cap” plan of $150 per
megawatt-hour. That day, California was paying wholesale prices of over $1400 per megawatt-hour,
compared to $45 per megawatt-hour average one year earlier.
On January 17, 2001, the electricity crisis caused Governor Gray Davis to declare a state
of emergency. Speculators, led by Enron Corporation, were collectively making large profits while
the state teetered on the edge for weeks, and finally suffered rolling blackouts on
January 17 & 18. Davis was forced to step in to buy power at highly unfavorable terms
on the open market, since the California power companies were technically bankrupt and had
no buying power. The resulting massive long term debt obligations added to the state budget
crisis and led to widespread grumbling about Davis’ administration.
Consequences of wholesale price rises on the retail market
As a result of the actions of electricity wholesalers, Southern California Edison and
Pacific Gas & Electric were buying from a spot market at very high prices but were unable
to raise retail rates. A product that the IOU’s used to produce for about three cents
per kilowatt hour of electricity, they were paying eleven cents, twenty cents, fifty cents
or more; and, yet, they were capped at 6.7 cents per kilowatt hour when charging their
retail customers. As a result, PG&E filed bankruptcy, and Southern California Edison
worked diligently on a workout plan with the State of California to save their company
from the same fate. PG&E and SCE had racked up US$20 billion in debt by Spring of 2001
and their credit ratings were reduced to junk status. The financial crisis meant that PG&E
and SCE were unable to purchase power on behalf of their customers. The state stepped in on
January 17, 2001, having the California Department of Water Resources buy power. By February
1, 2001 this stop-gap measure had been extended and would also include SDG&E. It would not
be until January 1, 2003 that the utilities would resume procuring power for their customers.
Between 2000 and 2001, the combined California utilities laid off 1,300 workers, from 56,000
to 54,700, in an effort to remain solvent. SDG&E had worked through the stranded asset
provision and was in a position to increase prices to reflect the spot market. Small businesses
were badly affected. According to a 2007 study of Department of
Energy data by Power in the Public Interest, retail electricity prices rose much more from
1999 to 2007 in states that adopted deregulation than in those that did not.
Involvement of Enron One of the energy wholesalers that became
notorious for “gaming the market” and reaping huge speculative profits was Enron Corporation.
Enron CEO Kenneth Lay mocked the efforts by the California State government to thwart
the practices of the energy wholesalers, saying, “In the final analysis, it doesn’t matter
what you crazy people in California do, because I got smart guys who can always figure out
how to make money.” The original statement was made in a phone conversation between David
Freeman and Kenneth Lay in 2000, according to the statements made by Freeman to the Senate
Subcommittee on Consumer Affairs, Foreign Commerce and Tourism in April and May 2002.
S. David Freeman, who was appointed Chair of the California Power Authority in the midst
of the crisis, made the following statements about Enron’s involvement in testimony submitted
before the Subcommittee on Consumer Affairs, Foreign Commerce and Tourism of the Senate
Committee on Commerce, Science and Transportation on May 15, 2002:
“There is one fundamental lesson we must learn from this experience: electricity is really
different from everything else. It cannot be stored, it cannot be seen, and we cannot
do without it, which makes opportunities to take advantage of a deregulated market endless.
It is a public good that must be protected from private abuse. If Murphy’s Law were
written for a market approach to electricity, then the law would state ‘any system that
can be gamed, will be gamed, and at the worst possible time.’ And a market approach for
electricity is inherently gameable. Never again can we allow private interests to create
artificial or even real shortages and to be in control.
“Enron stood for secrecy and a lack of responsibility. In electric power, we must have openness and
companies that are responsible for keeping the lights on. We need to go back to companies
that own power plants with clear responsibilities for selling real power under long-term contracts.
There is no place for companies like Enron that own the equivalent of an electronic telephone
book and game the system to extract an unnecessary middleman’s profits. Companies with power
plants can compete for contracts to provide the bulk of our power at reasonable prices
that reflect costs. People say that Governor Davis has been vindicated by the Enron confession.”
Enron eventually went bankrupt, and signed a US$1.52 billion settlement with a group
of California agencies and private utilities on July 16, 2005. However, due to its other
bankruptcy obligations, only US$202 million of this was expected to be paid. Ken Lay was
convicted of multiple criminal charges unrelated to the California energy crisis on May 25,
2006, but he died due to a heart attack on July 5 of that year before he could be sentenced.
Because Lay died while his case was on federal appeal, his conviction was vacated and his
family was allowed to retain all his property. Enron traded in energy derivatives specifically
exempted from regulation by the Commodity Futures Trading Commission. At a Senate hearing
in January 2002, Vincent Viola, chairman of the New York Mercantile Exchange – the
largest forum for energy contract trading and clearing – urged that Enron-like companies,
which don’t operate in trading “pits” and don’t have the same government regulations,
be given the same requirements for “compliance, disclosure, and oversight.” He asked the committee
to enforce “greater transparency” for the records of companies like Enron. In any case,
the U.S. Supreme Court had ruled “that FERC has had the authority to negate bilateral
contracts if it finds that the prices, terms or conditions of those contracts are unjust
or unreasonable.” Nevada was the first state to attempt recovery of such contract losses.
Handling of the crisis Governor Gray Davis
Perhaps the heaviest point of controversy is the question of blame for the California
electricity crisis. Former Governor Gray Davis’s critics often charge that he did not respond
properly to the crisis, while his defenders attribute the crisis to the power trading
fraud and corporate accounting scandals and say that Davis did all he could considering
the fact that the federal government, not states, regulate interstate power commerce.
In a speech at UCLA on August 19, 2003, Davis apologized for being slow to act during the
energy crisis, but then forcefully attacked the Houston-based energy suppliers: “I inherited
the energy deregulation scheme which put us all at the mercy of the big energy producers.
We got no help from the Federal government. In fact, when I was fighting Enron and the
other energy companies, these same companies were sitting down with Vice President Cheney
to draft a national energy strategy.” Signs of trouble first cropped up in the spring
of 2000 when electricity bills skyrocketed for customers in San Diego, the first area
of the state to deregulate. Experts warned of an impending energy crisis, but Governor
Davis did little to respond until the crisis became statewide that summer. Davis began
asking the federal regulator FERC to probe possible price manipulation by power suppliers
as early as August 2000. Davis would issue a state of emergency on January 17, 2001,
when wholesale electricity prices hit new highs and the state began issuing rolling
blackouts. Some critics, such as Arianna Huffington,
alleged that Davis was lulled to inaction by campaign contributions from energy producers.
In addition, the California State Legislature would sometimes push Davis to act decisively
by taking over power plants which were known to have been gamed and place them back under
control of the utilities, ensuring a more steady supply and slapping the nose of the
worst manipulators . Meanwhile, conservatives argued that Davis signed overpriced energy
contracts, employed incompetent negotiators, and refused to allow prices to rise for residences
statewide much like they did in San Diego, which they argue could have given Davis more
leverage against the energy traders and encouraged more conservation. More criticism is given
in the book Conspiracy of Fools, which gives the details of a meeting between the governor
and his officials; Clinton Administration Treasury officials; and energy executives,
including market manipulators such as Enron, where Gray Davis disagreed with the treasury
officials and energy executives. They advised suspending environmental studies to build
power plants and a small rate hike to prepare for long-term power contracts, while Davis
supported price caps, denounced the other solutions as too politically risky, and allegedly
acted rudely. The contracts Davis signed locked Californians into artificially high electric
costs for the next decade. As of October 2011 electric rates in California had yet to return
to pre-contract levels. The crisis, and the subsequent government
intervention, have had political ramifications, and is regarded as one of the major contributing
factors to the 2003 recall election of Governor Davis.
On November 13, 2003, shortly before leaving office, Davis officially brought the energy
crisis to an end by issuing a proclamation ending the state of emergency he declared
on January 17, 2001. The state of emergency allowed the state to buy electricity for the
financially strapped utility companies. The emergency authority allowed Davis to order
the California Energy Commission to streamline the application process for new power plants.
During that time, California issued licenses to 38 new power plants, amounting to 14,365
megawatts of electricity production when completed. Arnold Schwarzenegger
On May 17, 2001, future Republican governor Arnold Schwarzenegger and former Los Angeles
Mayor Republican Richard Riordan met with Enron CEO Kenneth Lay at the Peninsula Beverly
Hills Hotel in Beverly Hills. The meeting was convened for Enron to present its “Comprehensive
Solution for California,” which called for an end to federal and state investigations
into Enron’s role in the California energy crisis.
On October 7, 2003, Schwarzenegger was elected Governor of California to replace Davis.
Over a year later, he attended the commissioning ceremony of a new Western Area Power Administration
500 kV line remedying the aforementioned power bottleneck on Path 15.
National Energy Development Task Force Vice President Dick Cheney was appointed in
January 2001 to head the National Energy Development Task Force. In the spring of that year, officials
of the Los Angeles Department of Water and Power met with the Task Force, asking for
price controls to protect consumers. The Task Force refused, and insisted that deregulation
must remain in place. Federal Energy Regulatory Commission
The Federal Energy Regulatory Commission was intimately involved with the handling of the
crisis from the summer of 2000. There were in fact at least four separate FERC investigations.
The Gaming Case, investigating general allegations of manipulation of the Western energy markets.
The Enron Investigation, specifically investigating the involvement of Enron.
The Refund Case, involving wide-ranging recovery of illegal profits made by some companies
during the crisis. The Economic Withholding and Anomalous Bidding
Case. On August 17, 2013, the British Columbia company
Powerx agreed to a $750 million refund as a settlement over charges of manipulating
electricity prices during 2000. See also Energy crisis
List of power outages Footnotes References
Weare, Christopher. The California Electricity Crisis: Causes and Policy Options. San Francisco:
Public Policy Institute of California. ISBN 1-58213-064-7. Sweeney, James L.. The California Electricity
Crisis. Stanford: Hoover Institution. ISBN 0-8179-2911-8. External links
Federal Energy Regulatory Commission Final Report on Price Manipulation in Western Markets
Findings at a glance Chronology in detail
Further documents, including detailed report Reports on Enron and the California Energy
Crisis by McCullough Research – page includes a large number of downloadable reports, some
of which were presented as evidence during investigations into the causes of the crisis.
Susan L. Pope, “California Electricity Price Spikes: An Update on the Facts”
Enron Traders Caught On Tape – Gloating about manipulating California’s energy market.
Enron Tapes Hint Chiefs Knew About Power Ploys – Papers Show That Enron Manipulated Calif.
Crisis – “Defying Corporations, Defining Democracy”:
As Internal Memos Reveal That Enron Drove Up Power Prices in California – A talk
to Author Richard Grossman Schwarzenegger Accused of Involvement in $9B
California Swindle with Enron’s Ken Lay – “The Trouble with Electricity Markets: Understanding
California’s Restructuring Disaster”. Archived from the original on 2006-09-05.
“California Department of Water Resources 50th Anniversary Article on the 2001 Energy
Crisis”. Archived from the original on 2007-04-03. Michaels, Robert J.. “Electricity and Its
Regulation”. In David R. Henderson. Concise Encyclopedia of Economics. Indianapolis: Library
of Economics and Liberty. ISBN 978-0865976658. OCLC 237794267.
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