Role of Enron in the Collapse of California Restructure

 

The California electricity crisis or Western U.S. Energy Crisis of 2000 and 2001 was a catastrophe where the state of California had a shortage of electricity supply that was caused by market manipulations, the unlawful closures of pipelines by Enron, and capped wholesale electricity prices. Because of the crisis, California suffered from several momentous blackouts and one of the state’s largest energy companies collapsed.

In 1993 rumors of the government looking to reform the electricity sector spread in California and naturally the three main investor-owned utilities Pacific Gas and Electric Company, San Diego Gas and Electric Company, and the Southern California Edison Company wanted to protect their markets and eliminate competition so they could reduce any potential damage to their company. This conduct set the foundation for the shortfalls to come in the near future. The California Public Utilities Commission and the Federal Energy Regulatory Commission believed the state control and command regulation was lowering the efficiency in the electricity sector. These two organizations decided to undertake the role of pushing change.

Before the restructuring the regulatory structure the existed did not serve all of the public’s interest given the recent economic, technological, and environmental changes. The environmental community was frustrated by the delayed response by utility regulators to problems caused by the generation of electricity; independent energy producers were unsatisfied about the lack of regulatory backing for renewable energy facilities, industrial consumers were frustrated by the higher electricity rates in California compared to other parts of the United States. Private utilities were cutting energy efficiency resources and acquirement levels back by thousands of megawatts and were refusing to purchase the 1400 MW of clean cogeneration and renewables that were cheaper than utility power plants, simply because they were from competing businesses.

In 1992 California has launched its gas system seeking business from large industrial customers and power generators. There was now a ‘free’ market for natural gas. Large customers claimed they didn’t need storage and did not want to be forced to pay the rates for it. In 1993 the CPUC disconnected storage from other gas services. This gas utility now required reserving storage for core customers but non-industrial or non-electric generation customers could not buy the storage that they wanted on their own through auction and contract processes. Large customers did not have to buy storage but could make decisions on how much to procure based on market forces, rather than regulatory approval. Small customers did not complain because at the time large customers had to have oil or propane backup to not be core customers. The electric generators that did use natural gasses were mainly utilities that would make cautious decisions to guarantee the reliability of electric supply. Reliability was not supposed to be compromised if a few industrials did not want to buy storage. So now large customers had both no storage and no alternative fuel, the gas-fired power plants were sold to new owners, and no longer owned by the utilities that put gas away to promise reliability, and the Federal Energy Regulatory Commission got rid of all the price caps for short-term sales of gas pipeline capacity in spring 2000. In the summer of 2001, a drought in northwestern states limited the amount of hydroelectric power offered to California. 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 small enough that during peak hours the private industry, who owned the power-generating plants, could successfully hold California hostage by temporarily closing down their plants for maintenance in order to manipulate the supply and demand. These strategic shutdowns often happened for no reason other than to force California’s electricity grid managers into a situation where they would be required to purchase electricity on the spot market, where private generators could charge hefty rates. Even though these rates were semi-regulated and tied to the price of natural gas, the companies (which included Enron) also controlled the supply of natural gas. Manipulation by the industry of natural gas prices caused higher electricity rates that could be charged under the semi-regulations. In California gas storage is vital but companies’ gas storage was traded for financial hedges. Storing gas in the ground is good keeps California’s energy prices down. And California can’t afford to pay for all of this extremely expensive electricity during the winter as it will bankrupt the entire state. The power generators were charging for electricity based on the unhedged spot market price of gas, and society was being made to pay it.

Drought, delays in approval of new power plants, and market manipulation decreased supply caused an 800% increase in wholesale prices from April 2000 to December 2000. Also, the rolling blackouts unfavorably affected many businesses that were dependent on a reliable supply of electricity, and the blackouts troubled a large number of retail consumers. California had a generating capacity of 45GW and at the time of the blackouts, demand was at 28GW. A demand supply gap had now been artificially created by energy companies to create a fake shortage. Energy traders would take power plants offline for maintenance on days of peak demand to increase the price. Traders were then able to sell the power back at premium prices, sometimes 10 times its normal value. Because the state government put a cap on retail electricity prices, the manipulation of this market squeezed the industry’s revenue margins, this lead to the bankruptcy of Pacific Gas and Electric Company and also the near bankruptcy of Southern California Edison in early 2001. The financial crisis happened because of partial deregulation legislation introduced in 1996 by the California Legislature and Governor Pete Wilson. Enron took advantage of this deregulation and was involved in economic concealment and inflated price bidding in California’s spot markets. The crisis all together cost between US$40 to $45 billion.

One of the energy wholesalers that became notorious for manipulating the market and reaping huge theoretical profits was Enron Corporation. Enron traded in energy derivatives specifically exempted from regulation by the Commodity Futures Trading Commission.  Enron’s CEO Kenneth Lay mocked the California state government efforts 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 S. David Freeman who was selected as Chair of the California Power Authority in the middle of the catastrophe, made the following statements about Enron’s involvement in testimony submitted to 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.” However, eventually, Enron went bankrupt and signed a $1.52 billion dollar settlement with a group of California agencies and private utilities on July 16, 2005. However, because of the company’s other bankruptcy responsibility, only $202 million dollars of this was expected to be paid. CEO Ken Lay was convicted of multiple criminal charges unrelated to the California energy crisis on May 25, 2006, and died July 5 of that year before he could be sentenced to jail. At the Senate hearing in January 2002, Vincent Viola, chairman of the New York Mercantile Exchange advised that companies like Enron, who do not work in trading pits and do not have the same government protocols, be given the identical requirements for compliance, disclosure, and oversight. He requested the committee to impose greater transparency for the records of companies like Enron. The U.S. Supreme Court ruled that the FERC has had the authority to negate bilateral contracts if it discovers that the prices, terms or conditions of those contracts are unfair or unreasonable.

California’s electricity restructuring plan was unsuccessful because it was incomplete restructuring. The state partially deregulated the electricity supply market, representing the utilities’ cost to serve, but they did not deregulate the prices that utilities could charge their customer. Specifically, a little recognized double whammy of frozen retail electric rates, coupled with the absurd notion of negative stranded cost recovery charges, played a significant role in the disintegration of the California retail electricity market and the financial evisceration of its two biggest utilities. California’s restructuring statute, AB 1890, required that retail electric rates for bundled electricity service received from the utility be frozen through Mar. 31, 2002, unless a utility could demonstrate that it had paid off all of its stranded costs before that time.11 Customers who chose to leave utility service in favor of receiving service from a competitive supplier (referred to as “direct access”) could theoretically be charged something other than the frozen rate, but the practical reality was that the frozen rate became the benchmark, and competitive suppliers either had to beat it significantly, or provide some kind of value-added services to persuade customers to switch.

The California electricity crisis was a result of companies mainly Enron trying to outsmart the system and create monopolies of over entire industries. The state of suffered from several momentous blackouts and one of the state’s largest energy companies collapsed over the greed large scale companies. A crisis of this scale shows that there is order to everything and outsmarting the system can only last for so long before you are caught.

Bibliography

Marcus, William, and Jan Hamrin. HOW WE GOT INTO THE CALIFORNIA ENERGY CRISIS By William Marcus, JBS Energy, Inc. Jan Hamrin, Center for Resource Solutions (n.d.): n. pag. Web. 28 Feb. 2017.

Smith, Michael D. “Lessons to Be Learned from California and Enron for Restructuring Electricity Markets.” Lessons to Be Learned from California and Enron for Restructuring Electricity Markets. The Electricity Journal, Aug.-Sept. 2002. Web. 28 Feb. 2017. <http://www.sciencedirect.com/science/article/pii/S1040619002003408>.

Roberts, Joel. “Enron Traders Caught On Tape”. CBS News. CBS News. Web. 28 Feb. 2017.

Sweeney, James L. (Summer 2002). “The California Electricity Crisis: Lessons for the Future”. National Academy of Engineering of the Nation Academies. Web. 28 Feb. 2017.

Weare, Christopher (2003). The California Electricity Crisis: Causes and Policy Options (PDF). San Francisco: Public Policy Institute of California. Web. 28 Feb. 2017.

“Testimony of S. David Freeman”. April 11, 2002. Archived from the original (PDF) on July 24, 2004. Web. 28 Feb. 2017

“Testimony of S. David Freeman”. May 15, 2002. Archived from the original (PDF) on December 13, 2002. Web. 28 Feb. 2017

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