Power to the People

Fundamentals are being decided here. The power crisis that has blindsided California has also turned the state into ground zero in an unanticipated war between radical capitalism and a democratically controlled economy.

One of the great debacles of recent times--a classic saga of greed, ideology, stupidity, and media neglect--the crisis has already spawned the biggest utility bankruptcy ever in the United States, sparked the largest state-bond issue in the nation's financial history, triggered the first planned blackouts in the Los Angeles area since World War II, evaporated a huge state-budget surplus, and wrecked the presidential hopes of the most-populated state's Democratic governor, Gray Davis. With the crunch of summertime coming and utility customers still dependent on a wholesale power market dominated by rapacious out-of-state firms, the ordeal is anything but over.

Nationally, George W. Bush and Dick Cheney are using the crisis to promote their supply-side energy policy of massive fossil-fuel and nuclear development, downplaying the role of conservation and renewable energy, and guaranteeing unchecked consumer prices for their former colleagues in the energy industry. Yet here in California, progressive politics have been unleashed as well. With the preternaturally cautious Davis mostly along for the ride, California is now engaged in unprecedented state intervention in the energy marketplace, buying power for the strapped utilities, trying to buy the utilities' power grid, and setting up a state public power authority. An omnibus energy initiative spearheaded by a former Naderite looms for the 2002 ballot. Polls show extraordinary levels of public distrust of private companies.

The governor's effort to bail out Southern California Edison, the only big private utility in the state that hasn't declared bankruptcy, is foundering--as is his governorship. His repeated announcements of solutions that weren't have taken a toll. With his plummeting job-performance ratings, the only saving grace for Davis is the weakness of the Republican Party in California--and the $30 million in campaign funds he's spent much of the past two years raising.

In many ways, this is a new-economy struggle involving high finance, globalism, differing modes of technology, and new-style money politics. In even more fundamental ways, however, this is also an old struggle, as California Treasurer Philip Angelides points out. "In times past," he says, "public interests have had to step up to counter private greed, as California Progressives did in the early part of the last century and Franklin Roosevelt did with the New York Power Authority." Angelides, a wealthy developer and former state Democratic chairman, has joined forces with California State Senate President John Burton--brother of legendary Congressman Phil Burton--to create a state public power authority. This agency, which both houses of the California legislature have now authorized, will finance energy-efficiency improvements and renewable-energy technologies as well as build new conventional plants that will provide enough generating capacity to help tame an out-of-control market.

But that's for the future. In the meantime, Burton and Angelides' plan to help recapitalize the utilities and gain more control over power companies by purchasing utility transmission lines has stalled out owing to the bankruptcy of Pacific Gas and Electric (PG&E) and the very generous deal that Davis negotiated with Southern California Edison--so generous that it is in deep trouble in the legislature. (It would not require the Edison holding company to give back the billions of dollars it received in transfers from the utility as part of deregulation.)

Likewise, their proposals to get tough with southern power companies such as Enron and Reliant Energy that dominate the wholesale market--either by seizing their in-state plants (which they bought from PG&E and Edison) outright or taking over their operations--have run into one big stumbling block: Governor Davis. The governor simply will not act. Throughout the crisis, Davis has talked tough about the power companies, but his fundamental solution has been to hope for price caps from the Federal Energy Regulatory Commission. Angelides says his financial experts assure him that the state could operate the plants for half the current spot-market cost while ensuring a 20 percent return to the companies. But the governor would have to use his emergency powers to make it happen. To date, they remain unused.

Meanwhile, the state's foray into buying power on the wholesale spot market for the creditless utilities, an undertaking Davis justified as merely a brief commitment, has turned into a multibillion-dollar drain of the state's general fund that threatens core programs. The legislature has initiated a bond issue to reimburse the state for its outlays, but Republicans have just enough votes to delay its issuance until August. Conservation efforts, which some outside advisers urged Davis to focus on in 1999, are off to a late start and may also come up short. Alternative-power generators--the companies that use cogeneration, wind, solar, geothermal, and biomass technologies to provide electricity--went months without being paid by the utilities and may not provide the electricity the state needs.

In short, despite enormous levels of frantic activity, California is still in deep trouble. Davis's mismanagement, the Bush agenda, Bill Clinton's laissez-faire energy policies, and former Governor Pete Wilson's deregulation scheme have combined to hand the whip to the southern power cartel. And thanks to unusually high levels of maintenance outages and a major accident at the San Onofre nuclear plant, rolling blackouts have already been taking place. With the peak air-conditioning season yet to come, California is looking at a long, hot summer.

A Low-Voltage Governor

"So much of this was outside our office," says a rather plaintive Steve Maviglio, Davis's press secretary. "President Clinton had always delivered on every single item the governor had ever asked [for]." Until he asked for federal price caps on electric power, that is--something Davis spent most of last year doing as the storm gathered.

By all accounts, the governor is not a big-picture guy. According to a number of his past and present associates, Davis is most engaged by subjects "right in front of him"--placed there, usually, by polling. It's a good way to address, if only symbolically, the most immediate needs of a detached, contented electorate; and it's a method that served Davis nicely on the gubernatorial campaign trail. But it is anything but a good way to anticipate future needs.

Moreover, as former California Governor Jerry Brown's onetime chief of staff, Davis had a chance to see firsthand how energy could become a hot-button issue. In that position, he had to fend off the corporate backlash to Brown's conservationism, his antinuclear stance, and his preference for renewables. Now, as governor himself, Davis doesn't want to rock that same boat. His appointments to energy-related commissions mostly have been political cronies, and he held over Wilson's Energy Commission chairman.

Davis's appeal to Washington turned out to be a major mistake. Under Clinton, the Federal Energy Regulatory Commission, dominated by market-oriented policy-makers, effectively declined to cap the skyrocketing wholesale prices. Meanwhile, the opportunity to lock in affordable prices through long-term contracts between utilities and the power generators was being lost. The California Public Utilities Commission (CPUC) did vote last summer to allow the big utilities to enter into long-term power contracts. Such contracts would have saved billions of dollars. But the utilities chose to delay. (They complain now that they could not receive assurances from the CPUC that they would not be second-guessed on the terms of the contracts if they looked too generous in retrospect.) In any event, Davis did not press the utilities to enter into those contracts.

Davis-think went through several permutations (including a State of the State address in January that included not a word of criticism of the big utilities that had lobbied for the deregulation) before finally embracing an approach based on a high degree of government intervention. It was against his grain, say his advisers; he probably never would have gone for that level of public control at the beginning of this year.

But events were in the saddle. Davis was forced into the emergency-power-buying business by the utilities' lack of creditworthiness with power generators. Within the political establishment, Burton and Angelides brought significant pressure to bear for direct government intervention. Outside the establishment, consumer advocate Harvey Rosenfield, a former Ralph Nader disciple and veteran promoter of ballot initiatives, frightened politicians with credible talk of an omnibus energy initiative in the 2002 election.

At least as important to Davis's shift to more progressive policies were the results of extensive polling and focus-group research. Surveys conducted for newspapers indicated that most Californians blamed the big utilities and believed that power companies manipulated the situation to drive up prices and create a crisis.

Private research indicated still more: "We found that even some people who don't like government have had enough," says Davis adviser Paul Maslin. "They want a sense of control. They think government can give them that, and the market's given them chaos." Especially telling was a focus group with middle-aged, middle-class white men, who often disdain government programs and wax enthusiastic about individualism and private enterprise. Not this time. In the face of the market clout of the big energy companies, they wanted strong government intervention to reassert a sense of control.

But Davis has yet to pull the trigger. His emergency powers to take over or operate plants remain uninvoked. And his fateful opening up of the state's general fund to the spot market was akin to letting the vampires into the blood bank.

The Architects of Disaster

Davis didn't create the problem, of course. The deregulation of California's power industry was conceived at least partly in London. And its inspiration came, in no small measure, from Margaret Thatcher.

While former Governor Wilson made plain his philosophical support for deregulation in the early 1990s and pushed it through after he won re-election and his party took over the assembly in 1994, he needed a quarterback. Wilson found his man in the unlikely person of Daniel W.L. Fessler. This contract-law professor at the University of California at Davis had no particular background in energy issues, but he did boast a conservative ideology and the friendship of first lady Gail Wilson. It was enough to make him Wilson's choice as president of the California Public Utilities Commission.

After first trying to lead a revival of nuclear power in California, Fessler embraced electric-power deregulation. An Anglophile who enjoyed affecting a mock British accent, Fessler looked to Thatcher's electric-power deregulation of Britain for strategies, bringing back many ideas from a trip he and other regulators took there with top utility executives in 1994.

Fessler and company returned to California with a sense of purpose. Electric-power deregulation was hurtling along on the fast track. Trouble was, there was no clamor locally for deregulation. Unlike Britain, which had had a wheezy public power system (in sharp contrast to the many successful municipal utilities in the United States), California had a system that worked. Power cost more here, on average, than elsewhere in the United States, but far less was used per capita than elsewhere, too, because of energy-efficiency improvements begun during Jerry Brown's governorship.

If prices were high, the obvious solution was to come up with more generating capacity--and that's just what the state's municipally owned power companies did. "I had no trouble getting power plants built," says Ed Smeloff, former president of the Sacramento Municipal Utility District. But the big private utilities weren't moving on new capacity.

The only real constituency for deregulation in the early 1990s had been old-economy industries, like steel and cement, which were eager to lower production costs. But California also had a perceived "competitiveness crisis." There was then much rhetoric about the Golden State losing substantial portions of critical new-economy industries like entertainment and high technology to low-cost, nonunion states such as Nevada. This notion proved to be just a lot of talk. When it comes to energy, these industries are more concerned with reliability than with marginal price issues. But Fessler's view of a reconfigured utility industry would strike a resounding chord with utility leaders like Southern California Edison CEO John Bryson, and the power company executives ultimately emerged as the crucial backers of deregulation. Deregulation, that is, that suited their purposes.

Fessler opposed government efforts to promote conservation and saw renewable energy as illusory. To him the price signal was all that was needed to spur greater energy efficiency. Claiming that great benefits would accrue through the elimination of utility reserve margins, Fessler emphasized short-term savings at the expense of both reliability and control over supply. Fatefully, he strongly favored leaving regulation of the power grid to the federal government--which has barely regulated it at all, thus placing California in its present thicket. Through a variety of means, Fessler moved the CPUC away from the regulation of power generators.

Despite the market ideology, this was not a true free market. Instead, Fessler and the utilities worked together to craft a market with considerable entry barriers to firms other than the utilities themselves and other big power generators. The utilities were given a multibillion-dollar bailout for their investment in nuclear power. And in the best-of-all-possible deregulated worlds that Fessler and the utilities foresaw, the breakup of their vertical in-state monopoly would free them to roam the country, indeed the planet, buying and building power plants where they could seek the highest return, free from California's regulatory reach while still able to count on the vast California market for crucial cash flow. This is precisely what they have done.

The biggest blunder was to place the consumer in the easily manipulated wholesale spot market--the same mistake Britain made. In the Thatcherized United Kingdom, electric prices have been 70 percent higher than in the United States over the past decade, service has decayed, and blackouts have become more frequent. The very model of the California experience: "Deregulation and the Fessler-led PUC's insistence that California utilities sell off their power plants," notes Smeloff, "left the southern [energy-generating] cartel with the swing capacity."

With Wilson re-elected in a landslide, the state assembly in Republican hands, the utilities' big guns roaming the capitol as part of a multimillion-dollar lobbying blitz, and the media ignoring it all, California's electric-power industry was deregulated in 1996. Evidence of price manipulation emerged as early as the summer of 1998, according to a California senate investigative committee, but the Power Exchange, the now-defunct power marketplace, suppressed the reports. The manipulation was masked the following year by unusually heavy reliance on hydropower from Northern California and the Pacific Northwest. But that dried up last year.

Before deregulation, California utilities owned 46,000 megawatts of electrical-generation capacity, more than half again as much as needed to meet winter peak demand and avoid blackouts, and just enough for peak summer air-conditioning demand. It's often reported that the deregulation legislation required the private utilities to sell power plants. Not so. As energy expert V. John White notes, it was the Wilson CPUC that de-emphasized conservation and strongly encouraged utilities to sell off half their plants. After deregulation, California's private utilities rushed to do just that--to the very out-of-state firms now ramming it to the tarnished Golden State.

With the proceeds from the sale of their plants, the utilities immediately bought and built power plants in other parts of the country. PG&E, for example, quickly became one of the biggest electric-power generators in the Northeast. Incredibly, PG&E was planning to sell its precious California hydroelectric facilities as recently as January. For its part, Southern California Edison turned into a high-flying operation investing in fossil-fuel plants around the world. It, too, was considering selling off more plants in California earlier this year.

Now, PG&E is in bankruptcy, and Edison may yet follow. Yet their parent corporations are protecting billions in profits and assets that originated in California. Much of the utilities' debt is essentially to themselves. The utilities claim $14 billion in liabilities. But taking the parent company's balance sheets as a whole, consumer advocates and many state officials put the figure at much less.

State regulators say that the utilities have overcharged California consumers to the tune of $6 billion--and prices on the electricity-futures market are going up. The power companies' profits are so high now that Reliant Energy of Houston--on whose board former secretary of state and Bush recount consigliere James Baker III serves--recently flew in the face of a bear market for initial public offerings by raising its share price.

From Deregulation to Public Power

In the near term, California remains terribly vulnerable. But the resurgence of support for public power--something never anticipated by the radical-capitalist exponents of power deregulation--holds out hope for the future. "This is a historically time-tested idea which will work for California's future," State Treasurer Phil Angelides asserts. "We need public power in this state so we can control our own destiny."

Burton, the colorful San Francisco liberal who in the term-limits era is, along with Davis, easily the most experienced figure in the capitol, agrees. "We're going to be in a crunch for a long time," he says. "We have a steep hill to climb for the next five years, so we have to put this power authority in place now."

Modeled after FDR's New York State Power Authority, their plan would use the state's sale of revenue bonds to finance new power plants, renewable energy, and a conservation loan program. When squeezes come, the new authority is intended to stabilize the market. The bonds will be repaid through the sale of power. "Instead of selling back to Californians at cost plus an arm and a leg," says Angelides, "we'll sell it at just enough to pay off our bonds. If we controlled 10 or 15 percent of capacity, we wouldn't be victims of the market right now."

None of this provides an immediate solution to the price of power that the state is buying on the spot market today, however. Meanwhile, a populist reckoning waits in the wings in the form of the omnibus energy initiative likely to be sponsored by Harvey Rosenfield. While its substance is as yet unclear, its potential is large. California's energy backlash has just begun.