Joskow article on Electricity Crisis

Prices in wholesale electricity market increase 500% 1999-2000

- Retail prices fixed until early 2001, causing two largest utilities
to go insolvent b/c selling for less than buying
State of California had to use $8 billion to buy power from
unregulated wholesale suppliers to avoid blackouts
- Long-term contracts agreed to commit $60 billion more
California restructuring programme 1994-9
For century, industry organised around 3 regulated private vertically
integrated monopolies (IOUs)
- Owned and operated generation, transmission, and
distribution facilities
California Public Utilities Commission (CPUC) reviewed structure in
1993 and introduced reform programme in 1994
- Deregulated production of wholesale electricity creating
competitive wholesale market
Restructuring law (AB 1890) passed in early 1996 with following key
provisions:
- Retail wheeling (customer choice)
o Retail customers can choose competitive electricity
service provider (ESP) or accept default service from
local utility distribution company (UDC)
- IOUs required to provide open access to transmission and
distribution networks
- UDCs price set equal to wholesale spot market prices for
power determined in real-time markets
o Price to beat for ESPs
- Provisions made for utilities to recover their stranded costs
o Not prepared for wholesale prices to rise over retail
o Utilities can securitise some stranded costs through
bonds
- Residential and small commercial consumers received 10%
price decrease
- Climate change provisions included
Wholesale market institutions
Due to conflicting suggestions of interest groups, the end result as
complicated set of wholesale electricity market institutions
- IOUs had to crease independent system operator (CAISO) and
a power exchange (PX) and turn over transmission networks
to CIASO
- PX and CAISO then operated public market with hourly market
clearing rates
California ISO (CAISO)

Subject to FERCs regulation

Utilities turned over control of their transmission to this body
so that it could schedule power for the majority of the state
o Confusion b/c utility still owns the transmission and gets
the return from it
o You dont apply to the utility to get access to the line
go through CAISO and return goes to utilities
o Independent system operator just manages the
transmission which opened up the transmission to new
players as they didnt have to create their own
transmission systems
40% of generating capacity is old gas-fired steam and
combustion turbine capacity
Period of high demand dealt with by either favouring noninterruptible customers or imports
Responsibilities
o Manages operation of system in real time using market
information it receives from sellers and buyers
o Responsible for purchasing various operating reserve
services
o Responsible for developing protocols for financial
settlements between suppliers and customers

California Power Exchange (PX)

- Separate voluntary market for trading energy each hour of the
day
- Takes all demand and supply to form supply and demand
curves for each hour
Other Scheduling Coordinators (SC)
- Any wholesale entity licenced to schedule power on CAISO
network
Initial assessment of wholesale market performance
New competitive market began in April 1998 to a number of
software faults and poor communication between PX and ISO
- Flaws in market design increased cost of ancillary services far
above projections and increased cost of managing congestion
Lack of increase in generating capacity after the QF projects
required by federal legislation PURPA; because,
- Excess capacity in early 1990s that was overestimated b/c of
unexpected increase in demand
- Rules for construction of new power plants in flux at the time
Retail market performance
Retail prices fixed for 4 years as UDCs required to provide
consumers with fixed price for the transition period

Completely overestimated the amount of people that would switch

to ESPs (only 3% of consumers representing 12% of demand)
- Means these UDCs had to provide 88% of electricity
demand at a fixed price
- Utilities purchasing in volatile wholesale market and forced to
sell at fixed retail price
California Market Meltdown 2000-1
Beginning of the meltdown May September 2000
- Wholesale electricity prices began to rise above historic peak
levels and above the retail price
o Price of wholesale purchase double that of retail!
o Retail price deregulated at beginning of 2000 and began
passing on the costs to consumers BUT after negative
public reaction, CPUC enforced a cap
- Despite pleadings from utilities, CPUC refused to lift retail
price freeze
- Price increase the result of:
o (i) Rising natural gas prices
o (ii) Large increase in electricity demand in California
o (iii) Reduced imports from other states
o (iv) Rising prices for nitrogen oxide emissions
o (v) Market-power problems
Meltdown continues October December 2000
- Expectation of prices to decrease after peak summer season
o While D decreased, the P of natural gas continued to
rise, M remained low, NOx credit P remained high and
unusually large generating capacity was out of
service and unable to supply electricity
o Utilities claimed that their plants had been run so hard
during the summer that they needed repairs, some were
having NOx emission control systems installed, and
others down due to environmental restraints
o Govt officials insisted that the plants were shut down
for strategic reasons
- By December, utilities paying $400/MWh and forced to resell
at $65/MWh
o Losing $50m a day and requests for reform to FERC and
CPUC rejected
- FERC released report in November stating that California
markets were fundamentally flawed and wholesale prices were
unjust and unreasonable
o Proposed large number of changes
- Tension between state and federal regulators as FERC
demanded California act swiftly to resolve the crisis
o Actions included:
Increasing retail prices
Allowing utilities to enter forward contracts

Speeding up of construction of new power plants

o Unfortunately, actions took a while to implement with
state blaming lax FERC oversight, unregulated suppliers
strategic behaviours, and dishonesty over utilities credit
issues
At this point, the bills for all the energy start becoming due
and causes panic amongst utilities who were coming to their
credit limits

State takes over January June 2001

- Power suppliers began reusing to supply PX and ISO for fear of
not being paid
- PS and ISO began to stop making their payments
o PG&E and SCE effectively insolvent by January
- Bush administration which took power in January said that
federal authority wouldnt be used to force generators to keep
supplying electricity without assurance of being paid
o State of California spent $8 billion to buy power to meet
utilities net short positions
o State began agreeing to LR contracts to get better
prices
- Despite efforts, 1/3 of generating capacity in CAISOs areas
remained out of service for winter and spring of 2001
o Electricity supply emergencies in effect for most of the
period with several rolling blackouts
o Droughts and increase in demand cause further issues
- In response, California govt intensified efforts by entering into
further contracts and modified companies required to
participate in their cap and trade programme
- Pressure put on Bush administration to restore caps on
wholesale prices
o FERC responded slowly, but eventually adopted price
mitigation plans that involved the bidding of available
supplies with bid caps
- Prices began to decrease in June and demand fell due to
moderate season and public awareness of the problem
- While public thought the crisis was over, the systemic flaws
still remained as state funds were providing financial
resources to keep system running day-to-day
United Gas Pipe Line v Mobile Gas Service Corp
Facts
- SCOTUS case that interpreted Natural Gas Act of 1938
o NGA regulated rates charged by gas companies to
customers
- Ideal Cement Company wanted to construct cement plant in
Mobile, Alabama

Mobile Gas Service Company (Mobile) entered into contract

with United Gas Pipe Line Company (United) to obtain gas at
10.7 cents per thousand cubic feet (MCF)
o This was lower price than the price charged to other
customers allowed MGSC to charge cement plant 12
cents per MCF
Contract approved by FPC, but United Gas then increased rate
for resale at 14.5 cents which Mobile contested, arguing they
couldnt make the move unilaterally
o Tried to move the rate because there was an increase in
demand for gas
S. 4c NGA stated that filing must be made and no changes in
rates until 30 days after filing
o United interpreted this as the only procedure they had
to follow in order to unilaterally change rates
S. 4d NGA no change in rates should be made without 30
says of notice
S. 5c NGA states that the Commission must determine what
the just rate should be, not a court of law

Reasoning
- While NGA allows company to file new rates, doesnt authorise
them to abrogate any contract either
Decision
- Found act does not allow gas supply company to unilaterally
modify rates in natural gas supply contract by filing for new
rate with Federal Power Commission
o FPC could investigate rates in contracts but could only
reject or modify the contract if rate found to be so
low that it would be unjust, unreasonable, unduly
preferential or discriminatory
- Rates that are freely negotiated by sophisticated entities
are presumed to be just and reasonable
Federal Power Commission v Sierra Pacific Power
Facts
- Interpreted FPCs mandate under FPA to modify rate in
contract between electric utility and distribution company
when it adversely affects public interest
- Sierra distributed electricity and purchased majority from
PG&E (Pacific Gas and Electric Company)
o Accepted 15-year power contract at special, favourable
rate as PG&E wanted to keep Sierra from going with the
Bureau
o The energy they purchased was part of the surplus left
over from the hydropower dam
o After contact made, PG&E filed new rate schedule
without Sierra consent to increase rate 28%

PG&E claimed they were being big by not asking for the
ordinary ROR, were asking for a little below that

Decision
- Filing of new rate schedule and proceeding to review it not
effective to supersede the contract rate
o Mobile Gas held that NGA didnt authorise unilateral
change and judges here held this also applied to FPA
o Interpreted the statutes the same b/c the same words
were used in both laws
- FPA allows FPC to set aside contact on determination the rate
is unlawful
- Previous to the trial, the FPC had found that the original
contract rate was unreasonably low and unlawful b/c of the
low ROR for PG&E
o SCOTUS held that while FPC cant normally impose ROR
on public utility that is less than fair ROR, it didnt
follow that public utility may not itself agree by
contract to an ROR that is less than the fair ROR
as occurred here
- Under the FPA the proper standard for determining
unlawfulness is whether rate is so low as to adversely
affect public interest
o E.g. unduly discriminatory to third parties, excessively
burdensome to consumers, threat to continued service
to utility company
o Means that if the utility can prove that they were unable
to survive due to the low rate, then FERC can modify the
rate
Mobile-Sierra Principle
An electricity or natural gas supply rate established resulting from
freely negotiated contract is presumed to be just and reasonable
and thus acceptable under the NGA or Federal Power Act
Morgan Stanley Capital Group v Public Utility District No. 1 of
Snohomish County
Facts
- California legislature deregulated power industry in 1996
o Established spot market utilities purchase electricity
on day it was needed
- Wholesale electricity prices skyrocketed four years later due
to hot summer
o Several utilities could no longer afford spot market rate
and instead negotiated less expensive (but still inflated)
long-term contracts with power suppliers
- Once crisis passed, utilities asked govt to allow them to
change rates to reflect new prices

o Govt refused by citing SCOTUS doctrine presuming

utilities contracts are reasonable
Questions
- Assumption apply only when FERC conducting preliminary
investigation?
- Does presumption create as high a bar for purchases as it
does for sellers?
Decision
- Renegotiation allowed if contract poses serious harm to the
public interest
o Federal Energy Regulatory Commission failed to make
sufficient factual findings to determine whether the
harm could occur
- Ginsburg felt that further facts should have been found before
the case was heard as it had to be sent back to the 9th Circuit
to make the final decision on whether it would cause harm
- Public interest standard is just differing application of
just and reasonable test
Mobile-Sierra clause
- Clause will state conditions that must be fulfilled before rate
filing made
- Could be conditions based on time, other parties consent, etc.
NRG Power Marketing v Maine Public Utility Commission
Facts
- FERC approved settlement and redesigned New Englands
capacity electricity market which affected Maine,
Connecticut, and Massachusetts (MCM) even though they
werent parties to settlement
- MCM argued that FERC erred in finding that transition
payments under settlement should be reviewed under the
public interest standard required under Mobile-Sierra doctrine
rather than just and reasonable standard
Decision
- Question of whether Mobile-Sierra doctrines public interest
standard should apply to non-parties to a FERC settlement
- SCOTUS held that it did doctrine controls the FERC as well as
challenges to contract rates brought by contracting and noncontracting parties
- Held that Mobile-Sierra isnt exception to just and reasonable
standard, but application of that standard to context of rates
by contract
- 3 facts Commission must determine before overturning
rate

o 1) Impair financial ability of utility to continue

service
o 2) Cause them to cast upon other consumers an
excessive burden
o 3) Will be unduly discriminatory
Stevens dissented claiming that decision imposes special
burden on non-contracting parties attempting to exercise their
rights to object to unreasonable rates

California Public Utilities Commission v Sellers of Long Term

Contracts
Facts
- California Electricity Oversight Board (CEOB) and CPUC filed
complaints claiming that rates and T&C of certain LR contracts
(including Dynegy Long-Term Contract) were unjust and
unreasonable and sought to modify the contracts
Decision
- Found to be reasonable
Negotiating exercise
Business day definition
s. 7 Warranties
s. 10
Dispute resolution provision
Modification to Mobile-Sierra clause