California Energy Crisis and Its Lessons for Power Sector Reform in India

Author(s): Amulya K. N. Reddy

Source: Economic and Political Weekly , May 5-11, 2001, Vol. 36, No. 18 (May 5-11,
2001), pp. 1533-1540
Published by: Economic and Political Weekly

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 California Energy Crisis and Its Lessons
for Power Sector Reform In India
What appears to be an unstoppable and unquestionable 'consensus' regarding
the necessity of restructuring/reforming the electricity sector in India has been shattered
by the unbelic able news of the California energy crisis. In a state at the forefront of the
IT revolution, there have been unscheduled interruptions of power and rolling blackouts
covering hundreds of thousands of consumers. Suddenly, the situation there appears no
different from backward developing country cities. This paper is addressed to the
task of understanding the California energy crisis through a factual description
of the crisis and a discussion of the causal factors responsible for it. It concludes with
drawing the lessons from the California energy crisis particularly with
regard to power sector reform in India.

AMULYA K N REDDY

T he imperative necessity of restruc- system had a capacity of 52,349 MW in state's electricity industry to competition.
turing/reforming the electricity 1998. This consisted of 21,686 MW from Following a debate in the state capital, the
sector in India to overcome the non-utility sources including co-generation then governor Wilson signed the 'deregu-
financial ill health and technical shortcom- and of 30,663 MW from utilities - hydro- lation' bill on September 23, 1996. On
ings of the electricity boards is being electric plants (25.8 per cent), petroleum, March 31, 1998, the California Power
repeated ad nauseum, particularly by the gas- and dual-fired thermal plants (21.6 Exchange, the largest electricity market in
multilateral donors and their acolytes in per cent), nuclear plants (8.2 per cent) and the world, came into being to determine
government and academia. To justify the renewable sources (2.9 per cent). 82 per wholesale electricity prices.
recommendations, there are hand waving cent of the electricity was generated within
references to the successes of reform in the the state and 18 per cent was from out- Objectives
industrialised countries. Just when the of-state generation. 53 per cent of the oil Strictly speaking, the term deregulation
process appeared to be unstoppable and was produced within the state, 32 per cent should be used only when the generation,
unquestionable, the 'consensus' has been from Alaska and 15 per cent imported from transmission and distribution of electricity
shattered by the unbelievable news of theforeign sources. Only 16 per cent of the - involving both wholesale and retail
natural gas was produced within the state, electricity - are determined by market
California energy crisis. In a state at the
forefront of the IT revolution, there have
56 per cent was from other parts of the US forces without any intervention of the state
been unscheduled interruptions of power and 28 per cent from Canada. in decision-making. This complete with-
and rolling blackouts covering hundreds .In 1994, when California was just com- drawal of the state from all aspects of the
of thousands of consumers. Suddenly, the ing out of a strong, persistent recession, electricity system is not found anywhere.
situation there appears no different fiomthe role of its electricity system came under Different countries and regions reveal
backward developing country cities. One scrutiny. California's electricity prices were various extents of deregulation. The
is reminded of Hans Christian Andersen's relatively high in comparison with other Californian pattern of deregulation is a
story where it is discovered that "the states in the US. The main reason for the particular brand to emphasise which it will
emperor has no clothes". Clearly, there is high prices was that its consumers werebe referred to throughout this paper in
a need to understand the California energy burdened with the cost overruns of nuclear quotes as 'deregulation'.
crisis and to draw the lessons for India and powerl and the costs of high-priced alter- The Californian 'deregulation' process
other developing countries. native electricity (green power)2 - addinghad many objectives amongst which the
up to stranded investments of about $ 28following were prominent. (1) The large
Background billion. The century-old system of regula-vertically integrated utilities, Southern
California is the third largest state in the tors setting rates and guaranteeing an invest-California Edison and Pacific Gas and
US. With a population of about 34 millions ment return to the stockholders gave utili-Electric, would be compensated for their
in 2000, it has an area of 4,24,002 sq km, ties little incentive to trim costs since in any 'stranded costs' arising from uneconomic
which is roughly one-eighth the size of case most of these costs would be passedpower-generating capacity acquired in
India. If California were a separate coun- on to customers. Free-market proponentspre-'deregulation' days and for excessive
try, its economy would be the sixth largest argued that prices would drop if electricitypayments for alternative energy. (2) These
in the world. To serve its approximately providers had to compete for users. utilities would be relieved of their respon-
34 million electricity consumers with a peak In December 1995, the state's Public sibility for generation so that they could
demand of about 30,000 MW, its power Utilities Commission voted to open the focus primarily on transmission and dis-

Economic and Political Weekly May 5, 2001 1533

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tribution. (3) The construction of cleaner pel sales of electricity and natural gas to
frozen consumer rates because they antici-
fossil-fuel plants would be promoted. California and this federal ruling was
pated that the trend of falling wholesale
renewed six times.
(4) Greateruse of renewableenergy sources prices would continue and they would reap
would be encouraged. (5) Electricity trad- windfall profits from the difference be-
ing would be subject to market forces. tween the frozen retail prices and the falling Current Energy Crisis
(6) Customers would be given a choice of wholesale prices. Independent power pro-The development of the current Califor-
electricity suppliers. (6) Electricity retail ducers supported the move to get a piece nia energy crisis and its 'resolution' with
prices would be lowered. of the 'cake'. Manufacturers lobbied for short-term measures and a rescue plan can
be described with a chronology of the
the ability to buy their electricity cheaper
California's 'Deregulation' from companies other than Pacific Gasimportant
& events for a crucial one-month
California's 'deregulation' consisted of Electric, Southern California Edison and period.
several measures. The state's utilities wereSan Diego Gas & Electric. Environmen- January 7, 2001: A major storm resulted
compensated for their 'stranded costs' with talists wanted to preserve the half- in near shut down of the Diablo Canyon
the burden being passed on to new entrants billion-dollar annual subsidy for renew- 2,200 MW nuclear power plant because
to the generation scheme and to consum- able energy technologies. Labour hoped to waves of nearly 20 ft forced kelp into the
ers. This compensation to the utilities has win money to retrain utility workers. pipes that suck in sea water for cooling the
been considered by some to be excessive Consumers wanted implicit subsidies to plant. The loss of power adversely affected
compared to the book value of the assets. continue but interestingly, they were sh'ut the supply-demand gap.
The utilities were also compelled to sell out of the negotiations. Jacinuary 8, 2001: California's governor
their gas- and oil-fired (non-nuclear) power Davis in his State of the State Address said,
Year before Crisis
plants in California to other companies. "California's deregulation scheme is a
The intention was that a sufficient number The new millennium brought with it colossal and dangerous failure" and pro-
of new power plant owners would enter many indications of the looming electric- posed steps to reassert the state's control
the generation scene so that none could ity crisis. The electricity demand was far over its power market. It was felt that
single-handedly influence the price ofgreater than expected. In fact, it grew three out-of-state companies selling power to
electricity in California's new marketplace times more quickly than anticipated. The California were charging exorbitant prices
for electricity. heat wave in May 2000 aggravated the for electricity on the spot market for
Stripped of most of their generationpeak summer demand. From June 2000 immediate delivery. In fact, power produc-
capacity, utilities had to buy all their electri-onwards, the wholesale price of electricity ers were accused of price gouging.
city requirements in a transparent manner. rose alarmingly - there was a tenfold January 9, 2001: President Clinton called
This had to be done one day in advanceincrease from about $ 0.050/kWh to about a meeting of federal and state officials to
from the California Power Exchinrge,$the0.522/kWh. The rise in wholesale electri- resolve the California energy crisis. The
set prices was much greater than could governors of California, Oregon and
state-run wholesale electricity marketcity
up for the purpose. Any shortfalls hadbe to
accounted for by the rise in natural gas Washington argued that the federal govern-
be made up on the last day by a secondprices. The state's major utilities (Pacific ment should put a price cap on wholesale
organisation, California's IndependentGas & Electric and Southern California power. Clinton's Energy Secretary agreed,
Service Operator (Cal-ISO). Consumer but not the Federal Energy Regulatory
Edison) were paying far more to buy power
Commission.
than they were allowed by 'deregulation'
prices were capped or frozen until utilities
paid off their debts3 or until 2002. To win
to charge consumers. Thus, contraryJaniary
to 11, 2001: Following the biggest
widespread popular support, the 'deregu- storm in three years, governor Davis or-
expectations, the wholesale price ofeiectri-.
lation' was started with a 10 per cent dered a wide-ranging energy conservation
city was much greater than the retail price
reduction in consumer rates. Participationand the difference represented a loss to crash
the programme involving inter alia the
utilities. In places where there was no replacement
by utilities in the 'deregulation' was volunt- cap of bulbs in traffic lights with
ary and it is important to note that many on consumer prices (for example, San more efficient versions, redirection of
power from state-owned aqueducts to
Diego), businesses and homes paid more
cities with publicly owned utilities includ-
ing Los Angeles, Burbank, Riverside,in the summer of 2000 compared to the the grid, rebates on energy-efficient
Glendale and Anaheim, diJ not join the
previous year (for instance, they paid $ equipment,
10.9 etc.
experiment. billion more in San Diego). The power
Jan!uary 15, 2001: Electricity suppliers
threatened the payment-defaulting
system reserve ratio (defined as the ratio
Champions of 'Deregulation' utilities to take them to bankruptcy court.
of excess capacity to peak demand) started
The 'deregulation' scheme attracted a Ja(nuary
falling to dangerous levels. There was a 16, 2001: A Stage 3 Alert was
numberof:champions. The California PublicBay area blackout in summer and there declared. The California Independent
Utilities Coninission and the California were shortages on 22 days. The state even Service Operator, which manages the grid,
declared an emergency when there was a declared an emergency. The utilities asked
legislature were the architects of the plan
stage 3 Alert because the power system for a one-week deferment of payments.
to open electricity prices to market forces.
Investor-owned utilities, eager to be reserve
un- ratio had fallen below 1.5 per cent. Southern California Edison announced that
Seeing the precarious financial situation
burdened of their stranded assets, spent it would not pay $ 596 million due to
$ 5.3 million on lobbying and donationsof the utilities, suppliers became reluctant creditors to 'preserve cash'. This under-
to bring in 'deregulation'. The utilities
to supply them with electricity. Towards mined the ability of the utilities to buy
wholeheartedly supported the idea the of end of 2000, the Clinton administra- power on credit. Credit rating companies
market-determined wholesale prices and tion exercised emergency powers to com- reduced the rating of utilities to that of

1534 Economic and Political Weekly May 5, 2001

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junk bonds below investment grade. The total requirement compared to the two- because computer-based businesses in
utilities moved towards bankruptcy. thirds from (a) generation in the plants that particular, and the IT sector in general,
Out-of-state generators became reluctant the utilities were allowed to keep after increased demand (for stable and reliable
to sell power to California for fear that they'deregulation' and (b) cogenerators and power) and consumed electricity at rates
decentralised generators (wind and solar unheard of in the old economy. But there
will not be paid. The state assembly passed
a bill for the state to buy power frompower). The state was expected to sign was also a serious slackening of conser-
generators at long-term rates and sell it to
long-term contracts to buy power and sell vation efforts even when wholesale prices
it to the customers of the financially skyrocketed. This slackening was not
utilities thus emphasising a key role for the
state in the electricity market. strapped utilities. For this purpose, the helped by the rate freeze for consumers,
Jaznuty 17, 2001: Several factors - short-state would spend $ 500 million more whicll insulated them from wholesale
falls in generation, transmission bottle- (over and above the previous $ 400 mil- prices. There were also problems on the
necks and the financial ill health of the lion) buying electricity on the expensive supply side because polluting plants were
utilities - brought California's power spot market while making cheaper long- idled and old power plants (55 per cent
system to the brink. But, the system was term deals with wholesalers. In order to of California's plants were more than 30
pushed over the edge by the sudden encourage conservation, there would beyears a old) operated less efficiently. In the
decline in hydroelectric generation aris- tight supply situation, some generators
rate increase for residential customers using
ing from inadequate rainfall in the reser- were shut down because of untimely un-
30 per cent more than a baseli ne that varied
voir catchment areas. Rotating power with climate and end-uses. Governor Davis scheduled power-plant maintenance - fo;
cuts for up to one-hour duration affect- announced emergency conservation mea- instance, on March 19, 12,367 MW went
ing half a million consumers at a time sures (for example, curtailing outdoor out of action when the 7 PM demand
were implemented. Enron, an out-of-state lighting) intended to reduce demand by up reached 29,270 MW. Though California
supplier, stated that it would limit sales to 20 per cent. imports 18 per cent of its electricity, no
to utilities that are not credit-worthy. February 1, 2001: After an initial hiccup, new major power plants had been built in
Governor Davis declared an Emergency the Legislature also approved the Senate California in the 1990s. This lack of new
and ordered California's department of plan. With a new approach in place to capacity has been blamed on the citizens'
water sources to become the principal purchase electricity, the California Power 'Not in my backyard!' (NIMBY) attitude
purchaser of power from generators. It also Exchange that was set up for these pur-to new plants. Finally, just when California
became the seller of power to financially chases was shut down. depended most on importing power from
strapped utilities. February 2, 2001: Since the impactsout-of-state,
of there was increased demand
January 18, 2001: This was the second day the California energy crisis were feltin allstates exporting power to California.
of rotating blackouts affecting several over the western part of the country,Trcansmission
the bottlenecks: Trading in
million customers. Industry responded with governors of nine western states organised power has resulted in greater distances
temporary lay-offs of workers. Some pro- an Energy Policy Roundtable at Portland between generators and consumers as a
duction units were moved to other states. (Oregon). The purpose of the meeting was result of which the transmission grid is
The state's energy crisis threatened every- to plan their energy future based on overtaxed. In particular, there is a trans-
thing from milk supplies to gasoline de-short-term solutions to their energy short- mission bottleneck at Path 15 when electri-
liveries. Traffic lights went out in the Bay ages as well as a long-term plan for copingcity flows froln California's south to its
area, computer screens went dark, heaterswith increasing energy demand. To co- north. Unfortunately, 'deregulation' and
and bank machines were silent, and lightsincide with the start of the Roundtable unbundling has resulted in a situation where
went out in classrooms. California with on February 2, governor Locke of Wash- there is little incentive to invest on a trans-
50,000 MW capacity should have had ington no state published a New York Times mission grid that is accessible to all gen-
trouble meeting a 31,000 MW peak but op-ed article in which he said: "This erators.
is
11,500 MW became unavailable due to not a 'normal' market where the integrity Natural factors: The weather did not help
unscheduled plant shutdowns. Californiaof price signals needs to be protected. This the situation. Storms led to the shut down
lawmakers passed a $ 400 million rescueis a highly distorted market where inter- of the 2,200 MW Diablo Canyon nuclear
plan to buy electricity on the expensivevention is needed. And because interstate plant. And, late runoff on the rivers of the
spot market. Southern California Edisoncommerce is involved, only the federalPacific north-west reduced hydroelectric
was suspended from the California Powergovernment can supply this intervention." generation.
Exchange. The energy secretary Abraham from theDecfcts in 'deregulation': A sweeping
January 23, 2001: The new president, new Bush administration attended the divestiture (involving old generators being
George Bush, extended by two weeks Roundtable and praised California's forced to sell off most of their plants) was
federal orders that require power prod- energy bill. However, he rejected requests implemented without ensuring that new
ucers to sell surplus electricity and natural from eight of the governors for priceowners would sell electricity at a reasonable
gas to California, but said that after caps arguing that'they are disincentivesprice for a long number of years. There was
February 7, California would have to against reducing demand. widespread failure on the part of utilities
resolve its crisis on its own. to anticipate that energy supply companies
Causal Factors
January 31, 2001: The California Senate could easily exploit the mechanism and
approved a $10 billion plan to make the Supply shortage with respect to demand: earn very much more than the going rate
state a major power buyer to rescue utili- There was a gross underestimation of by holding back electricity and selling it
ties from bankruptcy. State purchases were California's electricity demand, which when the system was desperate for elec-
expected to account for one-third of the grew 25 per cent in 1990s. This was partly tricity. There was inadequate regulation of

Economic and Political Weekly May 5, 2001 1535

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wholesalers. 'Deregulation' did not prompt Myths Regarding Roots of crisis. In reality, volatile wholesale elec-
more competition right away. 'Deregula- California Energy Crisis tricity prices became increasingly greater
tion' has also resulted in disincentives not than capped retail prices resulting in the
only for new capacity but also for improve- Before proceeding, it is important toaccumulation of huge utility debts.
ment/expansion of transmission and for Rdispel some myths regarding the roots of Myth #2 is that the crisis arose from the
and D relevant to transmission. the California energy crisis. fact that the consumer rates were frozen
Imperfect market: On November 1, 2000,Myth #1 is that the crisis arose because and if they were allowed to rise, the utili-
the Federal Energy Regulatory Commis- retail rates were frozen whereas whole- ties would not have suffered losses. The
sion commissioners called the California sale electricity prices were allowed tofact
be is that where retail prices were not
market 'seriously flawed' and said that determined by the market. The implica- frozen, the resulting rise in prices led to
they found clear evidence of market powertion is that the 'deregulation' did notago revolt of consumers and to a political
far enough and was restricted only crisis.
based on rising natural gas prices, higher to Hence, uncapping retail prices is
wholesale but not retail prices. The de-
loads and supply disruptions. Cal-ISO also a non-solution when wholesale prices are
as volatile as they were in California.
regulation loyalists argue that all is well
became an easy way of bypassing the market
with deregulation (the real thing); it is theMyth #3 is that the crisis stems from the
- all that suppliers had to do was to withhold
Californian pattern (the unreal thing) that
electricity until the last day and, in order 'stranded costs' of the utilities arising from
is at fault. Thus, The Economist subtitled
'to keep the lights on', Cal-ISO would uneconomic power-generating capacity
have to buy at whatever exorbitant prices acquired in pre-'deregulation' days and
its January 20, 2000, article: "Don't blame
were quoted. deregulation for the chaos in California's
over payments for alternative energy. If,
Financial concerns: As the debts of utili- electricity supply industry. Blame 'de- however, according to the expectation of
ties accumulated to staggering proportions regulation'." The problem with this logicutilities from 'deregulation', the proceeds
($ 13 billion in debts), credit rating agen-is that if wholesale electricity prices had
from the sales of generation plants plus the
cies started rating California utilities as become increasingly lower than frozen gains from the difference between frozen
junk bonds less than investment grade. As consumer rates -- this was the 'deregula-consumer rates and lower wholesale electri-
investor-owned utilities approached bank- tion' scenario expected by the utilities - prices had been used as compensation,
city
ruptcy, they could not purchase electricity the utilities would have made windfall the stranded assets problem would have
for distribution. profits and there would have been no disappeared.

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1536 Economic and Political Weekly May 5, 2001

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 Assessments of California's scared the other states in the US that were and sell it to the utilities. (2) The utilities
'Deregulation' rushing along into deregulation - they are can be kept solvent while arranging
now applying the brakes on deregulation. long-term supplies of power to address the
There have been several negative assess-
It appears that deregulation is dead! shortages. (3) The state can buy power on
ments regarding California's 'deregula-
tion'. For instance, it has been said, "Cali- long-term contracts and insulate the dis-
California Governor's Rescue
fornia was hailed as a model for the rest tribution utilities from spot market pres-
Plan and Its Sequel sures. (4) A price cap can be imposed on
of the nation. And it has been a model -
of how not to do it". It has also been wholesale power. (5) Power plants can be
To tackle the energy crisis, California's
Governor's announced on February bought
asserted that deregulation has been "...one 15, and built so that the state becomes
2000, a strategy for tackling the more self-reliant with respect to external
state's
of the most expensive public policy mis-
suppliers. (6) Crash conservation measures
calculations in California history." energy crisis. This strategy aims at stop-
ping the financial haemorrhage of the can be implemented on a war footing.
The fundamental objective of 'deregu-
lation' - that consumers should exercise utilities and rescuing them from bank-After securing approvals from the state

choice of suppliers - was not realised. In ruptcy. It involves the following compo- congress and senate and 'successful'
fact, consumers by and large persisted with nents: (1) re-regulation of the negotiations with the main utilities,
electricity
sector involving massive intervention governor Davis addressed the state on
their old suppliers - less than 2 per cent
.of the state, (2) rescuing the utilities April 5 regarding his energy plan. The very
of homes switched to a new supplier
with financial inputs, (3) improving next
the day, PG & E made a move that took
compared to 25 per cent in UK. In the
California pattern of 'deregulation', a new electricity supply position so that the the governor by surprise - PG & E
even
filed for bankruptcy. This meant that while
marketplace in which prices fluctuatedsystem has enough reserve capacity to
cope with nature's vagaries, unscheduledit could continue to conduct its business,
violently replaced a monopoly in which
maintenance of plants, etc, (4) stabilising all decisions regarding its assets, debt
government set stable rates. 'Deregula-
wholesale electricity prices, and (5) payments, etc, would have to be decided
pro-
tion' resulted in enormous spikes in
tecting consumers from excessive rate by a bankruptcy court. Thus, another
wholesale prices. Increased revenues from
increases, crucial actor- the bankruptcy judge -
price hikes flowed to out-of-state energy
It is proposed that the state interveneshas entered the California energy scene
firms (for example, the Houston-based
Reliant Energy). Power producers are now in the electricity sector by (1) buying perhaps
the setting back the governor's plans
transmission system of the utilities to procure PG & E's transmission system.
with
being investigated for jacking up whole-
sale prices because of power shortages and cash from a bonds issue, (2) promoting The the governor soon announced that
financial troubles of utilities. California establishment of new capacity, (3) stabilis- SCE, in contrast to PG & E, had agreed
ing wholesale electricity prices at afford- to sell its transmission system to the
regulators estimated that generators
state. At the moment of writing (April 15,
charged $ 6.2 billions above competitive able values, and (4) permitting some in-
crease in customer rates. With 2001)
regard to it is not clear how the state and the
levels over 10 months. Investor-owned
wholesale electricity prices, apart from spot bankruptcy court will proceed with
utilities were pushed to bankruptcy (hav-
governor's plan.
purchases on behalf of utilities to circum-
ing run up about $ 13 billion in debts)
vent
because wholesale prices (reaching $ 1.40/ their loss of credit rating, the state
Issues Thrown Up by California
kWh) went far above retail prices (cappedwould also enter into long-term purchase
Energy Crisis
contracts with suppliers and with the utili-
at $ 0.066/kWh). At the same time, utilities
ties for the generation still under their
transferred billions to their parent compa- The California Energy crisis has thrown
nies - Edison transferred $ 4.8 billion andcontrol, and reduce the rate at which up
al- several crucial issues that need to be
addressed.
Pacific Gas and Electric $ 4.7 billion be- ternative energy is purchased.
tween 1996 and November 2000 - in Five sources of fresh cash infusion for Was California's 'deregulation' just
transactions that are now the subjectutilities
of are envisaged: (1) the sale to the badly implemented and can its electricity
audit and investigation. Generators state be- of their transmission (not distribu- market be made to work for example by
came reluctant to sell power to utilitiestion!) systems with about 32,000 miles of long-term contracts for wholesale electric-
wires for about $ 7 billions, (2) sale of fresh ity and/or uncapping consumer prices? If
because their credit ratings plummeted.
Cogenerators (accounting for 20 per bonds cent to the public, (3) dedicated rate the retail prices were unfrozen, would the
increases for customers in lieu of transmis- inevitable rise in consumer prices be
of supplies) had not been paid as much as
theycharges, (4) fees for operating the politically viable? Or was California's
$ 500 million. To survive, utilities say sion
need a release from 'deregulation'. 'De- transmission systems and (5) transfer of 'deregulation' 'botched' so thoroughly by
funds
regulation' has capped earnings from trans- to utilities from their parent com- the two-step purchase of wholesale elec-
elec- With these cash receipts, the utili- tricity that it could not possibly work
mission. 'Deregulation' has made the panies.
ties can unburden themselves of the mas- especially amid shortages?
trical system less technically reliable. Cities
like Los Angeles with publicly owned sive debts arising from wholesale electric- When 'deregulation' in California is
ity prices being increasingly larger than the compared with deregulation in Europe,
utilities that opted not to be deregulated
have been unaffected. It was said: "You frozen consumer rates. can the difference in outcomes be explained
look at where the lights are on in California,The measures planned by Californiaby the capacity excess, system reliability
and you look at the municipal utilities!" suggest that there are several short-term and rate unfreeze in Europe compared to
California's 'deregulation' is now deemed the capacity shortage, system unreliability
steps that can be taken to tackle a California-
and retail rate freeze in California?
type energy crisis. (1) The state (with its
a failure needing large-scale intervention
good credit rating) can purchase power Is the California crisis simply the result
in market. The California energy crisis has

Economic and Political Weekly May 5, 2001 1537

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of utilities competing for increasingly scarce ment of consumers would receive little the agencies and the regulatory practices
wholesale power in contrast to the expec- emphasis. And long-term R and D would to tackle the problein of the integrated
tation that, after 'deregulation', wholesalers get scant attention. operation of the whole system. But, the
would be competing to supply utilities? It is because of these limitations of the challenge requires special attention.
Should there be a cap on wholesale market and the virtual certainty of public In the past, electricity generation also
electricity prices based on cost-plus pric- benefits being neglected that regulation ofdisplayed strong economies of scale of
ing or should there be a vibrant and robust the market becomes imperative. Thus, generation (- 1,000 MW plants) and of
market for wholesale power? marketisation and regulation are two sides regional/national transmission grids
Should stranded costs be passed on to of the coin of restructuring. If there is (stretching hundreds and thousands of
consumers or should they be borne by marketisation without regulation, public kilometres). An alternative approach is to
shareholders because they are the result of benefits would be under-emphasised and emphasise decentralised and distributed
bad decisions by utilities, for example, perhaps even jettisoned. Already evidence generation and localised distribution. In-
with regard to choice of generation is pouring in from 'successfully' reformed deed this was the norm in the early days
technology? utilities in developing and industrialised of electrical systems but gradually the grid
Should utilities be allowed to go bank- countries that equity programmes, end-use started hooking together the local systems
efficiency measures, renewable sources
rupt or should they be saved by re-regulating because large-scale generation coupled to
the system with a major state presence in and energy research and development are extensive grids became more cost-effec-
electrical power? shrinking.4 tive. However, new technologies of dis-
Should the state concern itself with self- Quite apart from these general consid- tributed generation (for example, through
reliance in energy (and in the words of erations, it must be noted that electricity micro-turbines of - 1 MW) are becoming
governor Davis 'take control over our has several unique characteristics that increasingly viable. Today it can be argued
energy destiny') or should it allow intra-distinguish it from other commodities such that electricity is no more a natural mo-
country globalisation to take its courseas oil or natural gas and make marketisation nopoly, as it was in the past.
even at the risk of out-of-state profiteers.of electricity a different proposition. (1) For Assuming that tha classical vertically
all practical purposes, electricity 'cannot' integrated electricity monopolies are inef-
Fundamental Considerations
be stored economically except to a limited ficient and pass on the associated costs (of
There are also fundamental consider- extent through pumped storage and com- inefficiency) to their customers, and also
ations. For instance, can the power sector
pressed air storage. (2) Hence, continuous assuming that competition is the key to
supply-demand matching is required. If
(or for that matter, education, health, water, efficiency, there should be an emphasis on
roads, communication, transport, and all falls short of demand, the frequency
supply introducing competition into the system.
other infrastructural services) be le: falls
com- below the value for which generating This thrust has inspired reform of the
pletely to the market along with a and total
utilisation equipment is designed. And, electricity sector. But, it has invariably, but
withdrawal of the state? Markets (with if supply exceeds demand, frequency rises not always, been coupled to privatisation
vibrant competition) foster efficiency above
butthe frequency that is healthy for with the faith that efficiency requires
they also have limits. In general, with generating
their and utilisation equipment. privatisation. The experience, however, is
preoccupation with the bottom line (3) (of
Demand varies hourly, daily and season- -not uniform. Norway which is reputed to
ally with the peaks in demand being well
balance sheets), they have grave shortcom- have one of the most efficient electricity
ings. They do not safeguard equityabove
andthe 'average' demand. (4) Electri- systems, has introduced competition in
distributional justice. They are not both-
city has become so essential that demand generation whilst overwhelmingly retain-
ered about the environment (unless isenvi-
relatively price-inelastic. (5) Electricity ing public ownership, i e, it has coinpe-
ronmental externalities are internalised).
is very easy to control in the sense that tition without privatisation. The question
a supplier can easily turn the supply on
They are unconcerned about the strengthen- therefore is: what should be the objective
or off.
ing of self-reliance and the empowerment function - privatisation or competition?
of people and their communities. And they
An integrated system ofgeneration-trans- and if competition is the objective, it must
mission-distribution can handle the above
pay no heed to the long-term, particularly be accepted that privatisation is not essen-
research and development. in short,unique characteristics of electricity fortial. Privatisation is a separate agenda.
example by load dispatch centres that keep But, is economic efficiency the sole
markets do not protect public benefits.
the supply and demand in balance. Unbun-criterion in power sector reform? or must
In the case of the power sector, however
much market-driven efficiency maydling leadof the system into separate genera-one go beyond that to achieve public
to profit maximisation at the level oftransmission and distribution entitiesbenefits such as equity/access, self-reliance,
tion,
utilities, the balanced development of raises
the the problem of the integratedenvironmental soundness and the
whole sector is likely to be neglected. A
operation of the whole system. If all the long-term through R and D. If so, susta
profit-oriented electricity body would units
focusresulting from unbundling are drivenability should be the real objective in pow
on servicing profit-yielding customers. It
by profit maximisation (all players pursu-sector reform.
would have no incentive to connect and ing their self-interest), there must be an
serve un-connected consumers unless the authority that will coordinate their opera- Lessons of Californian Energy
Crisis for India
tion for supply-demand matching. The
resulting revenues justified the additional
absence of such an authority aggravates Before identifying what lessons the
investment. The protection of the environ-
ment through an emphasis on end-use the problem of grid discipline and man-Californinn energy crisis has for India, it
efficient devices and renewable sources agement. In principle, however, it is pos-is important to start with a brief analysis
would also .,e sidelined. The empower- sible for an unbundled system to establishof the power sector in India. In particular,

1538 Economic and Political Weekly May 5, 2001

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following the American adage: "If it ain't dation. Despite this, the WB approach is supplied to consumers and (3) the conti-
broke, don't fix it!", it is vital to decide being forced on the various states of India. nuity of the supply, and all these must be
whether the power sector in India is broke The objections and opposition are being within specifications.
and whether it can be fixed. There are three steam-rolled and brushed aside with the Lesson #4: Whereas a vertically integrated
responses to this question: (1) "it ain't leverage of conditionalities imposed by
system has to cope with sudden peaks in
broke and it does not need to be fixed", lending agencies. demand with reserve (capacity) margins of
(2) "it is broke but it is fixable and there- In this context, it should be noted that 15-20 per cent, an unbundled system in-
fore it should be fixed" and (3) "it is broke the California 'deregulation' bears strongvolving a large number of wholesale
but it is unfixable and therefore it should similarity to the WB approach particularlygenerators may have no incentive to
be scrapped and replaced". maintain such reserves. In fact, when
with regard to unbundling the electricity
The diehard command-and-control sector and privatising its components.
reserves fall below to precarious levels,
Hence, it is important to draw crucial
votary articulates the first response insist- profitable price increases may be facili-
ing that all is well with the vertically lessons from the California energy crisis kated. So, the policy, technical and insti-
integrated electricity boards and nothing to safeguard the Indian power sector. tutional measures to ensure safe reserve
needs to be done. However, the consum- Lesson # 1: It is not enough to point to margins are extremely important.
ers, the state and the balance sheets, havespecific shortcomings of the regulated Lesson # 5: The affordability of retail
a different story. electricity system, and therefore assume
electricity prices to consumers is a neces-
sary condition for the success of restruc-
From a detailed diagnostic case study ofthat a market-driven system will be ipso
Karnataka's power sector5, the Inter- facto nmore successful and advantageous turing, but it is not a sufficient condition.
national Energy Initiative came to theto society. The establishment of a market- Whether the consumer prices are frozen
conclusion that its power sector is 'brokedriven system is associated with transac-
or not, if wholesale electricity prices rise
but fixable' and that it should be fixed. tion costs and gestation times. Hence, above
a the retail prices, and the difference
lEI's bottom-lp cure for the sickness careful
of comparison of the costs and bene-
is borne by the utilities, then the utilities
Karnataka's Electricity Board includes, fits of tlt old regulated system and thego increasingly into debt - a process that
apart from internal generation of revenuesnew deregulated system is essentialis not financially sustainable. Hence, the
before dismantling the old and ushering
by eliminating theft of power, institutional impact of restructuring on prices must be
in the new.
changes consisting of liberation from direct anticipated before rushing into restructur-
government management control through Lessoni # 2: If it is decided to replace a ing particularly unbundling and privati-
corporatisation, and the establishment of cost-plus price regime with market-driven sation. In fact, the success of restructuring
an Electricity Regulatory Commiss1ion. prices, then it must be realised that a market must be judged by the behaviour of whole-
alone is not sufficient. It must be demon-
Further, as long as there is no) net subsidy sale and retail electricity prices. If there
to the power sector. subsidies to particular
strated (not merely argued!) that the marketare any doubts about the reliability of the
consumer categories and cross-subsidies does not permit the exercise of marketforecasting of prices, it is advisable to test
depend upon whether they are politically power. price gouging and gaming. Inthe assumptions und-rlying restructuring
necessary and acceptable. addition, the extent of competition mustin experimental areas.
There is only partial overlap between be monitored and it must be shown that Lesson # 6: Notwithstanding any general
IEI's bottom-up cure for the sickness ofthere is indeed effective competition.. considerations and expressions of faith
SEBs and the World Bank's top-down
Lesson # 3: The case for unbundling the regarding the wisdom of leaving the
reform process. The World Bank's cure power sector must not be made merely on development of the infrastructure to the
goes beyond corporatisation and the economic grounds (such as separate profit market, the unique character of electricity
establishment of an Electricity Regulatory centres, etc); the restructuring must also is such that a strong role for the state and
Commission. In addition, the WB also be justified convincing on technicalfor regulation is essential. The market alone
insists on unbundling of the vertically grounds. Thus, apart from economists and cannot take care of the integrated function-
integrated system into separate- gener-bureaucrats, power system engineers must ing of the electricity system, and therefore
ation, transmission and distribution also be involved. In particular, a techni- the requisite regulatory arrangements must
entities, and removal of all subsidies cally stable and institutionally sustainablebe in place. For example, it is important
and cross-subsidies. Further, the WB isintegrated operation of supply-demand to have mechanisms in place to ensure that
insistent on privatisation of generation, matching must be ensured before unbun- there are adequate reserve margins to cope
transmission and distribution. Thus, the dling is implemented and the vertically with sudden peaks of demand and short-
WB approach is based on the view that integrated system is dismantled into sepa- falls of supply. These mechanisms may
the power sector "is broke and unfixablerate generation, transmission and distribu- well involve supplementary markets for
and therefore it should be scrapped and tion entities. There must be a clear under- capacity for instance. In case the process
replaced'. The WB acolyte wants a com- standing of which agency will commandderails - as happened in California - there
plete dismantling of the old system and the supply-demand fine-tuning and whethermust be emergency procedures for the state
its replacement with a totally unbundledits writ runs over the generators, transmis-to come to the rescue.
privatised the generation-transmission- sion grid and the consumers. And the Lesson # 7: The behaviour of the actors
distribution system. sensitivity of the process to electricity involved in the electricity system is radi-
Whereas the IEl approach is much more shortages and surpluses must be clarified. cally different under conditions of supply
cautious and incremental, the WB cure The quantitative indicators of the success shortages compared to that under condi-
involves major surgery with little record of supply-demand matching are (1) the tions of surpluses. Further, it appears that
of proven success to justify the recommen- frequency of the system, (2) the voltage the experience of restructuring has come

Economic and Political Weekly May 5, 2001 1539

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by and large from countries and systems There is however a fundamental differ-
ence in sources, there is considerable simi-
with surplus capacity. 7Ti,:, deregulation larity in the papers - the facts charac- ence in the attitude to reform/restructuring
under conditions of shortage is not the terising the California energy crisis are
supported by this paper and that revealed
proven success that is being touted; it i: identical and almost the same list of causal in the BJT paper. This paper would like
very much an unproven experiment with factors are cited. Perhaps, one differencea detailed diagnosis of the problems of the
California yielding the first disastrous is that the BJT paper attributes a greaterpower sector to pinpoint the essential
results. role to the rise in natural gas prices, whereas elements of reform/restructuring leaving
Lesson # 8: Compared to increasing capa- the present paper tends to view gas pricesmeasures such as unbundling and
city by building new power plants, energy as not having a dominant explanatory roleprivatisation - that have more ideological
conservation measures provide the quick- in the rise of wholesale electricity prices.than empirical justification - to be ap-
est way out of the crisis. What is surprising is the similarity inproached cautiously and incrementally, if
Lesson # 9: It is unwise to go ahead with some of the lessons for developing coun- at all. The BJT paper maintains its faith
restructuring/reform without specifying. tries that have been drawn by the two in reform/restructuring which it believes
the criteria by which the success/failure of papers. Whereas the BJT paper has given is as a must that will succeed if there is
the restructuring/reform process will be a far more elaborate treatment of what sufficient caution, testing and insurance
judged. can go wrong with regard to wholesale against design errors. [3
Lesson # 10: Notwithstanding all the competition and retail competition, the
hype about the economic efficiency of general validity of Murphy's Law - if Notes
globalisation, there are major advantages something can go wrong, it will go wrong!
[The learning that went into the preparation of this
of state electricity systems being self-re- - is implicitly upheld in both the papers.
paper was based on a daily perusal of the reports
liant in the sense of not allowing control Unfortunately, the BJT checklist of whaton the California Energy Crisis in the Los Angeles
to be assumed by forces external to the Times and the New York Times via their web sites.
to ensure before embarking on reform
state. This means that dependence on The author is moved to acknowledge the
has come with 20-20 hindsight after the
contributions of all those who have made the
external power must be a strategy of the California crisis, and not before the reform
Internet possible because without the Internet, this
last resort. was undertaken. Foremost among the study by a non-Californian residing in India would
Quite apart from these basic lessons that dangers are the possibility of market
not have been possible. In addition, thanks are due
the California energy crisis has thrown up power undermining the effectiveness toofthe staff reporters, correspondents and columnists
who wrote the various reports of these papers.
for power sector reform in India and other the market. Also, competition requires
Special thanks are also due to Anton Eberhard,
developing countries, there are interesting adequate installed capacity and the short-
Jose Goldemberg, J Mohan Rao, Otavio Mielnik,
comparisons between the short-term mea- term market does not encourage invest- C Rammanohar Reddy and Robert Williams for
sures being pursued in California and the ment in new capacity and the maintenancetheir prompt and insightful comments on the
difficult predicame,.: faced by Maharashtra February 20, 2001, first draft of this paper.]
of adequate reserve margins. The BJT paper
state and the central government over the lists the large number of conditions that
1 PG & E's Diablo Canyon Plant ended up costing
horrendous bills from the Enron power must be satisfied for success and under- $ 5.8 billion compared to the 1965 estimate
project in Dabhol. But, these comparisons lines the importance of insurance against of $ 400 million and the Onofre plant, $ 4.3
are reserved for a separate treatment. market flaws. Its crucial recommendation billion compared to the budget of $ 1.3 billion.
is a guarded experimental approach in-2 The high prices for alternative power originated
Postscript volving testing proposed structures. The
from overestimates of the future prices of oil
and natural gas.
The February 20, 2001 (first) draft of problem with the big-bang approach to3 The underlying expectation was that the pre-
this paper received a number of useful reform tried in California - to quote the 'deregulation' trend of falling wholesale prices
comments that were taken into account in BJT paper - is that it "is open to the risks would continue and therefore the utilities would

finalising the paper on March 28, 2001. of unexpected market conditions, as well realise greater and greater profits from retail
Just after that, the author received an as the unexpected ability of players to prices being increasingly higher than wholesale
prices and recoup their stranded investments
emailed version of the March 2001 paper 'game' the market. A structured transition by 2002.
'The California Experience with Power strategy is needed that is planning for steps 4 In California, 'deregulation' has not resulted in
Sector Reforms' by John E Besant-Jones that might be taken if crucial assumption, disincentives for R and D relevant to the electri-
and Bernard Tenenbaum from the Energy such as continuation of surplus power city system. Although such R and D activity
and Water Department, Private Sector capacity and low natural gas prices, proved has indeed declined sharply at the big utilities,
public interest energy R and D is being carried
Development and Infrastructure of the to be wrong." All this is in tune with this out with funding from the System Benefits
World Bank. Since the Besant-Jones- paper's approach to restructuring/reform
Fund (SBF) created under 'deregulation' with
Tenenbaum (BJT) paper deals withthat
theit is better to make small reversible revenues from a non-bypassable wires charge
same topic and also draws lessons for than large irreversible mistakes on all generators. A SBF appropriately crafted
mistakes
and managed, can be used to support a wide
based on theory and ideology.
power sector reform for developing coun-
range of public benefit activities - and in fact
tries, it is useful to make some compari-
It is unfortunate that the BJT paper has the California SBF does support many such
sons with the present paper. not provided checklists to insure against activities. California is one of the few places
Whereas the present paper is basedfailures with regard to the basic reforms around the world where public benefits
virtually entirely on internet sources in
of unbundling and privatisation being protection was provided for as a key provision
advocated for India. It has, however, of electric sector restructuring legislation.
general, and reports of the Los Angeles
5 Reddy, A K N and D Gladys Sumithra, 1997,
stressed the importance of the system
Times and the New York Times newspapers 'Karnataka's Power Sector- Some Revelations',
operator and the vital function of supply-
in particular, the BJT paper has more diverse Economic and Political Weekly, Vol XXXII
demand balancing.
and academic sources. Despite this differ- No 12, pages 585-600, March 22-28.

1540 Economic and Political Weekly May 5, 2001

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