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It is tough to be in the power business in California
 
 
There have been points in my life where I have felt like the “font of wisdom” in some person’s life. For example, when my wife and I were dating and up until we were married, it seemed as if my every opinion was golden. That situation stopped somewhere around the return from the honeymoon. Similarly, my kids used to come to me with most any problem or any question. About the time they got drivers licenses, my “Oracle” status came to an end.

Fortunately, I have a true “font of wisdom” when it comes to energy related policy questions. For me, Christi Tezak is the best analyst in the energy industry for sorting out competing issues, laws and policies. I spoke to her and some others with experience in bankruptcy proceedings after Governor Newsom threatened to have the State of California “take over” PG&E. After all the conversations I had, the following occurred to me.

One more step, and I’ll shoot…

Assume for a moment that the state did take over the beleaguered utility. It would have to do so as a bankruptcy “workout." In such circumstances, the equity holders would likely get little to no return. Secured debt, consisting mostly of bondholders, would get some reduced value. That’s a standard bankruptcy workout. Recognize that many of the holders of equity and bonds are likely to be California residents. So far, so good?

Things only get more complex from there. If the state does not change the liability standard that has been at the root of the PG&E bankruptcy, who owns the risk when utility equipment may have sparked a wildfire? Normally public entities have certain protections from liability claims. Consider, though, that if the state has protection against claims under its unique “inverse condemnation” liability law, wouldn’t the insurance companies be on the hook for financial claims? Insurance companies have been the main reason the state has not changed its strange liability standard to something more traditional like “negligence.”

If, rather than the risk falling to insurance companies, the state assumes the risk under the inverse condemnation standard, then the state’s balance sheet is at risk for very large claims - $30 billion in the current PG&E calculation. We know that the state has run budget surpluses the last few years thanks to an economic expansion lasting a decade and the budget care of former Governor Brown. The state is in good shape now, but as recently as 2009, the state’s budget was in disarray. Even California does not have the Federal Government’s ability to “print money” to allow it to extend “full faith and credit” assurances. The risk to the budget for payment of claims of damages from the next incident – wildfire, etc. – could wipe out any future budget surplus.

But wait, wouldn’t a state agency have better motivation to manage capital, make wise investments and save money for state residents who use the system that was PG&E? Possibly.  As an example, one could argue that Salt River Project – an agency of the state of Arizona – is well run. But there are plenty of examples like the New York Power Authority (NYPA) and the Long Island Power Authority (LIPA) that have checkered histories of excessive costs and debt. Ironically, those entities ultimately had to be restructured with some of the assets privatized. Perhaps even more worrisome is the fact that states can issue debt (bonds) at cheap interest rates. This tends to provide an incentive to incur debt. Rare is the government administration that does not give in to this temptation.

I suspect that, at the end of the day, the state of California will not take over the utility for the reasons enumerated here. Additionally, it is too convenient a political “whipping horse” for the state’s politicians. When something goes wrong, many politicians like having an easy target to hit. Why spoil it?

Back to our regularly scheduled programming…

I have great regard for the people who operate and manage network markets like CAISO, SPP, MISO, and PJM. They do their best to operate an economically efficient market that enhances the operation of a reliable grid. While their commitment to independence is real, politics, overly controlling market monitors, or the financial challenges of its members often test it. These pressures can influence decision-makers resulting in policies that are, well, questionable. I would put PJM’s predicament regarding its capacity market squarely in this category.

Similarly, I think the CAISO’s aggressive regulatory and political constituency in the state, along with a very loose relationship with its Federal “parent," combine to incent questionable policies. Alone among the FERC regulated markets, the CAISO shuns any ownership of the way capacity (resource adequacy) is attained. This is probably because the CPUC wants it to keep it away from the Feds. The CAISO knows that FERC is eager to appease California whenever possible. Continuing with the “appeasement” analogy, the CAISO is Czechoslovakia in 1938. If Britain and France (FERC) don’t have your back, you must deal with the aggressor.  We know how that one went down.

This dynamic of uneven regulatory relations might explain why the CAISO is engaging in a dubious effort regarding “system market power." Typically, ISO market power concerns have been a matter of load pockets and local constraints. One of the benefits of a network dispatch of many balancing areas is that many resources are brought to bear and can compete over the entire area. I’m on record asserting that we have been too quick to mitigate so-called “market power” in the electric sector. It undermines the incentives for hedging, physical contracting and demand response. You get what you pay for, and mitigation distorts price signals.

If you ask around CAISO staff, you get the real impression that they think having measurements of system market power is both unnecessary and potentially damaging for reliability and incenting imports into the CAISO. The only logical explanation is that they are doing this to appease – there’s that word again – the Market Monitor. What’s worse is the method they are using to assess hours when there might be system market power – the Residual Supply Index – is a threshold test that is prone to giving off false positives.

Cutting off one’s nose to spite one’s face…

At the Regional Issues Forum of the EIM meeting held in Portland in late August, Kallie Wells, who works with Carrie Bentley on WPTF’s CAISO Committee, gave an excellent presentation on just this topic.  Specifically, she outlined 1) the failure of the analysis to demonstrate a System Market Power problem, 2) the limitations of the Residual Supply Index (RSI), and 3) the negative effects over-mitigation would have on imports into CAISO. Leaving aside the fact that the unloved RSI shows only a handful of hours of even potential system-level market power, let us consider the results of such mitigation.

A basic premise of market economics is that prices send signals and set appropriate values for assets. This, in turn, elicits a rational, efficient response. As alluded to above, this response may be a longer-term hedge, a demand response, an investment in a physical asset, or an investment in energy efficiency. Another basic premise: mitigation always reduces prices.  In any other commodity market, mitigation would not be contemplated until market power was observed over a period of weeks, months or even longer. CAISO staff seems to understand this, and no wonder. They must be worried about stifled signals for the imports that will be key to reliably accommodating increasing renewable generation and the retirement of legacy generation.

Rather than being focused on proper price signals, the CAISO seems to be worried about the reaction of its market monitor – a reaction that will likely be shared by the CPUC. Unfortunately, we have historically seen the CAISO Market Monitor more interested in price suppression rather than efficient outcomes. Will anyone be able to talk the CAISO into standing up to this folly?

Did You Get a Reasonable Price?
This question was posed to me by my wife when I told her I was going to buy “standing room only” (SRO) tickets to the first World Series game to be held in the nation’s capital since 1933. I’m going with my son, and I am not taking this opportunity for granted. Who knows when the Nationals might be in the “Fall Classic” again! All that said, I understand why my wife asked the question.
Surprise, surprise, surprise!
I’m sitting in the waiting room as our son goes “under the knife” … Well, that isn’t what one should call arthroscopic surgery these days. It is amazing what can be done with minimal invasion to repair a torn labrum (shoulder ligament). While I wait for a groggy 19-year old to emerge, I am basking in the glow of a surprising comeback win for my Washington Nationals in the Wild Card game of the Baseball Playoffs. After years of disappointment from otherwise successful Nats teams, this surprise was sweet indeed. Next stop: Dodger Stadium against the machine in Chavez Ravine! While the Wild Card win was unexpected, beating the beastly Dodgers would be a huge surprise. We shall see…
Undaunted Courage
The Pacific Northwest has historically had excess capacity. When your used to something, it’s easy to take it for granted – like youth and health. You don’t do the things that might be necessary to take care of yourself going forward – like establishing a market or a regional capacity obligation – because its hard and doesn’t really seem necessary. Now, that lack of foresight has the alarm bells ringing. With renewable mandates throughout much of the region coupled with retirements of legacy generation, that comfortable excess capacity is quickly becoming a luxury of the past. The mind is focused. But what to do?
Gluttony and Hunger
Last week I went with my family on a three-day cruise from Florida to the Bahamas. What would persuade me to go to the Bahamas in the middle of August with a ship of revelers? The occasion was the wedding of my niece who wanted to do something memorable for the happy occasion. It was so thoughtful, and she and her groom had a lovely ceremony. That said, this was one of those “all inclusive” cruises, where food abounds, and drinks flow freely. It seemed as if most of the passengers were intent on 72 hours of revelry on a scale that would have made Caligula blush.
A Movable Feast
This is a picture of my daughter, Miles, with all the “critters” of the house surrounding her. Perhaps our two mutts and cat can sense she will be leaving soon. It’s mid-August and my daughter is getting ready for her first year of college. My son will soon begin his second year of matriculating. It will be a quiet house; my wife and I will move into the next phase of our life. We’re still “parents” but it will be different. I can’t help but be a bit melancholy at the prospect of this new life. I know it has possibilities that were unknown to us the last 19 years, but I will miss those kids.
Raging at the Machine…
I was passing time waiting for a flight out of San Francisco and I ran across a LinkedIn article by a very bright friend of mine – Ron McNamara – on incentives and market outcomes. Ron used to oversee Markets in MISO, and before that, he worked for AEP. The gist of the piece is that if you have a financial interest in an organized electricity market, then you should also be invested in that market’s architecture and rules. In markets for equities, credit, or “normal” commodities there is a clear ownership structure and relatively light regulatory oversight. The imperative is to make sure nobody can game the market, but the outcomes are between willing buyers and sellers. Not so for electricity. Consider for a minute; who “owns” the CAISO? Who “owns” SPP or PJM or MISO?
This is Getting Muddy...
When you are from a small state like Kentucky, you pay particular attention to things that are part of your cultural fabric. College basketball comes to mind, although my primary team is the University of Louisville, not the better-known program down the road in Lexington. UofL is not my alma mater but Columbia University isn’t a frequent participant in high level hoops competition and, you gotta go with your home town. Similarly, the Kentucky Derby is a big deal for any Kentuckian. I always watch the Derby, stand when the horses are brought on the track and the band plays “My Old Kentucky Home”, and enjoy the most exciting 2 minutes in sports.
Biases are a waste of time…
This past week, I got to spend quality time with western state regulators and industry folks at the CREPC-WIRAB meeting in Salt Lake City. Meetings of NARUC are good, but most state regulatory bodies have a variety of industries to regulate from natural gas and electricity to taxis and other things of public interest. Consequently, it was great to have folks from all over the West discuss how the grid is going to manage so many challenges; from carbon policies in the coastal areas of the West to the changes in the generation mix all over the interconnection. This focus is the real benefit of CREPC-WIRAB – plus visiting beautiful Salt Lake isn’t bad either.
What goes on there? Sacramento and… FERC?
It was a strange week. A lot of travel, but it was all in the Eastern time zone – evident by the humidity in the air as Spring begins to arrive in the East. It began with a trip to Columbus, Ohio to present before the State Commissions in the PJM region on FTRs and then to Miami, FL to the WSPP meeting where I moderated a panel on the PG&E bankruptcy. Strange, but interesting.