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Scarcity 101

Like most of you, I’ve been working from home and dealing with co-habitants that aren’t used to being in the house all the time. In my case, these are our two kids who are supposed to be back in college. Let’s all put ourselves in their position: how you would like to be stuck in the house for weeks with your parents when you were supposed to be back on campus? If you did the exercise properly, you probably were just overcome by feelings of claustrophobia. They know they must stay home so that they don’t contribute to spreading the virus, but it challenges them, and their parents.

So, let’s consider how this environment is playing out and how it can be applied to our industry in the West. This isn’t to make light of our dangerous situation with COVID-19, but rather to try and distract ourselves by considering scarcity and how we react to it.

A little help here!

We’ve all walked down the aisles of grocery stores, the local Target or Walmart and noticed the empty shelves that used to be stocked with toilet paper. Most have attributed this to “hoarding”. An article in Bloomberg last week, however, demonstrated this is probably not the case. Rather, it is a supply-demand mismatch. It seems that the market for toilet tissue is divided into two segments: 1) home use, and 2) office/business uses. As most of us can attest, the product in one is different than the other. Consequently, folks at home are not using more toilet tissue daily, they’re just using it at home and thus exhausting the supply for that market segment. There is probably a glut of single-ply tissue in warehouses and supply closets around the country.

If this situation were not a pandemic or health crisis, one would expect costs to go up in the home market and production would shift to meeting that demand. But this is a temporary dislocation – for what length, we know not. Some production might shift to meet this different demand, but investments will most likely not be made for long-term production shifts.

Are there hygienic alternatives to toilet tissue to get one past the time when everyone is stuck at home? Well, try going to Home Depot or a plumbing and hardware store to get a bidet. That involves an investment that would be intended to be used beyond the current situation. It’s a fine alternative but it involves a change in how to, uh, “get the job done.” There could be other paper products that could be used, but these aren’t comfortable or good for downstream water treatment. It would, however, get a household out of an immediate predicament.

The connection to electricity…

So, even in places where markets are mistrusted (as they are in California) or dominated by a monopoly, supply and demand in electricity are normally in balance. One of the reasons many wanted to move to a market for electricity is that a market is better at incenting investments to meet demand or rationing scarcity so that the signal for future investments is made. Markets can do this efficiently, avoiding the kind of capricious outcomes that result from utilities making their own predictions and regulators making decisions that affect everyone.

However, every market gets out of balance at some point. Using our experience with the current toilet tissue shortage, if there were regulators in this market, they might take several actions. None of those actions would help matters and might make matters worse. The regulator might accuse toilet paper manufacturers of engaging in “withholding” and seek to penalize Proctor & Gamble (Charmin) and others. They might blame some specific intermediary like Target for not “acting prudently” by stockpiling enough toilet tissue for an emergency. Or, they could use the California response to the 2000-01 crisis and contract for toilet paper on behalf of retail stores.

Naturally, the Federal Trade Commission and even the anti-trust division of the Justice Department are, in effect, regulators who do watch how the broader economy operates –including consumer goods like toilet tissue. However, we do not expect these regulators to act the same way regulators of electricity act. True, the Federal government has invoked an authority to provide incentives for industry to increase production of things like ventilators, but these contracts will not have long lives like those California entered into in the early 2000s, nor will they be litigated for 20 years.

Why bring this up? Well, it would seem instructive to consider how the rest of the economy works when we contemplate the possibility of the electric market forming in the rest of the West. Perhaps we should not blindly follow California’s example of “command and control” asset deployment.

“I don’t care what the record says…”

As many of you know, the California Public Utilities Commission (CPUC) has been working on restructuring resource adequacy (RA) for a couple of years now. The motivation for moving beyond bilateral procurement are too numerous to detail here. After much debate, the CPUC offered a proposal for all three investor owned utilities (IOUs) to procure RA for all load serving entities (LSEs) in their respective service territories.

Well, pretty much everyone hated it. You can imagine that any non-IOU wanting to best serve its customers would dislike this as they would have only one place to shop for RA. Community choice aggregators (CCAs) would be handicapped in their main objective of serving their communities in a different way than the IOUs. Those who would have wanted to develop assets that might be used as RA found that an underlying revenue stream for financing was effectively removed.

The CPUC reacted to this unfavorable response by saying; “OK wise guys. You don’t like our proposal, come up with one of your own. If we don’t get a viable alternative, we’ll impose our own.” Then, a funny thing happened. One IOU (SDG&E) got together with several CCAs to discuss RA procurement by a central entity that was not an IOU but also was not affiliated with any market participant. It would be for residual procurement of RA. Everyone would continue to be responsible for procuring RA bilaterally, including system, flexible and local RA, but this entity would procure for those who might find themselves short, those who lose or gain customers (load) and thus need to make adjustments.

This group then reached out to folks like WPTF, which then led to intensive meetings last spring and summer to hammer out a proposed settlement to be made to the CPUC. It was such a successful collaboration and honest give-and-take between parties of diverse perspectives that it was truly astonishing. When parties were offering their perspectives, they listened to those with different priorities and perspectives and then the group worked on making the settlement better. It was what I would call an “edifying” experience.

The parties worked hard to file the proposal at the CPUC at the end of the summer. And then we waited.

At the end of March, the CPUC came out with a Proposed Decision. But it essentially went back to the original proposal, with a few twists. First, PG&E and SCE would be in charge of procurement of local RA for their service territories. The decision did not include SDG&E. LSEs in the PG&E and SCE territories would no longer be assigned local RA. They just take it from the IOU.

The decision was breathtaking from a procedural as well as an intellectual point of view. How could the CPUC embrace a proposal for which the record showed almost no support? Speaking as a recovering regulator, I recall times when some on our staff wanted to embrace a solution but were restrained by lack of support in the applicable docket. No such restraint appears to be in the CPUC rules.

Under the proposal, it is certainly true that nobody has any incentive to invest in solving local RA needs. The elimination of a possible revenue stream may also affect assets for other RA needs. The ability to manage energy for CCA procurement will likely become more problematic as well.

When deciphering the motivation for the CPUC to embrace such an unpopular and IOU-centric solution, one inevitably concludes that control is the main goal. While IOU procurement is squarely under the CPUC’s jurisdiction, CCAs and competitive energy service providers are less so. The parties that were part of the procurement settlement were aware that control was a major motivation for the CPUC. That was why nobody proposed the most workable solution: that the CAISO as the market operator be the procurement entity. But it would seem the CPUC wanted more direct control over procurement. If that is the case, California begins to feel more like the new administration in Mexico (only the state utility should make investments) than an American jurisdiction.

Well, at least the CPUC is not in charge of toilet paper procurement. Let us ponder small favors.