Gas Pains 

On energy: Texans snickered, but we all got snookered in the end

On January 16, 2001, California utility giants Pacific Gas & Electric and Southern California Edison officially defaulted on payments to power companies around the country. On January 17, the first rolling blackouts began across the state. The following day, Governor Gray Davis declared a state of emergency and began buying power, eventually spending an astonishing $11 billion in state funds -- billions that should have gone to schools, parks, and social programs -- just to keep the lights on. On January 20, Enron head Kenneth Lay, one of President Bush's closest friends, was in Washington attending the inauguration. The man who virtually engineered California's energy crisis, who at one point was on the short list to head the Treasury Department, stood sipping champagne while public school administrators scrambled to keep California's classrooms heated during the winter.

Villainy hits harder when it seems embodied in a single man. That's partly why Osama bin Laden eclipsed the energy crisis as the biggest story of the year. But for everyday Californians, the teachers and retail clerks who struggle to get by, the debacle of energy deregulation was the great populist parable, the year the big boys did a number on all of us. They got us coming and going, sinking and swimming, heaving and hoing. They took the one chance we had since the advent of Proposition 13 to make a difference in the quality of our squalid schools and snookered us all the way to the bank.

Forget all the red herrings you've heard about the energy crisis. The problem was not a sudden increase in energy consumption driven by the Internet economy; in fact, advances in information technology are the driving force behind rises in productivity, and energy consumption in December 2000 -- the month when wholesale energy prices began their ascent into the heavens -- actually decreased 1.4 percent. The problem was not tree-huggers who somehow dissuaded power companies from building new generators; according to the consumer watchdog group Foundation for Taxpayer and Consumer Rights, California built 185 new power plants in the 1990s, adding 4,000 megawatts of electricity to the grid. No, the problem, in a nutshell, was greed and opportunity.

When Pete Wilson and state Senator Steve Peace drafted the now-infamous deregulation scheme, Kenneth Lay and his fellow Enron executives pushed particularly hard for the creation of the California Power Exchange, a spot market where wholesale power could be bought and sold minute by minute, an exchange where the value of electricity could be distorted in a moment. All the electricity in the state was traded here; every drop of juice that powered every heart monitor and traffic light. It was a system that begged to be exploited.

Say it's a peak time of day for energy consumption -- a hot day in the Central Valley, for instance, or a moment when industry is running full speed. Suddenly a power generator has an "unplanned outage" or must shut down for "unscheduled maintenance," tightening up the power supply by as much as 25 percent. An energy-speculating company like Enron has bought chits in electricity long before they get to the Power Exchange, where traders begin bidding on the power. But power is different from any other commodity -- in fact, it shouldn't really be called a commodity at all. Power is something we absolutely must have. Intel, UC Berkeley, hospitals -- countless institutions can't do without it. The Power Exchange became the ultimate seller's market, where the price of power zoomed into the stratosphere, driven by feverish, desperate bidding. And by law -- by law -- the market price was set by the highest bid in any given hour.

The beauty is that no one can actually be accused of colluding with anyone else to fix the price of power. Of course the power generators are going to have unscheduled breakdowns. Of course energy speculators are going to buy chits with the expectation that some facility somewhere will break down. The game is simply -- almost elegantly -- rigged.

Is it any wonder that energy producers and speculators made a killing in the first half of the year? The numbers are mesmerizing: Dynegy's first-quarter net income shot up 73 percent to a record $137.5 million, especially in its energy trading subsidiary, where profits doubled; San Jose-based Calpine's net income for the first half of 2001 was $254.9 million, an increase of 216 percent over last year. This at a time when, economists now say, the country was first sliding into recession. Because the two major utilities were prohibited from passing costs on to consumers, and because their parent companies had built a legal firewall that safeguarded the billions in profits they had siphoned in the early days of deregulation, the state had no choice but to pay for the power itself. Every penny of profit represented a penny that could otherwise have gone to buying textbooks or funding social services.

By late spring, Davis panicked. The summer was approaching, and everyone breathlessly awaited armies of air conditioners collapsing the grid. Facing the biggest disaster of his political career, the governor signed a host of usurious long-term energy contracts that, while guaranteeing that the juice would never stop flowing, also guaranteed artificially high profits for energy companies for years to come. When word broke that the state-appointed officials who negotiated the long-term contracts actually owned stock in the very companies with whom they were negotiating, it seemed the perfect bitter ending.

Once the long-term contracts were signed, and political pressure to investigate power companies mounted, the shortages stopped altogether. Surprise -- we never had an energy crisis in the first place. As the events of September 11 horrified the nation, what was once the only story in town vanished back into the business pages. But the problem is still there, skimming public money in even more ingenious and subtle ways.

Nothing illustrates the continual drain better than something called Direct Access. Direct Access was the great promise that drove deregulation in the first place: Any consumer could buy power from any supplier, be it PG&E, Green Mountain, or direct suppliers like El Paso. No more monopolies -- the laws of supply and demand would drive the price of power down in the same way long-distance rates have steadily eroded. But as it happened, only the largest energy users like Cisco and concrete manufacturers took advantage of Direct Access, and most of those contracts had expired by the spring, at the height of the crisis.

In June, the Public Utilities Commission declared that it would prohibit Direct Access, robbing us of the ability to shop around for power. After all, Davis had bought enough power for the entire state, and millions of dollars would be wasted if a significant sector of the economy opted to buy power directly from producers. But the PUC didn't get around to prohibiting Direct Access until September 20, so for the remainder of the summer, power companies approached dozens of big energy consumers and cut deals with them at rates lower than those they had negotiated with the state.

Why? Because that way they get to sell their power twice. Davis is contractually bound to buy all the power California needs at $133 per megawatt hour. He then has to sell the surplus power back to the power companies at $19 per megawatt hour, and the companies can then sell it again to companies like Cisco, in accordance with their Direct Access contracts.

So while we're watching the carpet bombing of Tora Bora, the big boys are going to soak us for a projected $43 billion; it's a beautiful thing they got going on. Of course, not everyone managed to keep the gravy train running. In 1985, Kenneth Lay bought Enron and transformed it from a minor natural-gas pipeline company into one of the nation's largest energy speculators, playing the spot market so well that in December of last year, its shares hit a high of $84.87. But once the long-term contracts virtually eliminated the spot market, Enron hit the skids. Investigators with the Securities and Exchange Commission are still trying to figure out what went wrong, but on November 30, Enron's shares were selling at a mere 26 cents, and three days later, the company filed for Chapter 11 protection.

Texans had a lot of fun at our expense last spring, when the state's energy producers and traders were siphoning billions of dollars from Sacramento's coffers. But now that Enron has imploded, this sort of regional rivalry seems part and parcel of an atmosphere that allowed executives like Enron's to soak us all, Texan and Californian alike. Kenneth Lay, the man who virtually ran the Bush administration's energy policy in the dog days of California's electricity crisis, last year made $141 million in salary, bonuses, and stock options. Just before news of the company's finances went public, he cashed out $20 million in additional stock. The same happy result doesn't apply to 7,500 Enron employees in Houston, all of whom were contractually required to invest their 401(k) funds in their own company. Since their company's stock is worthless, their retirement packages disappeared overnight -- kind of like California's budget surplus.

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