Northwest electricity markets blow a fuse

High energy prices could have an impact on growth, with a shift toward areas that have access to low-cost power.

By TOM KARIER
Northwest Power Planning Council

Electricity is nearly invisible -- except when its price increases about 30 times its normal level.  At that point, it gets our attention.

In late June, the price of electricity on the wholesale market in the Northwest soared to over $1,300 per megawatt hour.  Wholesale electricity is sold in megawatt hours; one is enough to power about 625 homes for an hour.  Energy market traders, more accustomed to seeing prices in the range of $35 to $40 this time of year, were shocked.  It was as if the price of gasoline at the pump rose to $40 a gallon, if only for a short period of time.

Power council looks at solutions Tight energy markets were foretold by the NW Power Planning Council's February 2000 report on northwest electric power adequacy and reliability.  While describing how energy demand was overtaking supply, the report concluded that there was a one in four chance of an inadequate supply of electricity arising during any given winter within the next few years.  All it would take would be a dry year providing reduced hydropower capacity, followed by a cold snap in January or February and production outages, planned or unplanned.  The coincidence of such events is not so unusual and could result in a shortage of electricity ranging from a few megawatts for a few hours up to thousands of megawatts for days. Building new power plants could solve the problem but it would be very expensive if many of the plants sat idle waiting for a shortage that is expected only once every four years.  A better solution might be to have customers sign contracts to give back power in such an emergency in exchange for a break on their power bill.  This and other solutions will be explored in the Council's phase two report currently underway.  Copies of Council reports can be found at: www.nwppc.org

Unfortunately, these short-lived price spikes have combined with sharp increases in average wholesale electricity prices since May.  Wholesale power sellers have been having a field day, but buyers have been crushed -- including some industrial customers and utilities in Washington state.  Vanalco, Kaiser Aluminum, Georgia Pacific and Bellingham Cold Storage have all reported layoffs attributed to the sharp electricity price increases.  Some, like Vanalco and Kaiser Aluminum, have yet to resume production.

Price spikes like this would have been unheard of 10 years ago because wholesale markets were still regulated.  That regulation started to be removed in 1992 when Congress approved the  National Energy Policy Act, and there are now markets throughout the West that trade thousands of megawatts of power every day.

Part of the tightness in the energy market is due to increased urban development, especially on the west side of the mountains, in Seattle and Portland, where demand is outstripping supply. If energy prices remain as high as they seem to be it could have an impact on growth, with a shift toward areas with access to low-cost power.

The deregulation of the wholesale electric power market is the latest in a series of deregulations that have impacted trucking, airlines, natural gas and telephones since 1979.  In each case, the intent has been the same: to encourage market behavior in an otherwise regulated market. Deregulation of the electric power industry, however, is unique and has been so complicated, requiring the development of so many new forms of regulation, that it is usually described as restructuring rather than deregulation.

The promise of restructuring has always been that markets can deliver lower prices and better services through competition.  Whether this promise will be met in electricity restructuring remains to be seen, but the wild price swings in May and June have highlighted the negative aspects of markets that include more risk, uncertainty and volatility. Electric power customers, for the most part, do not appear to be fully prepared for this kind of risk.

The debate about restructuring will no doubt heat up after the recent round of price increases, especially in those states that have gone even farther by legislating for retail competition, including California, Montana and, more recently, Oregon.

Gov. Locke and the Washington Legislature have been more cautious. Because we already enjoy low prices and generally good service, there has been relatively little incentive to adopt universal retail competition.  In retrospect, the decision to let others experiment with market pricing seems to have been a good one.  We can always adopt a competitive model if it proves to actually provide lower prices and better service, but we can avoid some of the misery if it fails.

Not everyone in the state has been equally fortunate.  Some businesses participated in the market experiment and negotiated contracts with their energy providers that reflected market-driven prices, and some utilities made an unfortunate choice to rely on market purchases in the last three months to meet their customers' loads.  But things could have been much worse if Washington had adopted the California model and gone as far as the city of San Diego.  Residential customers in San Diego, for example, were rewarded in July for being the first to pay daily market prices for power with a doubling of their average monthly electric bills from $55 to $101.

The Northwest Power Planning Council is just beginning to investigate the factors that contributed to the recent run-up in prices. If prices had increased 25, 50 or even 100 percent, we probably would not have bothered.  But because hourly prices went up more than 3,000 percent, we need to know why.

I hope our study will determine whether this was a unique event that is unlikely to reoccur or whether this is the reality of a deregulated electricity market.  Was this merely a speed bump on the way to a well-functioning market?  Or is this a harbinger of what to expect in the future?  The answer to this question will be important in assessing the success or failure of this experiment in restructuring.