Longform

Shock Treatment

Page 2 of 7

Indeed, it is the emergence of a feeding frenzy among companies so often accused of collusion, not the blackouts in California, that could be the harbinger of doom for Arizona.

"The alt fuel thing, the real estate crash -- all the really bad things in Arizona happen when there's a frenzy like this," says Pat Sherrill, who has been fighting the proposed Caithness plant northwest of Phoenix in Mohave County. "You've just got to wonder what is lying in wait for us down the road. History tells us it just can't be good."


In 1996, California's major regulated utilities, Pacific Gas & Electric, San Diego Gas & Electric and Southern California Edison, got what they thought would be a smokin' deal.

The three utilities had been in trouble. They were saddled with heavy debt from bad investments in obsolete nuclear and coal plants. State-imposed rate caps were blocking them from the profits they felt were fair in a rich national economy. Big industrial customers were threatening to build their own on-site generation using new natural-gas turbine technologies or buy from elsewhere.

So the utilities successfully pushed through a law that, among other things, allowed them to impose surcharges on customers to offset their bad investment costs. Rate caps were put in place that would remain until the utilities' investments were paid off. After that, the utilities and the market would dictate the rates.

As part of the deal, utilities had to sell off their power plants, which freed them from the bad investments. The utilities would buy their power on the wholesale spot market. At the time, there was an abundance of cheap wholesale electricity being generated using cheap fuel supplies. In theory, wholesale spot prices would dive and, unburdened by expensive long-term contracts, dying plants and rate caps, there would be a fat new margin for utilities.

What they didn't predict, though, was that customers, buying at fixed low costs, had little reason to conserve. They didn't think about the power needed to create and run all of California's new high-tech industry, bursting with powerful computers and other electric gadgetry.

The utilities were caught off guard when California's economy turned robust, which cranked up demand. At the same time, hydro generation dried up, summer temperatures soared and winter temperatures plummeted.

In the old regulated market, utilities rescued one another when necessary because that was the cost-effective thing to do.



The new market, though, was built for sharks. As California became fatter and more vulnerable, the sharks, in the form of America's new breed of wholesale power merchants, circled.

In the months following deregulation, numerous power company executives and power investors met to discuss how best to profit from the California market. Many companies began buying up power plants in California, some began planning new plants in Arizona or Nevada. Within months, the nation's major natural gas distributors and wholesalers, wise from years of playing the natural gas wholesale spot markets, began re-creating themselves as electric power generating and marketing companies.

It seemed every energy executive in the country saw the critical loophole in the California law: Relying totally on a spot market for a vital and unstorable commodity only works if there is ample supply. If there isn't ample supply, prices will continue to skyrocket because utilities have no choice but to buy the commodity quickly.

In essence, it's the market power you get selling the only glass of water on a bus of billionaires stranded in the desert. California would have two choices: Pay up or go dark.



The billion-dollar question, then, is whether California's supply crisis was all bad luck and bad planning or rather a mix of bad luck, bad planning and collusion. Did the sharks push California off the dock?

Perhaps the most important of these early industry meetings was held on September 26, 1996, in Room 431 of the Embassy Suites Hotel near Sky Harbor Airport.

The meeting was attended by senior management of SoCalGas, San Diego Gas & Electric and El Paso Natural Gas. Notes of the meeting were obtained by Lance Astrella, a Colorado energy attorney, during discovery in a different antitrust case. But the attorney quickly realized the wider ramifications of what he saw.

In a lawsuit filed late last year in Los Angeles County by top antitrust attorneys, executives of the three companies are accused of agreeing to kill projects that would have undercut each others' control of natural gas markets (and thus electric power markets) in Mexico, Southern California and the Southwest.

At the time, SoCalGas' and San Diego Gas & Electric's near-monopoly of northern Baja and Southern California was being threatened by two Tenneco pipeline projects that would have doubled the natural gas flowing into the region. In the months before the Phoenix meeting, El Paso had purchased Tenneco.

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Robert Nelson