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Did Power Producers Manipulate Market? by Susan Kelleher, staff reporter Seattle Times, February 11, 2001

As lawyers and lawmakers try to wrest back power and profits from the energy industry, a sneaking suspicion that emerged last summer has gained momentum and credence:

What if the current energy crisis that started in California and spread to the Pacific Northwest was more than a result of too few power plants? What if the people who owned the generators withheld power when people needed it most, driving prices up and making stock in electric companies a ticket to the billionaires' club?

The scenario seems likely to Gary Zarker, superintendent for Seattle City Light and one of dozens of utility officials, lawmakers, and economists who see no other compelling explanation behind California's sudden loss of more than 15,000 megawatt-hours of energy - enough to power 13 Seattles at any given time.

The Northwest has its own shortage problems, as supply has lagged behind demand in the past 10 years and low reservoir levels this winter mean less water for the hydropower system.

But California typically shoots juice north in the winter, and a shortage of power there means Northwest utilities have been forced to shop more regularly in the high-priced spot market to meet their load, or demand.

As rate increases ricochet around the region, more than one official is casting a suspicious eye south.

"Last summer, they had a 47,000-megawatt load, which wasn't even a peak for California," Zarker said. "Somehow, the lights stayed on, which meant they had generating capacity somewhere. The system had enough.

"Now there's a 30,000-megawatt load because of cooler weather, and they're operating in a perpetual state of emergency. What happened to all that generation? Someone needs to answer that question."

So far, the disappearance of about 15,000 megawatts of energy in California is the subject of lawsuits, federal inquiries, academic studies and investigations by a half-dozen California agencies, as well as the attorneys general of Washington and Oregon.

Discovering precise reasons for the steep climb in prices will drive solutions, to the crisis, such as the extent to which environmental laws are loosened to encourage construction of new plants, and whether government regulation or market forces dictate future prices.

Suspicion falls on suppliers

For now, though, angry fingers are pointing to for-profit electric suppliers, many of them based in Texas and the East Coast.

The power-plant operators - which posted record profits last year - deny manipulating the market at any time since 1998, when California's energy industry was deregulated. They say some of their plants were off line for maintenance, while others were fitted for pollution-control devices and still others broke down.

Those with natural-gas generators also say steep increases in the price of fuel have added millions to operating costs, forcing them to charge wholesale prices for electricity that are hundreds of dollars in excess of last winter's prices.

"We're not going to be apologists for what we've done," said Richard Wheatley, spokesman for Reliant Energy of Houston, which operates five plants in California. "We've operated ethically. We've operated legally."

Accusations escalated in January when the company reported that operating income from the sale of wholesale energy increased from $27 million in 1999 to $482 million in 2000.

"We have a responsibility to make money, a reasonable profit, and a big responsibility to our shareholders," Wheatley said. "If California designed a screwed-up system, then California should fix it."

Collusion or bad design?

Although state officials have raised the specter of collusion among the generating companies, energy experts said the system for buying and selling electricity in California was so transparent and counterintuitive that no one had to conspire to make money. All they had to do was watch and wait.

That marketing system is all but dead now in the wake of state and federal intervention, but the effects of its meltdown linger.

To visualize how the California market worked, imagine a swimming pool that must be filled with water every day.

One supplier offers to fill the pool halfway for $1 a gallon. Another offers to fill up half of what remains for $5 a gallon. The bidding continues until the last supplier offers to sell the final cup. The asking price: $400.

And here's the kicker: If the final bid is accepted, everyone who contributed water to the pool will be paid $400 a cup, even if they offered to sell for $1 a gallon.

In theory, the market was supposed to encourage suppliers to bid early at cheap prices to avoid being locked out when the demand was met for the day.

In practice, it produced staggering prices for California and anybody else shopping for extra power.

Most of the power used by California ratepayers was bought on the day-ahead and spot markets run by the California Power Exchange, a not-for-profit agency that served as energy auctioneer for the state's deregulated market.

Under deregulation, California's three largest utilities - which previously enjoyed a monopoly on generation and transmission - were forced to shop on the power exchange, telling suppliers how much they needed and what they were willing to pay.

The state also created the California Independent System Operator, or ISO, which ran the state's power grid and solicited bids from suppliers each day to ensure sufficient reserves.

The daily market gave all suppliers an equal shot, and enabled utilities to buy only the power they needed. But it also telegraphed to generators just how desperate utilities were for power at any given hour, and provided fast feedback about when and where electricity would fetch top dollar.

"Where the system goes up and down in big swings is the weather," said Dave Warren, director of the energy-policy office at the Washington state Department of Community, Trade and Economic Development. "If they're predicting temperatures in the high 90s, you know pretty close how many air conditioners are going to be turned on at any given hour."

Because the system rewarded everyone with the higher price, and because everyone had a good idea about how much electricity was needed, it was obvious that the longer you waited to bid your electricity, the more you would get paid for it, said Daniel Allen, an economist with Synapse Energy in Cambridge, Mass.

"There are all kinds of crafty and technical ways of manipulating bidding strategy," said Allen, whose company conducted a study on the same type of market operating in the Northeast.

In California, three large utilities shopped for all of their power through the exchange. Suppliers, including up to a dozen companies that own the natural-gas plants that provide the bulk of the state's electricity, made hourly or real-time bids until the total demand was met.

By providing hourly feedback on bids, the system made it easy for suppliers to explore the price envelope, said Paul Joskow, an economics professor at the Massachusetts Institute of Technology.

"You experiment," Joskow said. "You bid $200 (a megawatt-hour) and see if it clears the market. If it does, you can try to go higher. If it doesn't, you go lower. A repeated game like that provides a lot of learning opportunities."

Allegations hard to prove

Zarker, the Seattle City Light superintendent, said Northwest utilities got hit with high prices because they were shopping - and continue to shop - from the same suppliers during times of shortage. They also got hit because suppliers, including Northwest utilities that generate power, knew they could charge premium prices.

Steven Klein, superintendent for publicly owned Tacoma Power, said allegations of market manipulation will be hard to prove because there are no laws requiring suppliers to put their goods on the market.

"On the surface, not wanting to sell power from day to day is not breaking the law," he said. "But the day that you learn how to affect the market, you're exercising market power."

If companies used their market power to manipulate prices, the federal government could prosecute them for violating antitrust laws. Klein, however, said it would take a lot of political will to sustain such an investigation, and even more to pursue a remedy.

In a study of California energy prices during summer 2000, Joskow and his partner found "considerable evidence" to support the presumption that suppliers held back power to drive up the price. The study found prices during that period were hundreds of dollars above what one would expect in a truly competitive market, even accounting for such things as higher gas prices.

Two inquiries by the Federal Energy Regulatory Commission (FERC) found no evidence of power withholding, but regulators conceded their probes were not in-depth investigations.

"Generators were not running during hours when we would have expected them to run," Joskow said. Southern California Edison, a utility that owes billions for wholesale power bought at sky-high prices, funded the study.

Several other studies found that a greater number of power plants were on scheduled and forced maintenance during the summer and winter of 2000 than in previous years.

Without access to proprietary records, utility officials can only feed their suspicions, not satisfy them. FERC, which can review suppliers' records, is responsible for keeping prices "just and reasonable."

Gregoire is investigating

Washington state Attorney General Christine Gregoire announced Jan. 30 that her office would investigate whether price manipulation and other unfair business practices were driving West Coast energy prices.

Her concerns, she said, stem in part from suppliers' Securities and Exchange Commission reports, which showed quarterly profits increased by 20 times since last year.

But Joskow, the MIT economist, said the investigations may only reveal what is painfully obvious to everyone: California-style deregulation was a failure.

"Everyone is looking for a bogeyman, and there's enough blame to go around as to why the markets aren't performing well," Joskow said. "The idea of assigning blame to specific suppliers for responding to a market with these attributes is the wrong road."