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Energy Deregulation: Is it Friend or Enemy? by Thomas A. Fogarty & Edward Iwata USA Today, May 15, 2002

California's electric power crisis reverberated on Capitol Hill Wednesday as attorneys for fallen energy giant Enron acknowledged deception in past electricity trading practices, and a key federal regulator vowed to make Western energy markets fair. "This is not what I have in mind when I talk about the benefits of a competitive energy market," said Patrick Wood III, chairman of the Federal Energy Regulatory Commission (FERC), which regulates the wholesale power market.

The fallout continues to spread from Enron's questionable trading practices and California's energy meltdown, which will cost the state, consumers and businesses tens of billions of dollars in energy overpayments and bailout money for its utility companies. As the finger-pointing quickens from Washington to Sacramento, analysts, lawmakers and consumer groups debate whether deregulation is a villain or an ally. Did the deregulated market in California fuel the wild trading by energy brokers, as Enron critics contend? Or, as the energy industry argues, can free-market trading keep energy prices low, and can regulators be counted on to stamp out illegal or manipulative behavior?

Outraged Western senators claim their constituents were bilked out of billions of dollars by Enron and other energy traders who sold power in 2000 and 2001 into newly deregulated Western markets. In documents released May 7 by FERC, Enron lawyers outline manipulation by the firm's West Coast traders during the California power crisis to drive up prices.

Wood, who took over the chairmanship nearly a year ago, walks a fine line in dealing with the issue. He's an outspoken supporter of deregulated power markets, appointed by a president for whom excessive regulation is anathema. Yet Wood has taken pains to condemn manipulation by Enron and other California wholesalers, and last year supported FERC's imposition of price caps at the wholesale level. That cools the crisis, at least until the caps expire on Sept. 30.

Under persistent questioning, Wood declined to say that the caps will be extended. He said only that FERC will not allow them to expire without protection for consumers against unscrupulous traders.

Lawmakers skewered the apparent inactivity of FERC for nearly a year before price caps were put in place. During that time, corporations went bankrupt, jobs were lost and Californians endured blackouts.

Said Sen. Byron Dorgan, D-N.D.: "The agency you head was shamefully absent. People at FERC sat on their hands and did nothing."

Some lawmakers, however, refused to let the California crisis be portrayed as the fault of scheming traders and indulgent federal regulators. The flawed design of California's deregulation law also bears blame, said Sen. Frank Murkowski, R-Alaska. "If you create a flawed system, riddled with loopholes, people will take advantage of it," Murkowski said.

Stephen Hall, an outside lawyer hired as part of an Enron defense team, said he became "increasingly concerned" as he interviewed Enron traders about how they bought and sold electricity. "Certain of these trading strategies involved deception," Hall said. Enron corporate lawyers agreed, and testimony indicated the practices ended in December 2000.

Hall was the main author of a memo made public by FERC that outlined trading strategies that artificially drove up prices paid by California utilities.

The Enron lawyers stopped short of declaring their clients' practices illegal, but there were no shortage of testifiers to list state and federal laws that seemed to be broken: fraud, antitrust violations and racketeering. Other testifiers also attacked the Enron lawyers for the suggestion that some good was done by their recommendation that the maneuvers be stopped, saying enormous economic damage had already been done by the time it stopped.

Richard Sanders, an Enron lawyer who continues to work for the downsized energy company, told the committee that in June 2001, about six months after the Hall memo, he briefed former Enron CEO Jeffrey Skilling about the firm's trading practices as the executive prepared for a trip to California.

He says he recalls Skilling responded with surprise to the sophomoric names given the strategies — Death Star, Get Shorty, Fat Boy, Ricochet and the like. Sanders said he doesn't recall any reaction from Skilling to the trading activities.

Enron spokeswoman Karen Denne declined to comment Wednesday on the hearings, saying, "We will continue to cooperate with all investigations."

In the meantime, energy experts and Enron critics say the deregulated electricity market in California allowed Enron to engage in disastrous trading of energy during the state's power crisis two years ago.

They believe that rampant trading — not an energy-supply shortage in California and aging power plants, as the energy industry says — led to blackouts and higher prices for businesses and consumers.

"Deregulation was a license to steal," says Doug Heller of the Foundation for Taxpayer & Consumer Rights.

In the 1990s, Kenneth Lay, Enron's former CEO, and other Enron and industry executives were the biggest cheerleaders for a free energy market in California.

As early as June 1994, Skilling urged the California Public Utilities Commission to embrace deregulation. A free market would drive down electricity prices and save the state $9 billion dollars, he said.

"The stakes are huge," Skilling said in a transcript of the Los Angeles hearing. "And every minute that we delay bringing competitive markets to California allows the meter to keep ticking."

Consumer groups warned that free-market trading of wholesale electricity would be disastrous. But politicians and regulators believed Lay, described by one politico as "the slickest pitchman" for deregulation.

In 1996, California became the first state to deregulate its electricity market.

Under the plan, the state's utility companies sold some of their power plants and repurchased electricity through a wholesale auction. In the auction model, freewheeling traders negotiated buy-and-sell prices with the state and power companies.

On paper, energy companies would compete fiercely for business and lower their prices on electricity sold to California and its utilities.

It didn't work. Trading quickly got out of control. In late 2000, wholesale power prices rose to more than $300 per megawatt hour from $30 earlier in the year.

Memos released by FERC suggest that Enron falsely overstated power demand in its requests for energy from the California Independent System Operator, which runs the state's power grid.

"The Enron schemes demonstrate that Enron was willing to go to any length to exercise its market power," says Sean Gallagher, general counsel for the California Public Utilities Commission.

The recession also struck, worsening the crisis. Heat waves and a cold winter fueled surges in demand for power. Blackouts swept much of the state. Bills for consumers, small businesses and corporations tripled. Pacific Gas & Electric, the utility for Northern California, filed for bankruptcy protection.

Energy industry officials defend the free-market system and energy trading, blaming California's crisis on a drought in the Pacific Northwest that hurt hydroelectric production there while driving up demand and prices in California. "Everyone is pointing fingers at FERC, when it was a supply-and-demand problem," says Jan Smutny-Jones of the Independent Energy Producers Association.

California officials demanded that White House officials and FERC take action. After months of delay, federal regulators last year capped the price of wholesale electricity, and the energy system stabilized.

California Gov. Gray Davis and his negotiators ended up signing long-term power contracts with energy companies for $43 billion — well over market prices. State officials are negotiating to rewrite the contracts.

"Billions of dollars got thrown overboard," says Nettie Hogue of The Utility Reform Network, a San Francisco consumer group. "Who's going to pay for the party now?"