Power crisis leaves some asking: Market manipulation or Econ 101?

Michael Liedtke

Monday, March 26, 2001 | 11:16 a.m.

SAN DIEGO -- Attorney Michael Aguirre has taken on mobsters and swindlers in his career, but he says he has never felt as strongly about a case as the class-action lawsuit he is pursuing against the power wholesalers behind California's high electricity prices.

"This is the best fraud I have ever seen," Aguirre said as he flipped through the boxes of energy market data he has accumulated during the past six months. "The generators are doing everything that you think that they might be doing, only it's worse than you ever imagined."

The managers of California's power grid began to fill in the blanks on Thursday, releasing a 100-page market analysis that concluded the wholesalers overcharged the state by as much as $6.9 billion during the past 10 months.

The study, commissioned by California's Independent System Operator, or ISO, could be the first step to asking federal regulators or a court to order the wholesalers to refund excess profits.

It's just the latest volley in a legal barrage aimed at a handful of power generators and marketers that contributed to a nearly fourfold increase in California's utility bill last year, to $27.1 billion.

If something isn't done soon, the ISO warns that California's electricity costs will rise to $70 billion this year -- about $2,000 for every person in the state.

To make matters worse, state power regulators may have to raise rates for customers of Southern California Edison and Pacific Gas and Electric Co. at least 50 percent to cover the state's power purchases on their behalf, the Associated Press learned.

The situation so far is producing plenty of outrage and few solutions.

At least five lawsuits, including a case brought by the city of San Francisco, have been filed against the wholesalers, alleging various market abuses.

The wholesalers, based mostly outside California, characterize the complaints as meritless actions brought by opportunistic class-action lawyers looking to make a quick buck.

"They are on fishing expeditions," said Gary Ackerman, executive director of the Western Power Trading Forum, a Menlo Park trade group. "People are very angry and frustrated about electricity right now and attorneys are trying to take that anger out on us."

The legal backlash is intensifying.

Attorneys general in Washington, Oregon and California are also on the case, probing whether the generators violated antitrust laws or engaged in unfair business practices in pursuit of higher profits.

And a California Senate committee is prepared to issue subpoenas for records and the testimony of top energy executives if they don't cooperate.

Natural gas providers also are being investigated. The cities of Long Beach and Los Angeles allege in their lawsuit that five major gas companies decided in a Phoenix hotel room in 1996 to block construction of pipelines that could have helped the state avoid its power crisis.

But it's the wholesalers who are getting most of the attention, and they feel they're being scapegoated for a badly flawed market. They deny any wrongdoing, citing numerous studies that blame California's high prices on the sloppiness of state lawmakers and regulators who oversaw energy deregulation.

"There have been accusations of wrongdoing for eight months now and there isn't a shred of evidence to support the allegations," Ackerman said.

All the lawsuits and investigations are being driven by allegations that generators conspired to hijack billions of dollars from consumers and taxpayers in the state, driving up prices by withholding electricity from energy-starved California until the last minute.

"What these guys pulled off could very well have been considered criminal acts if they had been acting as ordinary individuals on the street," said Michael Shames, executive director of the Utility Consumers' Action Network in San Diego.

"But because they run big corporations, they get their pictures plastered on the covers of business magazines depicting them as hard-nosed visionaries."

Working with three other lawyers, Aguirre is seeking to certify his suit as a class-action representing virtually every household and business in California. The lead plantiff in the case is a San Diego restaurateur, Ruth Henricks, who runs a "meals on wheels" program for the infirm.

For Aguirre, the crux of the case revolves around five out-of-state wholesalers: Reliant Energy and Dynegy, both of Houston; and Atlanta-based Mirant Corp., Charlotte, N.C.-based Duke Energy and Tulsa, Okla.-based Williams Energy, which sells electricity on behalf of AES.

Other industry critics also are focusing on Enron Corp., which doesn't own any large California power plants, but plays an influential role in the market as the nation's largest energy broker. Enron's operating profit from its wholesale energy division increased 160 percent last year, to $1.6 billion.

Aguirre is trying to prove that the wholesalers defrauded California five years ago, by promising lawmakers that the 1996 deregulation law would decrease electricity rates, even though they knew that changing market dynamics would soon position them to raise prices.

Even if he can't show the wholesalers colluded behind closed doors, Aguirre hopes to prove that they broke antitrust laws, by citing a legal doctrine known as "conscious parallelism."

This principle applies to an oligoply of companies who begin mimicking each other's behavior after recognizing that the conduct is swaying the market in their favor.

The doctrine isn't frequently used, although it has been around for years. One of the most famous cases involving conscious parallelism occurred in 1939 when the U.S. Supreme Court ruled that a group of movie distributors and theaters had engaged in a pattern of uniform behavior to fix market prices to their advantage, Aguirre said.

The wholesalers say they did nothing more than follow the basic rules of supply and demand.

Electricity became scarce in California after years of explosive growth, not only in its tech-driven economy, but in neighboring states including Nevada, Arizona and Washington.

California's economy grew by 29 percent in the five years ending in 2000, fueling a 24 percent increase in electricity consumption, according to Cambridge Energy Research Associates, an industry consultant.

Some power generators claim state electricity consumption shot up again in 2000 -- Reliant Energy estimated demand increased by 13 percent. The actual increase, according to power grid data analyzed by the San Francisco Chronicle, was just 4.75 percent last year -- but even that is about twice what state regulators had anticipated.

At any rate, California didn't add any new plants as its electricity needs grew, making it increasingly dependent on energy imported from other states.

And in general, power became more expensive for the same reason fruits and vegetables cost more after a deep freeze -- supply shortages turn even the most basic staples into precious commodities.

California's average wholesale electricity price soared from $30 per megawatt hour in 1999 to $114 per megawatt hour in 2000, according to state figures. At times, generators and markets charged as much as $1,500 per megawatt hour during 2000.

Soaring prices for natural gas, which generates about 30 percent of California's electricity, accounted for much of the astonishing increase. For example, Reliant said it spent $700 million on natural gas fueling its five California power plants, up from $178.4 million in 1999 and $86.6 million in 1998.

And the generators were doing more than just passing on their higher natural gas expenses, based on the calculations of industry analyst Barry Abramson of UBS Warburg.

Abramson estimates that natural gas prices added as much as $114 per megawatt hour to the cost of California electricity in December. But the average peak price for electricity on California's spot market during December was $600 per megawatt hour.

"We interpret this to mean that the high price of natural gas is not solely responsible for the higher power prices in California," Abramson said in a note to investors.

Combined, the five companies targeted in Aguirre's case pocketed a $3.1 billion profit from their continuing North American wholesale energy operation in 2000, more than tripling a collective $959 million profit in 1999. The companies won't say how much of this came at California's expense.

The out-of-state generators paid a premium to gain a foothold in California. Sales prices for the mostly aging California plants were substantially higher than the values recorded on the books of the previous owners, PG&E Corp., Edison International and Sempra Energy.

In all, they spent $2.9 billion on 18 plants with a total capacity of 17,000 megawatts, enough electricity for about 17 million homes.

The deals gave the newcomers control of about one-third of California's indigenous electricity supply, and an even larger share of the swing market that sets short-term prices.

At the time, some thought the stodgy California utilities had fleeced a bunch of rubes.

Electricity rates "are going to stay down for several years, and then go down again," PG&E Corp. chief executive Robert Glynn boldly predicted to shareholders in April 1998. "By the year 2001, electricity rates ... will be about 20 percent lower than they are today. There is no product bought on a daily basis that has such a predictable downward price trajectory in the future. None."

Californians now look at those deals and wonder if the out-of-state generators willingly paid extra for the plants because they planned to raise prices all along.

The power wholesalers contend they've done all they can to extract power from aging plants that weren't designed to work so hard. Fifty-five percent of California's power plants are 30 years or older, according to the California Public Utilities Commission.

Energy economists who have studied the market see signs of ruthless, but perfectly legal, behavior.

"Every business exercises market power when it can, so I don't know why people are so surprised that (the generators) used their market power," said Paul Joskow, an MIT economist who concluded in January that generators did deliberately withhold power.

"I didn't see any evidence of collusion in what they did," Joskow said. "It was just good business."

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