‘Perfect storm’ led to energy crisis

Friday, Feb. 22, 2002 | 5:06 a.m.

The $922 million question in Southern Nevada's power crisis is whether Nevada Power Co. was the victim of market conditions beyond its control or the culprit behind poor management decisions.

How Nevada Power found itself in the mess it's in will be sorted out beginning March 4. That's when the utility goes before the state Public Utilities Commission to plead for a $922 million rate increase to offset costs incurred during last year's power crunch.

The utility will say it kept the lights on in a tough market. Critics say the company made bad decisions and ratepayers shouldn't foot the bill.

Although the truth may lie somewhere in between, Nevada Power is in this spot because of a complex web of events that affected power companies across the West.

Power companies say a "perfect storm" of events conspired against them: California's flawed attempt to deregulate electricity, hot weather, a Pacific Northwest drought, a lack of new power supplies and alleged market manipulation by the likes of Enron Corp. It all hit about the same time, resulting in skyrocketing wholesale electricity and natural gas prices.

Chairman Walt Higgins of Nevada Power's parent, Sierra Pacific Resources of Reno, bristles at critics who have said the utility bought too much power and paid too much.

"When people started saying that we had a terrible case and that we were imprudent, that surprised us," Higgins said. "It surprised us that the allegations were insulting and reached the point of being lies. Apparently this has become a public trial, but not a trial by evidence.

"We have never taken speculative positions. We have no motive to speculate. We make careful projections of what we need and then build a portfolio of power that comes closest to meeting our needs."

One critic, state Consumer Advocate Timothy Hay, has insisted that the utility spent $950 million more than necessary to keep the lights on in Southern Nevada between March and September.

"If you look at the history of the company's purchasing practices over the last 18 months, the track record (it has) established shows a shortsighted lack of prudence and inadequate planning," Hay said.

The rate dispute's roots were planted in the mid-1990s, when Enron and other giant wholesale power suppliers pressed Congress to deregulate retail electricity that was sold to homes and businesses. The sales pitch was that deregulation would lead to lower consumer prices, though critics feared that residential customers would be shunned by retailers more willing to serve large businesses.

When Congress left deregulation to the states, Enron and the others went coast to coast to make their case.

Deregulation passed in California in 1996. In 1997, Nevada adopted it. Bogged down by delays, studies and a lawsuit, the plan never was implemented.

California's plan, however, would be enough trouble for both states.

Deregulation

California had problems over such issues as the monitoring of power supplies, access to transmission lines and willingness of utilities to serve residential and small- business customers. Utilities also complained about that state's price cap on retail electricity.

"It was a badly flawed market model," Higgins said. "The consumers had fixed prices, but the utilities had to pay whatever the wholesale prices were."

Those troubles were exacerbated beginning in May 2000 when Californians endured unusually hot weather, a situation that led to rolling blackouts throughout much of the state.

Wholesale electricity prices in the West then began to skyrocket from roughly $25 per megawatt hour to about 10 times that amount. The cost of natural gas used to fuel power plants likewise rose fivefold.

Some industry observers said the energy shortages that Californians experienced were caused in part by a gradual power-plant construction slowdown in the West. Nevada Power was part of that trend as it had been increasingly relying on the purchase of wholesale power.

Enron

But in a lawsuit filed last year, California Lt. Gov. Cruz Bustamante accused five power-plant operators -- Duke Energy, Dynegy Inc., Mirant Inc., Reliant Energy Inc. and Williams Cos. -- of conspiring to drive up wholesale prices by reducing the supply of electricity and participating in unlawful trading. Those companies denied the charges but Bustamante's attorney, Michael Aguirre of San Diego, said they contributed heavily to the energy crisis.

"They withheld energy, and they manipulated the market so that trading was in the hands of a few people before the power was sold on the spot market," Aguirre said. "Many of these people are racketeers. The ethics and honesty of the industry as a whole has been drawn into question."

Enron also has come under increasing scrutiny for its role in the energy crisis because it controlled roughly 30 percent of the wholesale power market in the West before it went into bankruptcy.

It did not escape the notice of industry observers that wholesale prices fell sharply as Enron's influence in the market began to wane.

Nevada Power purchased $504 million in electricity from Enron and sold back $114 million worth to that company between October 2000 and September, a period that includes the pending $922 million deferred energy case. But Hay said Nevada Power took roughly a 50 percent loss on the energy it sold back to Enron.

The Federal Energy Regulatory Commission, which regulates wholesale energy prices, announced earlier this month that it would investigate whether Enron and other energy companies manipulated electricity and natural gas prices in the West.

"Enron got deregulation started here and with the other energy suppliers (it) stole billions of dollars from the California economy," Consumer Advocate Douglas Heller of the Foundation for Taxpayers & Consumer Rights in Santa Monica, Calif., said. "Electricity is run by a fairly small cartel. (The companies) don't have to sit in a room and pass napkins. They know what each other is doing."

Nevada Power, which buys nearly half of its electricity on the wholesale market to serve its 611,000 customers, began complaining in spring 2000 that its business was severely affected by California's energy crunch.

Nevada's plan

Hay said Nevada Power deserved much of the blame, however, because it changed its energy purchasing strategy in late 1999. Up to then, the utility purchased most of its power for the summer the previous fall, he said.

But Hay said the utility chose instead to purchase it summer energy closer to the time it needed it. That left it in short supply and at the mercy of the inflated wholesale market when California was struck with a severe shortage in May 2000, he said. The utility wound up paying 85 percent more for power in summer 2000 than the previous summer.

"The first sign of trouble was (its) inability to meet electricity demands in the spring of 2000, which led to their financial distress," Hay said of Nevada Power. "Their excuse is that they didn't know what their customer base would be following deregulation but we dispute their reasoning entirely."

Nevada Power conceded that it procured only 7 percent of its summer 2000 energy by that January, whereas it had secured 60 percent of its summer 1999 energy by January 1999.

Nevada Power and Sierra Pacific say they were caught preparing for the state's deregulation plan that never came.

In testimony filed with the state PUC as part of its March 4 rate case, Mike Smart, vice president of resource management, said the purchasing strategy changed because deregulation was still a possibility.

"It was both imprudent from a business perspective and contrary to public policy for Nevada Power to enter into new long-term purchased-power contracts during this period," Smart said.

During the state's discussion of deregulation, "our efforts to execute long-term energy contracts with either customers or suppliers were openly described as 'anti-competitive,' " he said.

Critics say that argument is a lark because the utility would have more than made up for the loss of customers through deregulation by getting new consumers through population growth.

In fall 2000, however, Gov. Kenny Guinn cast doubts that open competition would mean lower power rates because there was high demand for electricity, but short supplies, and he put the plan on hold.

It was around that time Nevada Power, assured that it would not yet face competition for customers, went back to its pre-1999 strategy of locking up most of its summer-power needs well in advance.

'Perfect storm'

By then, however, Calfornia's energy crisis was compounded by a drought in the Pacific Northwest that created further wholesale price increases because of hydropowered plants inability to produce enough spare electricity.

"We have our own hydro dams that supply about 70 percent of our electricity, but because of the drought, they produced only about 40 percent," Dan Williams, Seattle City Light spokesman, said. "We had to make up the rest in the market, but the market was terrible. The prices on the West Coast were driven by what was happening in California. Generators were withholding power, pushing prices up and bidders were bidding into that system."

Seattle City Light, a publicly held utility, raised its residential and commercial rates 56 percent last year. At Idaho Power, that state's largest investor-owned utility, residential rates climbed 31 percent while industrial customers took a 57 percent hit.

"We kind of refer to it as the 'Perfect Storm' analogy," Idaho Power spokesman Dennis Lopez said. "California was in total chaos; natural gas prices were out of control, which affected gas-powered generation; and we had a drought. It was difficult for people to understand why we were affected."

Portland General Electric also had rate increases last year of 31 percent for residential customers and 37 percent to 53 percent for businesses, according to spokesman Scott Simms. He termed the conditions that drove prices skyward an "anomaly."

"More supply has since been brought on line," Simms said. "We have good snowpack this year so there are good conditions for hydro. Our demand side has also gone down because of conservation, energy efficiency and the economy. So there is light at the end of the tunnel."

Keeping the lights on

For Nevada Power, the pressure has been to keep the lights on at whatever the cost.

In the process, it has asked for several rate increases, including a 17 percent, $300 million rate increase in February 2001. The utility complained it was on the brink of insolvency, and Public Utilities Commissioner Richard McIntire, in defending the rate increase, said at the time that rolling blackouts would be unacceptable in Nevada.

"We need to keep the lights on, or we'll be conducting the hearing by candlelight," McIntire said then.

The Legislature passed a bill that scrapped the bulk of the deregulation plan and froze rate hikes for a year. But the bill gave Nevada Power authority to establish a deferred energy account for electricity purchased from other generators between March and September

Under that law, the utility has three years to recover those funds from ratepayers. Again, the directive to the utility was that it had to do whatever possible to keep the lights on in Southern Nevada as long as it made prudent decisions in the purchase of wholesale power.

"It's a terrible idea believing there could be power shortages," Higgins said. "We heard the Guinn administration say we absolutely had to have enough power. We had left the process in the spring of 2001 believing we had dodged the bullet."

Utility's woes

The Legislature's action hardly put Nevada Power on solid economic footing, however, at least according to the utility. Wholesale prices continued to rise in the first half of last year and electricity remained in short supply, thanks in part to the hydropower shortage.

"We lost about $325 million that our investors won't get back," Higgins said.

Nevada Power said it suffered another blow in June when the Federal Energy Regulatory Commission capped spot market power prices on behalf of California consumers. The utility said the move added $200 million to $400 million to its deferred energy costs because the cap limited the revenue it could recoup by selling spare power. On behalf of the utility, Guinn complained to the Bush administration.

"It's a big freebie for California," Guinn said in November. "Washington and Oregon feel the same way. So does Arizona, Idaho, Utah, New Mexico."

Consumer advocates also argue that federal regulators did not act quickly enough to address California's energy crisis because they are manipulated by the power industry.

Higgins said any rebate Nevada Power receives because of a favorable ruling from the federal regulators would go to defray the $922 million in deferred energy costs plus interest that the utility is now asking consumers to pay.

The company's original request to recover those costs over the next three years would have meant an increase of as much as 25 percent in monthly utility bills. Nevada Power has since amended its request so that the costs could be spread out over six years, with the increase amounting to about 12.5 percent. But that offer also has been met with criticism from Hay, who said it would cause the interest payments to balloon from an estimated $138 million to $285 million.

"My goal is to retire with Nevada Power not having to go through another volatile era," Higgins said. "My fear is that we will go back into the same cycle if more power plants aren't built."

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