Energy crisis testing mettle of regulators

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In December 1999, Seattle City Light paid an average of $34 for each megawatt hour of electricity purchased on regional wholesale markets. A year later, the utility was paying an average of $323 per megawatt hour.

This nearly tenfold increase reflected tight power supplies and strong demand, a classic market formula for a run-up in prices.

But market forces aren't supposed to be given totally free rein to set wholesale power rates. Back in 1935, Congress passed a law that required the Federal Energy Regulatory Commission to ensure that those rates stay "just and reasonable."

Sixty years later, the Western energy crisis is emerging as the acid test of the commission's ability to enforce this law in a new era of independent power producers and volatile, multibillion-dollar regional electricity markets.

"A federal hands-off approach, in my judgment, is absolutely unlawful. It is an abdication of our responsibility under the act," said Frank Massey, a commissioner on the Federal Energy Regulatory Commission. The commission concluded last fall that California markets are deeply flawed and at times last year produced "unjust and unreasonable prices."

On Dec. 15, the Federal Energy Regulatory Commission ordered changes in market rules and set up a bid-review process that could result in refunds of excessive charges.

But there's still no end in sight to the high prices, and the commission is struggling to determine what - if any - other actions should be taken in California.

The commission also has the authority to intervene in Pacific Northwest wholesale markets, where rates have equaled, and at times exceeded, those in California.

The commission, in a brief study of Northwest markets released Feb. 1, acknowledged that prices in November and December soared to "extremely high levels," well above short-term production costs.

But the commission did not make any determination on whether regional wholesale prices were "just and reasonable." And it has yet to scrutinize bids for possible refunds.

Gov. Gary Locke and many Washington utility officials are closely studying the commission's enforcement of the 1935 act and have repeatedly called for stronger - and more-wide ranging - intervention to bring down rates in the Pacific Northwest.

President Bush, in published interviews, has not been specific about what the commission should do. But he said that any effort to put a cap on wholesale electricity prices would just delay the market signals necessary to expand supplies. "It's a nice political, convenient thing to do, but it doesn't ultimately solve the problem," he told reporters.

The five-member commission currently has two Democrats, a Republican and two vacant seats. Bush recently appointed the lone Republican, Curt Hebert, as chairman. Hebert, a strong supporter of a market system, only reluctantly supported the Dec. 15 California order.

Commissioner Massey, a Democrat, doesn't think the California order goes far enough. He has called for assigning price limits to power producers, which would vary according to a producer's operating costs.

Ultimately, the full scope of federal intervention could be determined by new congressional legislation, or by the courts. Seattle City Light already is joining in a commission appeal process likely to end in the federal courts. But few expect swift passage of any congressional legislation. And no court rulings are expected anytime soon.

In the meantime, utility officials are bracing for a tough summer, when the drought is likely to seriously reduce Pacific Northwest hydroelectric power generation and further tighten markets. By then, Seattle City Light officials expect the average spot-market price will have climbed above $600 per megawatt hour.

City Light increases

To help cover the cost of wholesale power purchases, Seattle City Light raised rates by 10 percent on Jan. 1, and another 18 percent increase will take effect March 1. More rate increases are expected in July and October.

The high-priced wholesale markets have helped fatten the profits of private energy companies that both sell their own electricity and also broker sales of other power.

Duke Energy of North Carolina, for example, sold more than $13 million of electricity to Seattle City Light during a five-month period that ended in December at prices ranging from $38 to $650 per megawatt hour.

Duke was one of the standout performers in the energy industry this year. Its division on U.S. wholesale electric sales reported more than doubling earnings before interest and taxes compared to 1999.

"The markets are reflecting the dynamics of weather, regional supply, how much water there is and how many players there are. These are the fundamentals of supply and demand," said Jennifer Pierce, a spokeswoman for Duke. "We certainly believe in letting the markets work because that drives the greatest efficiency."

But in 1935, when Congress passed the power act, many lawmakers' belief in capitalism had been badly shaken by the Depression. The 1935 law deemed that electricity was a commodity too precious to be left to market forces alone. It requires "just and reasonable" wholesale pricing, making illegal any power prices that fail to meet that standard.

In the decades that followed, the commission closely regulated private utilities and required them to submit exhaustive documentation of all their expenses. The commission then approved rates that would result in a reasonable rate of return. Some utilities still sell wholesale electricity through this regulated process.

But rather than painstakingly inspect every rate request, the commission now allows private utilities to sell most electrical power under a market system. Companies lose the assurance of a fixed rate of return but gain much more freedom to set prices and use transmission lines that regulated utilities once held under monopoly control.

Federal commissioners have hoped that competition would ensure that wholesale rates would remain just and reasonable. Through much of the past decade, the new market-based system appeared to be working reasonably well, encouraging private companies to build new plants in some areas of the country and largely avoiding huge price increases that might spark public outcries.

But the California energy crisis changed all that. The markets were hampered by the state's botched attempt at deregulation that choked off new plant construction even as demand soared. The problems were exacerbated as California sought to buy huge quantities of power in volatile short-term markets.

`Unjust and unreasonable'

The Federal Energy Regulatory Commission, in its California investigation, found that the markets had yielded some "unjust and "unreasonable" price increases. But investigators were unable to determine just which transactions were violating the federal standards.

The commission has required all companies selling wholesale power in excess of $150 per megawatt hour to submit justifications for those rates. Most of the December and January sales have been above that level so the commission has been flooded with company reports on these transactions.

"I can't say what the commissioners may - or may not - do in relationship to the refunds,'' said Barbara Connors, a spokeswoman for the agency.

The commission also is setting up a longer-term plan to monitor the California markets.

But there's no similar effort to require price monitoring in the Pacific Northwest, even though spot-market prices in this region have rivaled - and at times exceeded - those in California. And there are no prospects here in the Northwest for any refunds of excessive wholesale charges.

Wholesale markets are complex, and fixed price controls set too low could cause big problems. Some utilities, for example, have racked up huge costs buying power at high prices. They then try to recoup these losses by selling at equally high - if not higher - prices. If the caps precluded all high-priced sales, these utilities could fall even deeper into the red.

Private energy companies that enjoy some of the most robust profits also are key to expanding generation through new plant construction. Clamp too tightly on these rewards, and the commission risks wiping out incentives to build new plants.

"We need to hear the market signals, so we know where to invest," said Pierce, the Duke Energy spokesman.

But Massy, the federal commissioner, says those signals already have been sent, loud and clear for all to hear.

"Surely, suppliers have gotten the message by now," Massy said. "The real question is whether consumers are going to be the road kill over the next two to three years until the market gets back in balance."

Hal Bernton can be reached at hbernton@seattletimes.com