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Californias Energy Future: A Framework for an Integrated Power Policy
Californias Energy Future:
A Framework for an
Integrated Power Policy
Bay Area Economic Forum
A ppartnership oof tthe B
Bay AArea C
Council aand tthe
Association oof B
Bay AArea G
Governments
November 2002 Ta b l e o f c o n t e n t s
Page
Acknowledgments
i
Executive Summary
ii
Forward
iv
Chapter 1. A Call to Action
1
State of Californias Power Market
An Integrated Framework
Chapter 2. Elements of an Integrated Policy
6
Establish a Competitive Wholesale Market with
Safeguards to Prevent Abuse
Establish a Competitive Retail Market
Link Wholesale and Retail Markets
Improve Transmission Dispatch and Planning
Improve Distribution Efficiency
Reform Californias Energy Regulatory Agencies
To Improve Efficiency and Clarity
Chapter 3. A Key Challenge
23
Power Contracts Held by the State
Accelerate Renegotiation of Contracts
Manage Existing Contracts More Efficiently A c k n o w l e d g e m e n t s
The Bay Area Economic Forum and its sponsoring partners, the Bay Area Council and the
Association of Bay Area Governments, prepared this report. It follows two prior reports:
The Bay Area A Knowledge Economy Needs Power, published in April 2001 and
California at a Crossroads Options for the Long-Term Reform of the Power Sector,
published in October 2001.
Contributors to this report include McKinsey & Company, which prepared much of the
supporting analysis on a pro bono basis (key contributors include Olga Perkovic, Bret
Connor, Jon Welner, Stuart Colaco, Zander Arkin, and Rita Koselka), and the energy
committee of the Silicon Valley Manufacturing Group, especially Jeff Byron, Joe Desmond,
John Redding, K.C. Mares, and Justin Bradley. Many other individuals within the
academic community, public interest organizations, and the power sector were helpful in
providing a range of useful information and insight.
The Bay Area Economic Forum would like to thank all of the above for making this
report possible.
i ii
E xe c u t i v e S u m m a r y
The California energy crisis is not over. Although prices on the spot market have fallen,
the power sector is far from functioning well. While no blackouts have occurred in 2002,
the state power systems limits were severely tested during the summer and blackouts in
Silicon Valley were only avoided by voluntary curtailment from large users. The state is
locked into overpriced, long-term contracts, and the regulatory environment and thicket
of oversight bodies remain unwelcoming to private investment in new power generation.
Without continued, timely investment in new generation capacity and related
infrastructure and concerted conservation efforts, the state could face more power
shortages. State actions to date represent only a bandage, not the full-scale reform the
market needs. This reform should be based on an integrated power policy for the state,
which ensures low-cost and reliable power, while supporting the state's conservation and
environmental goals.
There is room for debate around specific policy measures, and this report is presented as a
platform to stimulate that discussion in a fact-based manner. With that objective, we
believe an integrated power policy should include:
Developing a well-functioning and competitive wholesale market (between power
generators and power distributors/retailers) with stable market rules that will attract
needed investments in new capacity
Restoring and maintaining the financial solvency of the states utilities
Allowing customers to choose among retail providers, thus encouraging more plan
options, improved service, and lower prices
Linking wholesale and retail markets through pricing structures that reflect the real costs
of power based on time of use and that also promote conservation and energy efficiency
Simplifying transmission rates and encouraging regional resource sharing, including
possible participation in a western Regional Transmission Organization (RTO) to
dispatch and facilitate greater regional efficiencies
Reaffirming the mission of the investor-owned utilities as common carrier distributors
with minimal risk, restoring their financial solvency, and creating performance-based
incentives for their distribution systems
Rationalizing the number, role, and size of state agencies responsible for setting and
monitoring market rules and ensuring power system reliability iii
Minimizing the cost of the long-term power contracts signed by the Department of
Water Resources (DWR) during last year's crisis by using these contracted resources
more efficiently, renegotiating these contracts, or disposing of these contracts through
agreed-upon contract buy-outs or auctions.
The estimated savings to the ratepayers from transitioning to a carefully planned,
integrated market for California and reducing the cost of the DWR contracts would
include a one-time savings of $2 billion to $4 billion on the contracts and ongoing
savings of over $8 billion over 10 years (Exhibit 1) from adopting a dynamic retail
pricing structure, improving transmission and distribution efficiency, and reforming
California's energy agencies. This is not to mention the broad benefits that a well-
functioning market will bring by encouraging private investment and innovation and
putting downward pressure on prices. Although forecasting power prices is difficult,
restructuring in other power markets such as the Pennsylvania-New Jersey-Maryland
(PJM) power pool, Alberta, Canada, and the United Kingdom has shown that energy
prices can drop significantly.
The task is huge and recent events make it even harder for state leaders to make
reforms in such a complicated but critical sector and do what is necessary to create a
robust system that protects the interests of all Californians. The costs of not doing so,
however, could be very high.
IMPLEMENTING REFORMS COULD SAVE CALIFORNIANS BILLIONS
$ Billions
EXHIBIT 1

1 Assumes contracts (excluding Calpine Corporation's contracts) can be renegotiated

at 70-80% of total nominal value of the out-of-market portion of the contracts

2 Includes IOU capacity, long-term QF contracts, state-owned generating plants,

and municipal and federal generating capacity

3 Savings from reducing the PUC and ORA budgets to be comparable to other states

and rationalizing the EOB and CPA

4 Assumes 15-20% improvement in maintenance, customer service, and SG&A (selling,

general and administrative) from implementing performance-based rates

5 Benefit realized after real-time meters installed for all large C&I customers and interval

meters installed for approximately 50% of small commercial and residential customers;

numbers are rounded
Source: California State Controller's Office; press clippings, interviews; McKinsey analysis
8.0-11.0+
?
0.5-1.0
4.5-6.0
3.0-4.0
2.0-3.5
DWR contract
renegotiation
Wholesale competition
One-time savings
Ongoing savings following
implementation (over 10-year period)
Agency reform
T&D efficiency
Monthly floating prices/
real-time metering
5
2
1
3
4 Fo r e w o r d
This report outlines one possible framework for the future of California's power sector,
supported by fact-based analysis of the experience of other markets that have successfully
introduced competition into the electric sector. As with previous efforts by the Bay Area
Economic Forum, this report seeks to provide a basis for an informed, constructive
dialogue among all parties on the future of California's and the region's power policy.
While some may disagree with the exact policy positions described in this report, the facts
and data presented herein clearly outline the magnitude of the challenge and the
opportunity in front of California policy makers.
California needs a clear, comprehensive power policy to ensure low-cost and reliable
power over the long term. While this report is most concerned with overall policy
direction, it also presents an integrated set of market structures. There are other workable
approaches, and every option presented in this report need not be adopted in its entirety;
each is open to discussion and debate. However, the energy sector is an interrelated
system that must be considered comprehensively, and as learned with California's last
attempt at market restructuring, piecemeal measures only increase the risk of another
failure. In addition, California's power policy cannot exist in a vacuum and will be
affected by the policies of neighboring states.
This paper builds