Whine Country

Sure, Texas energy companies have made handsome profits lately. But they're not to blame for California's crisis.

August 2001By Comments

It has been a long summer of blackouts and black eyes. For months California politicians and officials have been pointing a finger at Texas, claiming that its energy companies are chiefly responsible for the Golden State’s skyrocketing electricity bills. Governor Gray Davis has accused them of nothing less than “unconscionable price-gouging.” “Davis Says Bad Guys Went Thataway, to Texas” declared a headline in the Los Angeles Times for a story that began, “When the lights go dark, this is what Gov. Gray Davis wants us to see: President Bush and V.P. Dick Cheney smirking as their Texas pals make off with our money.” Then there was the remarkably crude swipe California’s attorney general, Bill Lockyer, took at Kenneth Lay, the chairman of Houston-based power merchant Enron and a top Bush contributor: “I would love to personally escort [Kenneth] Lay to an eight-by-ten cell,” he told the Wall Street Journal, “that he could share with a tattooed dude who says, ‘Hi, my name is Spike, honey.'”And the tide of public opinion in California is running against Texas too. A recent Los Angeles Times poll found that a whopping 86 percent of Californians believed that power companies had, in fact, manipulated their state’s electricity market.

Yes, Texas bashing is in full swing again. With a Texan in the White House—one with roots in the oil patch, to boot—and lingering perceptions that Texas energy barons are a bunch of greedy J. R. Ewing types, California has come out swinging at its longtime rival. Its main targets are a Gang of Four companies from Houston, all of whom are involved in selling power to California: Enron, Reliant Energy, and Dynegy, which generate or trade power, and El Paso Corporation, which owns the pipelines that carry the natural gas that many California power plants burn as fuel. All are now targets of government investigations and lawsuits, some of which charge the companies with conspiring to drive up the wholesale price of electricity.

The four alleged energy bandits are based in downtown Houston, where Louisiana Street is fast becoming known as the nation’s “energy alley.” They say they’ve done nothing wrong. But Lockyer, the California Public Utilities Commission, and a California Senate committee are seeking to prove that they improperly manipulated prices while reaping enormous profits. Lockyer says he may bring civil or criminal charges under laws that cover unfair business practices, racketeering, and white-collar crime. Meanwhile, the Federal Energy Regulatory Commission (FERC) has been probing to see if El Paso, which operates the nation’s largest natural-gas pipeline network, used its sizable market power to drive up prices for natural gas and worsen California’s energy crisis.

The Texas companies make big, tantalizing targets. They’re the brash new brokers of power, making money on the unregulated or newly deregulated parts of the once-stodgy natural gas and electricity businesses. “These companies pride themselves on an underdog culture that allows a thirty-year-old trader to make millions,” says former U.S. deputy energy secretary Bill White.

But do they deserve the lion’s share of the blame for California’s energy woes? I don’t think so. After reading stacks of documents from the investigations and talking to energy experts, I found more smoking guns in California’s energy crisis than in a Clint Eastwood movie, and none of them have Ken Lay’s prints on them. California has its own bungled deregulation, atrociously bad planning, bad timing, and plain old bad luck to blame for its energy problems. Sure, Texas companies made money off its energy market, but so far, not one of the probes has found that their profits were made illegally. Looking past the bluster and political maneuvering (Governor Davis is up for reelection next year), the real culprit is a tremendous imbalance of supply and demand set up years ago, before the state’s burgeoning population and famous high-tech industry began sucking up more power than the state could supply.

In hindsight the crisis looks like a train wreck that was waiting to happen. California regulators unwittingly set it in motion with their botched deregulation of electrical power in 1998. Under that plan, the state’s public utilities sold off power plants to private companies like Reliant and Dynegy. But that didn’t solve a basic problem of power supply, which was that no new major power plants in California had come on line since 1988, largely because of environmentalists’ opposition. Instead, California relied heavily on importing hydroelectric power from the Northwest. “Everybody talks about the Texas bandits, but they forget that California depended on hydro for thirty percent of its power,” says Pat Wood III, the former Texas Public Utilities Commission chairman who was sworn in as a new FERC commissioner in June. But drought left the hydro plants in the Northwest unable to produce enough electricity.

To make matters worse, California’s electric utilities had relied on the volatile spot market to buy electricity rather than locking in long-term, fixed-price contracts. That worked fine when wholesale prices for electricity were low. But when wholesale prices moved up sharply, as they did last year, utilities slammed up against another legacy of California’s flawed deregulation scheme—limits on the retail prices they could charge consumers. Buying high and selling low caught up with them. The state’s largest utility, Pacific Gas and Electric, filed for bankruptcy in April (among its creditors are Enron, Reliant Energy, and Dynegy, which are owed hundreds of millions of dollars for power sales to California). To attract more power generators, the state has since lifted the limits on what consumers pay, but that has made their electricity bills shoot up. And talk about a double whammy: Last winter cold weather drove up prices and dried up supplies of natural gas, which fires about a quarter of California’s power plants. “It was the perfect storm,” Enron spokesman Mark Palmer said of the combination of factors that led to the crisis.

To be sure, Texas energy companies have profited handsomely from the huge increase in energy prices in California. But the numbers fall far short of the billions and billions of dollars that California claims they’re pocketing. Davis says California power users paid $27 billion for electricity last year, a mind-boggling $20 billion increase from 1999 (the total includes all utilities and power generators supplying California, not just those in Texas). El Paso, Enron, Dynegy, and Reliant have posted hefty gains in revenues and earnings since 1999, especially in their trading operations. But they operate on slim margins, buying and selling energy in huge volumes and making money on small spreads. “They’re big in the transaction business like Citibank is big,” says Paul MacAvoy, an economics professor at Yale University’s School of Management and the author of The Natural Gas Market: Sixty Years of Regulation and Deregulation. “They’re not big in the sense of Standard Oil or J. P. Morgan, which had the market power to set prices and could wield that power to maximize profits and destroy competition. You can’t say that about Enron, which operates on the slightest of edges. It buys billions of dollars worth of energy product to receive billions plus a penny.”

Enron, the nation’s largest buyer and seller of electric power, has had spectacular growth in its commodity sales and services business, which includes not just natural gas and electricity but other commodities that it trades online. First-quarter income in that business jumped 76 percent to $755 million, thanks to price volatility in the gas and power markets. El Paso, now an industry behemoth since its merger with Coastal Corporation in January, also did well in the first quarter. Revenues at its merchant energy business, which includes trading operations, more than doubled, and operating income in that business increased to $300 million from $72 million a year earlier. When I tallied up the profits Enron, El Paso, Reliant, and Dynegy made for all of last year, for all of their operations—including those not related to California—the total came to $2.6 billion for all four companies combined. That’s a tidy profit, but it’s not $20 billion.

Meanwhile, the FERC investigation into El Paso has become a test case in the California versus Texas energy battles. A ruling could come as early as September, and the case is being closely watched. While the picture painted by California politicians is of Texas energy companies swooping in like vultures, in fact El Paso has been doing business in that state since 1949. It built the original pipelines that carried gas from gas-producing basins in West Texas and Oklahoma to markets in California. “Our pipelines going west were built to serve customers in California,” says Norma Dunn, an El Paso senior vice president. “We have millions and millions of dollars invested in the state.” Through June 30 El Paso Natural Gas’s pipeline system has been shipping an average of 2.5 billion cubic feet daily to California. All this summer the FERC has been holding hearings into whether El Paso had market power—meaning the size and influence to manipulate markets—and used it to drive up prices. “Sure, we made money,” Dunn says. “But we didn’t make the billions and billions that people are talking about.”

The blame game will no doubt continue as more hearings are held, lawsuits advance, and investigations probe deeper. But if Lockyer really wants to lock up all those responsible for his state’s energy debacle, he’s going to need something a lot bigger than an eight-by-ten cell. And that Spike guy is going to have a lot of company.

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