----- Forwarded by Sarah Novosel/Corp/Enron on 12/27/2000 11:42 AM -----

	"Tabors, Richard" <tabors@tca-us.com>
	12/27/2000 10:39 AM
		 
		 To: dwatkiss@bracepatt.com, snovose@enron.com
		 cc: 
		 Subject: Today's Van Vactor column


Dan and Sarah

I don't know if you see Sam VanVactor's materials or not.  If not, here is a
shot from the 26th

Richard

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Copyright , 2000 Economic Insight, Inc .
EDITORIAL
S.A. VAN VACTOR
Energy Crisis Myths
Mythology has always been an important part of the
human experience and never more so than when hard
choices must be made. Thus it should come as no
surprise that our current energy crisis is accompanied by
a seemingly endless array of apologies, exaggerations,
and myths.
Far and away the most common myth concerns the
persistent view of many that suppliers are holding back
generation in order to jack up prices. Similar charges
were levied during the oil crises of the 1970s. In those
days, critics complained that tankers could be seen just
off the coast, waiting until prices rose. Holding back on
electricity sales makes even less sense because once a
moment of demand has passed, it is gone forever. No
rational supplier will turn down the price offers persisting
in the present marketplace day after day. Indeed, most
suppliers are laboring to squeeze out every electron
possible from aging and unreliable generators.
An equally common error arises when the crisis is
blamed on "deregulation" and free markets. Although
California was the first state to adopt wide-scale
consumer choice, its market has been heavily regulated
and constrained. For example, after nearly three years
of consumer choice in the retail market only 12% of the
total volume is served by entities other than traditional
utilities. The volume of direct access has actually
declined in recent months as buyers have scrambled to
reconnect to regulated utilities that offer frozen rates.
More importantly, the development of reliable forward
markets and planning was stillborn because the
California Public Utility Commission either prohibited or
limited such trading at the same time that it granted
automatic "prudency" to spot purchases. Deregulation
may have changed the nature of the crisis, from a
physical to a financial problem, but the demand and
supply fundamentals at the heart of the current energy
crises were inherited from an earlier era of regulatory
stumbles.
Officials in neighboring states are eager to blame
California for the crisis, but nothing could be further from
the truth. The Western power market is fully
interconnected by design and if one part is short, all
regions are short. In fact, every operating area
recognized that demand would occasionally exceed
supply; planners simply relied on the proposition that it
would not happen simultaneously in all regions of the
West. However, this is exactly what has happened.
The current crisis was precipitated by a scarcity of
natural gas, unexpected demand growth in California
and the Southwest, the second hottest summer on
record in the Southwest, and low water runs in Northern
California and the Pacific Northwest.
If these myths are at odds with reality, how should the
energy crisis be viewed? Famine and pestilence are
normally reserved for biblical parables, but they do play
a role in this story. The Western power market is tied to
the vast generation potential of the region's hydroelectric
system. The system's potential is not, however, always
available. Unlike hydro systems in Quebec and Brazil,
the Columbia River system has only three months worth
of water storage. (Quebec is said to have ten years of
water inventory). The difference between a drought and a
year flush with water can be as high as 6,000 average
megawatts per hour - roughly the capacity of six of the
West's nuclear generating stations. Thus, the availability
of electricity swings from abundance to scarcity in an
unpredictable pattern based on the state of the region's
rivers. In the key months of June and July this year,
hydroelectric generation from the Northwest Power Pool
averaged 4,635 megawatts per hour below that of the
favorable year of 1997.
System planners in the 1970s understood the nature of
the hydroelectric system very well and planned to add
thermal generation facilities to ensure adequate supply
even under "critical-water" conditions. These conditions
represented the worst-case scenario for hydroelectric
generation. Such planning, however, renders most
prospective thermal plants uneconomic, because they
would lay idle except under the driest of conditions. With
the collapse of the WPPSS plants, the Pacific Northwest
quietly shifted its planning criteria from critical water to
average water. In times of heavy water flow the region is
a net exporter, but during a drought, it must import
electricity.
Over the last decade, utility planning has been replaced
by a market, and not just in California. Almost all new
generators are independent power producers. In a
market, new supply will only be built if there is the
incentive to do so. That incentive takes the form of
profits, and profits arise through high prices. What no one
has thought through is the implications of the variability of
hydro-electric power on the incentive to construct thermal
generation. If new thermal generation is constructed, but
is only needed one out of every ten years, then prices in
years of drought must be extremely high in order to make
building such thermal plants attractive to investors. In
short, this is what the western power market is
experiencing this year, and will continue to experience
until water flows improve and new supplies catch up with
the region's overall economic growth.
The first step in solving a problem is to understand its
cause. While it is true that California and other Western
states have not invested sufficiently in generation
capacity and natural gas delivery systems, additional
supply is not, by itself, the answer. Politicians, planners,
and market participants alike must recognize that drought
years will produce power shortages, and they should plan
accordingly. The extremely high prices observed this last
month arise, in part, from fear that the Pacific Northwest
may be entering a cycle of cold, dry weather. So far the
reaction has been uneven and not terribly productive.
Instead of blaming suppliers or each other, the region's
leaders should implement energy conservation programs
aimed at solving a short-term, not just a long-term
problem. Publicity that explains the situation with the aim
of conservation among consumers, "buy-back" programs
for industrial and commercial customers, and other such
pricing incentives should be implemented as rapidly as
possible, before low water forces everyone into rolling
blackouts and manufacturing curtailments.
Samuel A. Van Vactor is the publisher of the Energy
Market Report, and former Head of Planning for the
Oregon Department of Energy.
The Energy Market Report welcomes unsolicited
manuscripts for possible publication. Editorials can be
sent by electronic mail only to emr@econ.com <mailto:emr@econ.com> .