Throughout its history, California has had its fair share of economic booms and busts. In the mid-1800s, prospectors streamed across the Rockies to pan for gold in the Bay area. Defense contractors swarmed into Southern California in the wake of World War II. The entertainment industry mushroomed in and around Los Angeles with advances in motion picture and television technology. Silicon Valley spent the late 1990s in the grip of dot-com fever. No matter what the era or industry, the Golden State's enormous population and abundant natural resources always have served as a tremendous economic draw.

In electric-utility terms, California's latest boom-bust cycle has been electric deregulation. In the 1990s, state leaders came up with a plan that promised consumer choice, increased competition and lower electric prices. In late 1998 and early 1999, that plan kicked off with great fanfare. By early 2001, though, California's newly deregulated electric industry was in ruins, with the state dealing with rolling blackouts, skyrocketing prices and the imminent bankruptcy of the state's two largest electric utilities.

Enough has been written about what went wrong and why. For electric transmission and distribution firms, a fresher and perhaps more relevant question is what happens now? Where do we go from here with electric-industry restructuring in California and across the country?

One thing that seems certain is that no state or region will jump into electric deregulation without studying what took place in California. Many states, in fact, have decided to put restructuring on hold, waiting to see what happens after the smoke clears in the West.

Ken Rose, senior economist at the National Regulatory Research Institute, tracks electric deregulation on a state-by-state basis. He says that since the California electric crisis of this past winter, several states have gone from studying or planning to implement deregulation to a category he calls “no longer interested [in deregulation].” California, he says, has become a “category of one,” as the only state that has started deregulation only to suspend it, but several states have disbanded deregulation task forces or publicly announced delays in electric-industry restructuring.

Jim Owen, a spokesman for the Edison Electric Institute (EEI), says lawmakers, regulators and utility executives around the country have taken a step back to make sure their states do not face the same fate as California if and when they deregulate. “We have seen states saying, ‘let's take a breather here and make sure we have all our ducks in a row before we move into retail access,’” Owen says. “They want to make sure they have the rules in place to properly make it work.”

All Eyes on Texas

One state that thinks it has all its ducks in a row is Texas, which began full-scale electric deregulation on Jan. 1, 2002. Officials in the Lone Star state say Texas' electric deregulation has been designed to avoid the main pitfalls of California. Officials point out that Texas law will not require or even encourage utilities to divest themselves of generation assets, something widely regarded as a misstep on the part of the California plan. Texas also has abundant local generation facilities, with more constructed in preparation for deregulation. Reggie Bonner, power delivery manager for TXU in Dallas, says the state has added some 23 new power plants since statewide deregulation was first discussed in 1995, with an additional 24 under construction today. “California had a supply and demand problem that we won't have,” Bonner predicts.

Another difficulty California experienced was transmission constraints. David Gill, rates and regulatory manager for the Transmission Business Unit of TXU, says Texas has had ample time and opportunity to observe what happened in California and to design its system to avoid a repeat of transmission supply problems experienced in the West. TXU and other Texas utilities, he says, began work on open-access wholesale transmission rules in the mid-1990s, and had open-access wholesale tariffs in place by the start of 1997. “We worked to make sure we have ample infrastructure that is available at reasonable prices,” he says. “A lot of the things you saw in California, those transmission bottlenecks, they served as a signpost that we were on the right track regarding transmission.”

Dan O'Neill, a director at worldwide energy consultants Navigant Consulting, says everyone will be watching deregulation in Texas, using its success or failure to guide their own deregulation plans. “The scare of California is still vivid in many regulators' minds,” O'Neill says, “and much of the public is thinking, ‘deregulation, no way!’ But as every month goes by without a repeat of California and every already-in-place deregulation goes smoothly, you will see less of that concern. Success in Texas in particular would make California's experience an aberration, not a harbinger of what is to come.”

Rose is even more direct. Electric deregulation must succeed in Texas, he says, in order for it to have any chance of near-term adoption in other states. That said, he says the state that houses the Alamo is the right place for deregulation's first Last Stand. As opposed to California, Rose says, Texas has taken a far more deliberate approach to deregulation, has plentiful generation resources and has done significant work to enhance statewide transmission. Texas also has had the benefit of being able to watch what happened in California and adjust its plans accordingly. “Texas has had the benefit of seeing failure, and to learn from it,” Rose notes. “If deregulation doesn't work in Texas, it won't work anywhere.”

Transmission Takes Center Stage

While much of the coverage of the California crisis has focused on the need to build more power plants or cap prices to consumers, many are pointing to an even bigger issue that has yet to be resolved — the need for stepped-up transmission facilities, not only in the West but across the country.

A look at the role transmission congestion played in the California crisis only begins to illustrate the problem. Recent studies by EEI and the Electric Power Research Institute estimate the cost to expand and upgrade transmission facilities in the Western transmission system through 2009 to be at least US$10 billion and maybe as much as $30 billion. Another US$1 to US$3 billion dollars per year will be needed to maintain that system and accommodate continued growth. Yet current plans to expand transmission in the West amount to US$1.5 billion through 2009, assuming all current plans are carried forward. The cost of transmission congestion, the studies suggest, is staggering. The costs of rolling blackouts in the San Francisco Bay area during the winter of 2001 were estimated at as much as US$1 million per minute of lost economic output for the hundreds if not thousands of high-tech and computer firms in the area.

Many of those blackouts, moreover, happened or were on the brink of happening because of transmission constraints among a single major transmission line, Path 15, which connects the northern and southern parts of the state. On at least some of the blackout days, power was available in Southern California to meet needs to the north, but Path 15 had been loaded to its maximum safe reliability limit, closing off further transmission. Though that cost Northern California businesses and energy users dearly this past year, in the end, it may prove to be the beginning of a turning point in the way transmission is viewed in the overall electricity-restructuring picture.

“Transmission is really becoming one of the big stories going forward,” Owen says. “A few years ago, no one thought about Path 15 in California. Now everyone in this industry knows about transmission bottlenecks. People are realizing that transmission plays a critical role as the linchpin in a robust power market. Policy makers and governors are going to be very focused on that.”

Many already are. In late December 1999, the Federal Energy Regulatory Commission (FERC) issued Order No. 2000, encouraging utilities to form Regional Transmission Organizations (RTOs). In July 2001, FERC proposed that four RTOs be formed in the United States, one in the Northeast, Southeast, Midwest and West. FERC Commissioners William Massey and Linda Breathitt have been stressing the importance of RTOs and upgraded transmission systems in many of their public appearances and statements. FERC even held what it called “RTO Week” in October 2001 featuring workshops and presentations on RTO formation and management.

“The current grid management in the United States is not conducive to an adequate reliable supply of energy or to reasonable consumer prices,” Massey said in a speech last August. “RTOs will streamline interconnection standards and help get new generation to market. RTOs will ensure access to regional power markets, improve transmission pricing, regional planning and congestion management, and will produce consistent market rules across a region.”

Maybe so, but will that happen anytime soon? Critics, or perhaps more accurately skeptics, of FERC's RTO strategy are more concerned with the time, effort and coordination involved in forming an RTO than the governance of RTOs once formed.

“I see the persistence of the ‘controlled market’ mentality,” says Lynne Kiesling, director of economic policy for Reason Public Policy Institute in Los Angeles. “Regulators seem to want to manage competition. Looking at FERC's RTO policy, in Order 2000 they sort of said let a thousand flowers bloom, we don't want to impose a solution, you transmission owners figure it out among yourselves. Then later they went to ‘one size fits all’ saying RTO West was a good model for the rest of the country to follow. Everything they are doing is still predicated on the natural monopoly model.”

Kiesling prescribes decreased rather than increased regulation as the key to unlocking transmission constraints. “I would like to see transmission and distribution deregulated,” she says. “I certainly think distributed generation increases the potential for competition against existing transmission grids. If I have some of my own generation, you have to price more favorably to get me to hop on the grid.”

Kiesling, though, says she holds little hope that federal or state regulators will move away from the RTO model in favor of deregulation of transmission and distributed generation.

“Everything is still grounded in the basic government granting of a franchise to string wires from point A to point B,” she says. “That is old regulated service territory obligation to serve. It has stifled distributed generation that could open the grid. My policy suggestion is so simple that it will never be implemented. It is to cut the Gordian Knot of the monopoly franchise. Allow customers to opt out of buying power from the grid. That would go a long way to solving the problem, but it is far too simple to ever be implemented.”

More Hurdles to Clear

Gordian Knots or not, electric deregulation faces other challenges subsequent to or in conjunction with the California electric crisis. One major challenge is the nationwide economic downturn of 2001, which has made raising capital for new plant construction or new transmission facilities that much more difficult. Hand in hand with that is the fate of energy giant Enron, an early market leader in deregulated energy that has fallen on hard times and by the end of 2001 filed for Chapter 11 Reorganization Protection.

“We have already gone from the first boom in restructuring to the first bust in restructuring,” says Rose. “I am hearing anecdotally that a lot of plants that were being planned are not being built, even though they are getting siting and going through the process. The Enron thing is being cited as a caution. If you put Enron together with the economic downturn, we may see that effect on the capital market for transmission upgrades as well.”

Rose and Kiesling say the troubles at Enron may have little to do with restructuring or deregulation, but that fact may escape regulators or the public. “Most people in the industry know that there were a whole bunch of actors that led to the California situation, but it translated politically as deregulation was the problem,” Rose says. “Enron may get translated the same way.”

“I think in the public's eye there is some link,” Kiesling adds. “Parties that are suspicious of deregulation have been good at supporting that link. Enron's decline is entirely the fault of bad accounting and bad judgment. It does not mean risk management is not appropriate, but they pioneered the entire risk-management services industry in energy. The first mover gets a lot of attention and eventually it falls from its high perch. Trying to tie its fall to deregulation is not accurate, but it has been done before in history.”

One thing that had not been done before but may prove to further cool the zeal to deregulate electricity markets was the September 11 terrorist attacks on New York and Washington. The attacks themselves may not have derailed any specific restructuring plan, transmission upgrade or new plant construction, but one aftereffect of what happened that September morning has been that the electric-power industry has stepped-up concerns and surrounding power reliability and security.

“Utilities are clearly more focused on reliability and security,” Kiesling notes. “I have not seen any discussion about the need to change reserve markets and things like that, but more on securing nuclear plants and making sure power can be restored.” Kiesling says she also would like regulators and utilities to address the potential vulnerability of electrical systems that are based on natural monopoly models. “The premise that electrical service is a natural monopoly runs counter to and assumes away the benefits of having redundant systems,” she argues.

Regarding the future of electric deregulation nationwide, both O'Neill and Kiesling predict that the California crisis, with some help from the general economic slowdown of 2001, will delay but not forestall electric competition in other states.

“In states like Texas and New York, the horse is already out of the barn and it is not going back in,” says O'Neill. “The states that were sitting on the fence are probably going to wait a while. Over time, California will be seen more and more as an isolated aberration, but until then you will not see deregulation going forward in states that have not passed it already.”

“There certainly has been an effect,” Kiesling says of the California crisis. “There is a natural human tendency to be risk averse. We see this potentially horrible thing having happened, so there has been some retrenchment and that is natural. But I agree with those who say the deregulation genie is out of the bottle. The deregulation and restructuring process is far enough along and generating enough benefits that it is not going back, except — ironically enough — in California. Nevada, Montana and some of the states in the Southeast have delayed some exploratory processes. The short-run consequences of the California collapse are going to be bigger than the long-run consequences.”