Early History of Electricity Web viewattached between the key and a Leyden jar, a primitive capacitor for storing an electrical charge. ... In recent years, high voltage (as high as

2 Electricity and Utility IndustryEarly History of Electricity

The nature of matter was not known in 600 BCE when Greeks generated a spark by rubbing amber with fur. The term electricity is derived from the Greek word for amber. Nothing happened for about 1,300 years when the next advance occurred in magnetism, not in electricity. In 700 CE, the first astrolabe measured the inclination of the North Star to determine latitude on land; and in 1100 CE, the magnetic needle was first used by the Chinese for maritime navigation. In the thirteenth century, a freely turning lodestone that aligned itself with the magnetic north pole along with the sextant, an adaptation of the astrolabe for use at sea plus the cross staff also capable for determining latitude at sea, made long sea voyages beyond the sight of land possible, inaugurating the Age of Exploration. It was not until the 1700s that a ship could be located with some degree of accuracy by a quadrant measuring latitude by means of the inclination of the sun at high noon, its highest point in the sky, and longitude by means of the time difference between a chronometer on board the vessel running on Greenwich time and local noon. Measuring location for other times of the day depended on dead reckoning from the last known position using a magnetic needle or lodestone for direction and a knotted line for speed. This collection of technological innovations made navigation in open waters more predictable and charts more accurate.

These advances had to do with magnetism, not electricity. Further interest in electricity had to wait 23 centuries after the discovery of generating a spark by rubbing amber with fur. Curiosity over electricity began to percolate in the eighteenth century. The reader may ponder why it took so long, but the slow progress in adopting magnetism as a means for navigation may provide a hint: no one had any idea what they were dealing with. Early scientists in the eighteenth century thought that electricity was a two-way flow of mysterious fluids. Benjamin Franklin simplified the analogy to a single flow such as air or water pressure where a fluid thought to be electricity flowed from a positive to a negative pressure. But Franklin had no idea about the nature of the fluid or its direction of flow, but that did not stop him from initiating the convention of positive and negative charges with electricity assumed to flow from the positive to the negative charge plus introduce the concepts of conservation of charge, conductors, and capacitors to the world. Decades would past before the direction of electricity flow established by Franklin was shown to be wrong, but it was too late to correct it. Franklin’s error is scrupulously preserved to this day.

Franklin is best known for his experiment of flying a kite in a lightning storm. His son William got the kite aloft, a dangerous undertaking in its own right as he was running on wet grass in the middle of a field during a thunder storm. A silk string was connected from the kite to an iron key. A thin metal wire was

©Routledge/Taylor & Francis 2016

attached between the key and a Leyden jar, a primitive capacitor for storing an electrical charge. Also attached to the key was a silk ribbon that allowed Franklin to hold the kite in place once airborne. Franklin stood on dry ground in a shelter, which along with the dry portion of the silk ribbon near his hand insulated him from potential shock. Even with this precaution, he could have been killed had the kite been directly struck by a lightning bolt. Lucky for him, a bolt of lightning miles away was able to induce a small current in the kite string that reached the key, which was then stored as electrical charge in the Leyden jar. When Franklin moved his free hand near the iron key, he received a shock when the negative charge on the key, stored in the Leyden jar, was strong enough to attract the positive charge in his body. He concluded that the spark from lightning via the key was the same as a spark from rubbing amber with fur, demonstrating that lightning was electricity. This led to his invention of the lightning rod, a metal conductor that provides a path of less resistance for lightning to reach the ground rather than passing through a wooden structure possibly setting it afire.

Franklin’s work spurred others to take a deeper look at electricity and knowledge of electricity began to advance one incremental step at a time. The history of electricity is one person learning from another continually expanding on previous efforts. Each step creates an idea for another to pursue. Eventually this research takes on the aura of some sort of research development and then becomes more defined as technological progress culminating in an advance in technology even though the participants have no idea what form that technological advance may take, if it occurs at all. This was particularly true in the development of electricity. Only looking back can we see the uneven step-by-step progress leading to electricity becoming part of our daily lives. Except for a gifted few, looking forward during the process provided little guidance to its eventual outcome.

After Franklin, Charles Coulomb discovered that a charge of electricity weakened as one moved away from the source with the same inverse square law that Newton had discovered for gravity. For this, his name was attached to a measure of electrical charge, the coulomb. Luigi Galvani, while dissecting a frog, noted that its legs began to twitch. Galvani thought that the cause might have been from a nearby flash of lightning. Digressing for a moment, after Galvani demonstrated that electricity could twitch the muscles of a dead frog, others like Giovanni Aldini observed that applying an electrical charge of the right strength at the right place could twitch the dead muscles of a human corpse. Aldini applied electricity to open and shut the eyes of a corpse and move its arms and legs. This became a parlor game where individuals would repeat Aldini’s experiment replete with a finale where the corpse would sit upright and open his dead eyes to watch a hysterical and panicked audience scrambling over one another to get out of the parlor. Consistent with mankind’s ability to perform mental leap from dead frogs to dead humans, some immediately took the ultimate logical step that if electricity can make the dead at least appear alive, why cannot electricity restore life to the dead?


Fiction often is an advance warning of what might become future reality. Mary Shelley at least knew about these shenanigans and she visited the castle of a notorious nobleman who conducted gruesome experiments with the dead. All this became the inspiration of her novel Frankenstein, the name of the doctor, not the monster. She wrote the novel while vacationing in Switzerland with her husband Percy Shelley and Lord Bryon as a dare on who could write the most frightening story rather than spend cold, dreary days outside their Swiss chalet in 1816, the year without a summer. She was the first woman novelist and her book, when first published, was ascribed to a male author as it was thought that no one would buy a book written by a woman. The point of this digression was the lesson hidden in Frankenstein on unintended consequences of madly adopting new technology without forethought as to what may be its consequences—a lesson that humankind has yet to learn. The modern day version of Frankenstein is doctoral candidates trying to break new ground for PhD theses by mixing the human genome with that of pigs or tomatoes or viruses to see what might happen without any apparent concern over potential or unintended consequences.

Back to the history of electricity, after some experiments, Alessandro Volta decided that two dissimilar metals, the knife and the tray holding the frog, were the actual cause of the twitching. From this he developed the voltaic pile, the forerunner of the battery made of disks of two dissimilar metals such as zinc and copper or silver separated by paper soaked in saltwater. Electricity flowed through the pile when Volta completed the circuit with a copper wire. Although Napoleon honored Volta by making him a count, Volta was more permanently memorialized by having his name attached to a measure of the electromotive force represented by a difference in a given electrical charge, the volt. Galvani was not forgotten and was memorialized in the phrase galvanic action, the corrosive interaction of dissimilar metals, and in the verb galvanize, to stimulate action as if by electric shock. André-Marie Ampère was one of the first to establish a relationship between magnetism and electricity, inaugurating a new field of study called electromagnetism. As with other discoveries, Hans Oersted simultaneously and independently performed experiments that demonstrated the same relationship. Technological progress, once started, advances step by step where an individual step is a logical extension of what had preceded it—probably the explanation why simultaneous and independent advances in science and technology occur quite regularly. But the honor went to Ampère by having his name attached to a unit of electrical current, the ampere or amp. Oersted was not completely forgotten: a unit of magnetic intensity, the oersted, was named after him.

Georg Ohm originated Ohm’s Law, one of the fundamental laws of physics, which states that the electric potential difference between two points on a circuit (ΔV) is equivalent to the product of the current (I) and the resistance between those two points (R). This equation describes the relationship between potential difference in electric charge, current, and resistance. Ohm’s law can be rearranged and expressed as I = ΔV/R. This equation determines current if the potential difference in electric charge and resistance are known. Current in a circuit is directly proportional to the potential difference in electric charge impressed across its ends and inversely proportional to the resistance within the circuit. The


greater the battery voltage (i.e., potential difference in electric charge), the greater the current; and the greater the resistance, the less the current. A volt is an electromotive force, the difference of potential charge capable of driving one ampere of current against one ohm of resistance. Resistance in ohms is named in honor of George Ohm.1

Michael Faraday, considered one of the greatest experimenters of all time, started out as a bookbinder’s assistant who read the books that he was supposed to be binding. He developed an interest in chemistry, but was encouraged to switch to electromagnetism where his repetition of Oersted’s experiments led to his discovery of electromagnetic induction. Faraday could induce an electric current by either moving a magnet through a loop of wire or moving a loop of wire over a stationary magnet. From this he developed a working model of a hand-turned electric dynamo, the progenitor of the modern electricity generator. Faraday also postulated that light was a form of electromagnetic wave; a conclusion also reached by James Maxwell when he discovered that the speed of electromagnetic waves was close to that of light. Faraday’s experimental work and his “lines of force” inspired Maxwell to mathematically describe the behavior of electricity and magnetism. Maxwell’s equations became the building blocks for Einstein’s theories. And so it goes.

Although one might think that the definition of electricity is obvious—it is what turns the light bulb on—the nature of electricity is not that easy to comprehend. Electrical energy that keeps a light bulb shining is similar to X-rays, light, microwaves, and communication signals except that it has a much lower frequency (60 cycles per second in the US and 50 cycles per second in Europe and elsewhere). Electrical energy is also known as electromagnetic energy, consisting of magnetic and electrostatic fields that move in the vicinity of wires near the speed of light in response to the movement or vibration of electrons within the wire. Electrons along with protons and neutrons are the building blocks of atoms. Protons have a positive charge and electrons a negative charge. When present in equal numbers, there is no net charge; when imbalanced, there is a charge called static electricity. Current is associated with the movement of electrons, actually the drift of electrons that are individually moving among themselves at very high speeds called the Fermi velocity. Without a difference in charge, there is no net drift even with the free electrons rapidly moving about one another. When a charge or electrostatic field is applied as direct current, the drift speed of free electrons in a conductor is measured of the order of millimeters per hour depending on the strength of the electric field, an incredibly small velocity. For alternating current, there is no drift velocity, but the electrons oscillate back and forth in response to the alternating electric field. However the electromagnetic field associated with the drift or oscillation of electrons travels very close to the speed of light depending on the type of insulation around the conducting wire. The electromagnetic field is outside the conducting wire. Individuals living near high voltage transmission lines have been caught stealing a utility’s generated electricity by installing copper bars in their attics to supply their homes with “free” electricity! Electricity propagates at about 300,000 km per second from the generator to an electrical outlet when a switch is turned on, instantaneous from our perspective. For 60 cycle alternating current, this means that a single wave length of a propagating


electromagnetic field is 5,000 km long. Moreover there has to be a return conductor for electricity to do its job, usually the Earth itself. So do you think you understand electricity?

Let us take one more stab at this subject. An electric current is caused by a difference in electrical charge. When an electrical charge is present in a conductor such as copper wire, electrons in the copper are forced to either flow (drift) quite slowly in one direction for direct current or oscillate back and forth for alternating current. The propagation of electrical energy by moving or vibrating electrons within metal conductors is similar to sound waves propagated by vibrating air molecules. The speed of sound, of the order of 345 m per second or 770 miles an hour, is not caused by air molecules moving at the speed of sound, but by the speed of sound waves propagated by vibrating air molecules coming in contact with one another. Similarly, electrical energy is not propagated by electrons moving at the speed of light through wires; but by electromagnetic fields associated with the vibration or movement of electrons traveling close to the speed of light outside the insulated conductor while the electrons within the metal conductor barely budge. Now do you understand electricity?

Generating Electricity Commercially

Thomas Edison invented the electric light bulb in 1878 by trial and error of innumerable attempts, numbered in the thousands, to find a material for a filament that could conduct electrical current to the point of incandescence without consuming itself. Besides being an inventor-genius, Edison was also an astute businessman and founded the first investor-owned utility in 1882, Edison Electric Illuminating Company of New York, predecessor to Con Edison, with financial backing by J.P. Morgan, the first to have a residence lit by electricity. Pearl Street station lit up about one square mile of lower New York with direct current from electricity generators built on the principles of Faraday’s electric dynamo and powered by reciprocating coal fueled steam engines. To say the least, Edison was the man of the hour. But he was almost immediately challenged by George Westinghouse, who backed Nikola Tesla’s alternating current electricity generators. Tesla had previously worked for Edison, but was unable to convince Edison of the virtues of alternating current. Tesla was better classed as a scientist-genius, although he held many patents and was considered a preeminent inventor in his own right. In this contest between two geniuses as to the future direction of electricity, Edison publicly backed the idea of an alternating current electric chair for the state of New York to execute criminals. His purpose was to give alternating current a black eye in the minds of the public by demonstrating its inherent danger and win adherents to direct current, which he considered safer. To demonstrate his point, he publicly electrocuted animals, one a circus elephant, which gravely affected his public image. He won the contest of New York State selecting an alternating over a direct current electric chair, which more or less fried its first victim, another black eye for Edison’s public image.


But more importantly, he lost the contest as to whether homes and businesses would be fed by direct or alternating current. The problem with direct current in Edison’s day was that it could not be distributed over a wide area without significant line losses; thus direct current electricity would be distributive in nature with many plants, each serving a small area of only a few square miles. The advantage of alternating current was that its voltage could be easily raised for transmission and lowered for distribution by transformers, something Edison could not do with direct current. In recent years, high voltage (as high as 1 million volts) transmission of direct current with less line losses than high voltage alternating current has been technologically developed. The breakpoint between using AC or DC for high voltage transmission is having sufficient distance for DC transmission to compensate for losses at converter stations to change from AC to DC for transmission and back to AC for distribution to consumers. Thus high voltage AC transmission is preferable for shorter distances and high voltage DC transmission for longer distances.

Until fairly recently, alternating current was superior to direct current in that it could be transmitted over long distances at a high voltage with relatively small line losses. Alternating current allows for a small number of large centralized generating plants with their inherent economies of scale to serve a wide area via long distance transmission lines. Two events were to convince Morgan that he had backed the wrong horse. One was the 1893 Chicago’s Columbian Exposition World Fair lit by over two hundred thousand alternating current light bulbs supplied by Westinghouse and Tesla. The second was Westinghouse winning the bid for alternating current electricity generators for the Niagara Falls power plant project in 1895. This single plant was thought to be capable of eventually supplying the entire electricity demand for the Northeast, something that Edison’s direct current plant could never do. Morgan switched horses by first gaining access to Westinghouse’s patents in less than a gentlemanly way (a threat of a patent infringement suit whose legal fees would bankrupt Westinghouse) and then quietly buying up majority control of Edison General Electric. Edison found himself outgunned and outmaneuvered and outflanked by Morgan when Morgan told him that the company’s name would be changed to General Electric, Edison would no longer be involved with its operations, and General Electric would change its underlying technology from direct to alternating current.

Niagara Falls plant decided the issue whether electricity distribution would be alternating or direct current, and became, via the advantages of AC transmission over long distances, the progenitor for all future electricity generating plants.2 Niagara Falls electricity generating plant was powered by water diverted via a conduit around the falls to turn downstream turbines that powered the generators. Westinghouse spearheaded the development of the steam turbine, the brainchild of William Rankine, to make electricity generating plants ubiquitous on the American landscape, particularly near a supply of coal. The substitution of the steam turbine for the steam engine used by Edison in the Pearl Street plant increased thermal efficiency for generating electricity from 5 percent for a reciprocating steam engine to about 20 percent for the first steam turbines, which cuts fuel needs by a factor of four (a modern steam turbine has an efficiency of 35–40 percent).


Tesla’s ultimate dream was for a few high-powered alternating current generating plants feeding their output directly into the Earth with a consumer only having to insert some sort of collector or conductor for access to electricity plus some sort of metering device for billing purposes—in other words, supplying electricity without investing in transmission and distribution systems. Obviously this did not come to fruition, but his successful inventions included the induction motor, Tesla coil, radio, neon lighting, and others. Marconi got his idea about the telegraph from visiting Tesla’s lab, but Tesla never pursued this matter of intellectual theft. He gave up his key patents to Westinghouse to save him from bankruptcy. Despite his successes and protection provided by hundreds of other patents worldwide, he died broke and alone. It is thought by some that Tesla tried to unlock the secrets for teleportation and time travel and was also thinking about a death-ray: whether one or more of his esoteric efforts had anything to do with his death is a matter of conspiratorial conjecture on late night television.

When Demand Exceeds Supply

Deregulation assumes that competitive interactions between independent suppliers of electricity (utilities, IPPs, etc.) would act in the consumers’ best interests by lowering rates through greater efficiency of operations, productivity gains, and investments in capital assets that can generate electricity cheaply. Competition lowers the overall return on investment to a level that sustains the investment process without overly impoverishing or greatly enriching the investor. This assertion only holds true, however, when supply exceeds demand. The devil in free enterprise rears its ugly head whenever demand exceeds supply. When supply exceeds demand, electricity rates fall to the costs of the last provider needed to clear the market. Depending on the degree of oversupply, electricity rates can fall to the marginal rate that basically pays for fuel. In extreme cases electricity rates have gone negative. Renewables have legal priority as a source of power and if too much renewable supply is being generated, large nuclear or coal plants may end up paying for someone to take their power to avoid the cost associated with reducing output. Other cases of negative electricity rates are subsidized wind power providers selling their night time output at negative rates in order to qualify for government subsidies that are worth more than the loss of paying someone to consume their output. On the other hand, when demand exceeds supply, there is no real impediment to how high rates can go other than individuals and companies pulling the plug.

California electricity crisis of 2000 illustrates what can happen when demand exceeds supply. While demand exceeding supply affected not just California but the entire western part of the US, the peculiar regulatory framework set up in California provided a launch pad for a rocket ride that sent one major public utility company into financial oblivion and reduced others to a precarious state of illiquidity; squandered a state surplus; caused the issuance of bonds to ensure that tomorrow’s taxpayers will pay


for yesterday’s utility costs; created unpaid receivables that will forever remain unpaid; brought about financial distress among energy traders and merchants; locked ratepayers into long-term, high-cost electricity contracts; and set off an avalanche of allegations, investigations, lawsuits, and countersuits to provide guaranteed lifetime employment for a gaggle of lawyers. In short, the California electricity crisis of 2000 is a classic case study of how not to deregulate the electricity industry.3

As background, investor owned utilities (mainly Pacific Gas and Electric, Southern California Edison, and San Diego Gas and Electric) supplied 72 percent of electricity to California customers; 24 percent was supplied by municipal utilities and the remainder by federal agencies. Investor owned and municipal utilities had historically operated as vertically integrated monopolies generating, transmitting, and distributing electricity in their franchise areas. California Public Utilities Commission (CPUC) set rates for investor owned utilities on the basis of covering costs plus providing a fair rate of return on invested capital while local authorities regulated rates for municipal utilities. CPUC was particularly aggressive in implementing the Public Utility Regulatory Services Act (PURPA) regulations by opening up third party access to electricity generation. CPUC forced the investor owned utilities to enter into contracts at higher rates than what would have applied for conventional sources to justify third party Qualifying Facilities (QF) investments in wind farms, biomass and waste fueled generators, and cogeneration plants run on natural gas. By 1994, 20 percent of electricity generating capacity in California was from cogeneration (12 percent) and renewables (8 percent), the highest proportions in the nation. Electricity rates to jump-start renewables, coupled with cost overruns on nuclear power plants, resulted in an average cost of 9 cents per kilowatt-hour for California residents in 1998 versus a nationwide average of nearly 7 cents per kilowatt-hour. However California was not the highest, electricity rates were higher in Hawaii, Alaska, New Jersey, New York, and New England.

In the belief that deregulation (liberalization) would lower retail rates, CPUC aggressively set out to deregulate the electricity industry to give major customers a choice among competing providers of electricity. CPUC’s Order Instituting Rulemaking on the Commission’s Proposed Policies Governing Restructuring California’s Electric Service Industry and Reforming Regulation (R.94–04–031), commonly referred to as the Blue Book, in 1994 started the process of liberalization by first recognizing that existing utilities had stranded costs, such as nuclear power cost overruns, that had to be taken care of before the electricity market could be deregulated. New IPPs with no history of cost overruns could build a plant and offer electricity at rates that would bring financial ruin to existing utilities stuck with stranded costs. The Blue Book dealt with stranded costs by creating a rate increment that would be paid by all electricity buyers no matter what the source. The revenue would be directed to the appropriate utility to pay for stranded costs until they were liquidated. There was nothing wrong with this approach other than CPUC capping retail rates until stranded costs were liquidated. The rationale for capping retail rates was that CPUC believed that wholesale rates under deregulation would fall. As they fell, a larger portion of the difference between the capped retail and wholesale rates would be dedicated to repaying stranded costs, hastening the time when stranded costs would be liquidated and the retail rate


cap removed. However, if wholesale rates rose, a smaller portion would be available for stranded costs, delaying the lifting of the retail cap. The financial strength of the utility would not be affected with capped retail rates and repayment of stranded costs would offset changes in wholesale rates as long as wholesale rates did not rise above the retail cap. Since the unanimous belief was that deregulation would result in an overall lowering of wholesale rates, no one envisioned a situation where wholesale rates would rise above the retail cap.

The Blue Book was followed by a Memorandum of Understanding that created an independent system operator, the California Independent System Operator (CAISO) with the sole responsibility of managing the electricity grid, and an independent power exchange (PX) with the sole responsibility for managing the spot market in electricity. The only allowable markets were an hourly day-ahead and an hourly spot market with transparent rates and transactions. Whereas deregulation elsewhere called for a tightly integrated structure of managing the grid and overseeing the wholesale trading of electricity, CPUC made these separate and independent functions with no coordination and limited information flow. This administratively imposed barrier on the interchange of information between CAISO as operator and PX as market maker created inefficiencies that became made-for-order profit opportunities for energy traders and independent merchants. The Blue Book and Memorandum of Understanding set the stage for passage of Assembly Bill 1890 in 1996, which became effective in 1998. Although the investor owned utilities still owned generating units, transmission lines, and distribution systems, they could not translate ownership to operational control. Control of transmission would be handled by CAISO and all generated electricity would be sold to PX. An investor owned utility supplying its customers would first have to sell its electricity to PX and then purchase electricity from PX with CAISO handling the transmission details.

Within the western region, California accounted for 25 percent of electricity consumption. The state was a net importer of electricity during the summer from the increased air conditioning load and a net exporter to the Pacific Northwest during the winter. Thus California utilities were net consumers of electricity when the crisis occurred in the late spring and summer of 2000, purchasing more electricity from PX than they supplied. In the dubious belief that the only way to create a market with substantial depth to reflect the true value of electricity was to channel all sales through the spot market, CPUC prohibited investor owned utilities from entering into term contracts to fix the cost of their purchased electricity. This prohibition was put into effect by mandating PX as the only conduit for sales and purchases of electricity by the investor owned utilities with PX limited to buying and selling electricity on the day-ahead and current spot markets. This made it impossible for the investor owned utilities to enter into term contracts, but municipal utilities could act independently and enter into term contracts with providers because they were not regulated by CPUC.


PX operated on a day-ahead basis, accepting bids from each generator to sell its output at some offering rate with each investor owned utility distribution company indicating the amount of electricity to be purchased on an hourly basis. Offering rate bids were ranked from the lowest to the highest, and their volumes accumulated until they met demand. The rate at which the amount of electricity from accumulated bids by suppliers equaled the amount of electricity required by purchasers became the hourly market clearing rate for all bids. All sellers received the same market clearing rate even if they had bid less than the clearing rate. Sellers who had bid more than the market clearing rate would have no market outlet for their generating units. The underlying rationale for this pricing mechanism was that the risk of bidding too aggressively would result in idle generating units. This fear of idle capacity would encourage bidders of generating capacity to price electricity close to the marginal cost of each generating unit. This rationale held true as long as supply exceeded demand.

A computer system was set up to handle 24 separate markets for each hour of the current day and the day-ahead market. Providers basically had to guess at what would be the appropriate bid for each hour and those with multiple generating units would be playing an hourly rate bidding game for each of their units to try to maximize company revenues. Owners of various type plants would bid low on those units that best served base needs to ensure their employment and higher on those units whose output could be more easily changed to try to capture incremental revenues. What was not envisioned was how the system would behave if nearly all generating capacity was needed to satisfy demand. Under these circumstances, owners of generating capacity became emboldened to bid more aggressively for their units that were dedicated to satisfying variable demand. There was less risk of being left with idle capacity because most units had to operate to meet demand. Moreover the financial loss of being left with an idle unit was less because of the higher clearing price for the operating units that were employed. In a tight market with little leeway between system demand and system capacity, meaning few idle generators, a new pricing pattern emerged that was never seen before. It was dubbed the hockey stick pattern. When surplus capacity was plentiful, price for electricity rose slowly in response to large increments in demand. When surplus capacity became scarce, price rose sharply in response to small increments in demand. The combination of these two price patterns as demand approached limits of supply looked like a hockey stick, a price pattern common with all commodities, but not one experienced by utilities.

Jumps in the spot price were particularly harmful to investor owned utilities in California who, as net consumers of electricity, were forced to buy and sell exclusively in the spot market. Municipal utilities in California and utilities in other states and provinces of the western region outside the jurisdiction of CPUC had entered into fixed rate term contracts for the bulk of their electricity purchases, thereby escaping the financial carnage faced by the California investor owned utilities. While spikes in spot prices starting in California spread throughout the western region, they had limited impact on the aggregate cost of electricity throughout the system because most electricity needs were filled by term contracts.


“Throughout the system” was, of course, true everywhere and for everyone except the investor owned utilities in California whose net electricity purchases were funneled entirely through the spot market.

Another adverse consequence of prohibiting investor owned utilities from entering into term contracts affected the construction of new electricity generating capacity in California. Investors could not reduce their financial risk by entering into term contracts with the investor owned utilities that made up 72 percent of the market. They could, of course, enter into term contracts with municipal owned utilities to assure at least partial employment, but that excluded much of the market. Without assurance of employment, investors were reluctant to bear the financial risk of building new capacity. On top of this, plants under construction in California faced public hearings and inspection hurdles that delayed the start of construction by as much as two or more years compared with other western states.

The separation of responsibilities between the system operator, CAISO and PX, as market maker, and the prohibition for these two organizations to coordinate their activities and interchange information, forced CAISO to become a buyer on an immediate spot basis. This was the only way for CAISO to handle mismatches between supply and demand that CAISO was not allowed to communicate to PX. Thus there came into being two spot markets: one run by PX and the other by CAISO. With limited information exchanged between the two, energy traders had a field day taking advantage of rate disparities between these two separate markets. To make gamesmanship even easier for energy traders to play one market (PX) off the other (CAISO), computer coding for the CAISO model for determining electricity rates was in the public domain.

Shortly before the emergence of the crisis in 2000, the three investor owned utilities were 57 percent reliant on natural gas to run local generating units, 12 percent on nuclear power produced locally, 13 percent on hydropower from California and imported from the Pacific Northwest, 5 percent on imported electricity from coal burning plants in the Southwest, and the remaining 13 percent renewables (wind, geothermal, biomass, and solar). Growth in natural gas consumption for electricity production was beginning to strain pipeline delivery capacity and the surplus of generating power throughout the western region had been eroded by demand growing faster than supply in the preceding years. A drought in the Northwest forced a reduction in hydro output. This became the precipitating event that led to an overall shortage of capacity to satisfy California electricity demand just as it began to climb toward its seasonal peak in the late spring of 2000.

Before the crisis erupted, the wholesale rate in the western region varied $25–$40 per megawatt-hour ($0.025–$0.04 per kilowatt-hour). The average retail rate of $0.09 per kilowatt-hour also included distribution and stranded costs pertinent to California. Remembering that retail rates in California were capped and all purchases and sales by the investor owned utilities had to be transacted through the spot


market on PX, and that they were net buyers of electricity during this time, an intolerable cash flow squeeze occurred when wholesale rates jumped to $75 per megawatt-hour in early May. This was followed by a decline, then a surge to $175 in mid-May, followed by a decline, then a surge to $300 in early June, a decline, then an all-time record spike of $450 in mid-June, again a decline, then another surge to $350 in late July. At these rates, aluminum smelters and other industrial concerns in the Northwest laid off their workforce in order to sell electricity in the spot market that was either generated at the facility or had been purchased cheaply under term contracts. This shutdown of industrial output increased the supply of electricity in the western region and contributed to limiting the magnitude of the crisis (laid-off workers had another view of the situation).

With a tight market in which nearly every generator had to be employed to meet demand, providers, knowing that few of their operating units would remain idle, became extremely aggressive in their bidding. A provider with multiple units could afford to bid high on a couple of units as the probability of ending up with an idle unit was pretty low. Moreover, since the highest bid that cleared the system would apply for all bids, the financial loss of having an idle unit with the rest employed at high rates would be an acceptable outcome. This change of attitude—from fear of idle capacity giving way to unrestrained greed—was reflected in the hockey stick pattern. To add misery to woe, environmental rights to emit pollution had been issued in California, based on actual nitrous and sulfur oxide emissions in 1993. The intention was for the issuing authority to slowly decrease the availability of such rights. The staged retirement of these rights to emit pollution resulted in a higher rate, providing an economic incentive for utilities to build new and cleaner burning plants or add equipment to existing plants to reduce pollution emissions. This program was successful in gradually reducing pollution emissions by utilities.

But in 2000 California was experiencing rolling blackouts (although these blackouts gained national notoriety, only six occurred, each affecting only a small portion of the population for a relatively short period of time). Every plant in California had to be put into operation to generate electricity including reactivating previously mothballed plants with high pollution emissions. These could not be operated without purchasing emission rights. The shortage in emission rights sent their price through the ceiling and added to the cost of generated electricity that could not be recouped from customers. In the midst of the electricity crisis, legal actions were being taken against utilities for not having the necessary pollution rights to cover their emissions. Utilities were faced with an impossible choice: to fulfill their public obligation to supply electricity by breaking the law (not buying the requisite rights to cover total emissions) or obeying the law by buying the requisite rights at extremely high prices and thereby aggravating their cash drain. Though it was possible for them to cut back on their electricity generation to reduce their need for emission rights, this would have caused more chaos in the market, more extended blackouts, higher rates, and charges of manipulating the market. Not only did politicians stand fast on doing nothing to increase the volume of pollution emission rights under these dire circumstances, but they also stood fast in making sure that retail cap remained intact.


Thus investor owned utilities were drained of all their liquidity by buying high and selling low, leading to the bankruptcy of one and the insolvency of others. CUPC’s insistence on not allowing retail rate relief was challenged as a violation of the due-process clause of the Constitution (the state not allowed to rob shareholders of their wealth without giving them due process for redress) to no avail. Electricity providers became increasingly unwilling to accept payment other than cash in advance from investor owned utilities rapidly becoming insolvent. Refusing to sell electricity through PX to investor owned utilities, the state of California was forced to step in and buy electricity for the investor owned utilities. Now it was California’s turn to buy high and sell low, which quickly squandered its entire surplus. Although California had prohibited utilities from entering into term contracts when wholesale spot rates were low, now California itself entered into term contracts with sellers for large quantities of electricity when wholesale spot rates were at record breaking highs.

During this entire crisis, retail customers, other than being inconvenienced by an occasional rolling blackout, had no economic incentive to reduce consumption. The only action the state took to reduce demand was to order state office buildings to cut electricity usage and initiate a program to subsidize the introduction of energy efficient fluorescent light bulbs—hardly a palliative for the ongoing crisis. There was a concerted effort on California’s part to ensure that state inspectors did all they could not to unnecessarily delay the completion of electricity generating plants already under construction. The fact that they did hasten the completion of construction is a bitter commentary on their performance prior to the crisis. The crisis began to cool, along with the weather in the fall of 2000, which reduced the air conditioning load and need to import electricity. Eventually completion of additional electricity generating plants in California and elsewhere in the western region added enough capacity to restore a surplus and a semblance of order to what really should be a very orderly business.

Having bankrupted one utility and left others stripped of cash, California had to issue bonds to restore the surplus squandered by buying high and selling low. This enabled California taxpayers to foot the bill plus interest over the long term for what they did not have to pay in the short term. And, to complete the picture, the term contracts entered into by California, while attractive when they were inked with record high wholesale spot rates, became decidedly unattractive when wholesale spot rates fell to pre-crisis levels. The people of California were not only saddled with repaying billions of dollars of bonds to restore the state’s liquidity, but also spending more needless billions of dollars for high priced electricity fixed on term contracts. Not all the purchases of high priced electricity were paid. The bankruptcy of PX in January 2001 left those holding PX receivables with something to paper their bathroom walls.

Eventually retail electricity rates were raised substantially, but in a manner that had limited impact on households consuming less than a baseline amount of electricity. Those who consumed above the


baseline amount faced significant step-ups in rates. The Federal Energy Regulatory Commission (FERC) eventually banned utilities from having to buy and sell all their power through PX or CAISO, restoring the old world in which utilities could make deals in the forward markets, enter into term deals, and dedicate their generated electricity to supplying their customers. FERC attempts to rectify matters in other areas were resisted by state authorities, who were ultimately responsible for the regulation of utilities under their jurisdiction.

After this crisis, the California electricity industry was basically under state control. The crisis is past, but its legacy will go on for a long time in terms of repaying bonds, honoring high priced contracts to buy electricity, rejuvenating financially crippled utilities, dealing with unpaid receivables, plus the accusations and investigations, suits, and countersuits. In 2006 the estimated cost of the California debacle to the state was $70 billion, of which $6.3 billion in settlements had already been made. Sixty different investigations of market manipulation and a host of criminal and civil trials were still in the works.

Evidence during the criminal trial of Enron executives found that Enron would purchase spot market electricity for the day-ahead market and then, the following day, shut down generating plants that it owned in California during peak demand for spurious reasons. This created an artificial shortage in capacity that was reflected in a spiraling market. This allowed Enron’s previously purchased electricity to be liquidated at a margin that created billions of dollars in ill-gotten gains. E-mails and tapes were discovered that point to rather unsavory behavior on the part of some energy traders with Enron high on the list “to give it to the California grandmas.” Actually grandmothers were not hurt because retail rates were capped, but the statement revealed Enron’s sense of social responsibility. Enron earning billions was the result of a fatally flawed market design set up by regulators giving suppliers the opportunity to take advantage of a resulting shortage that turned out to be artificially contrived. From the start of the energy debacle, and at all times during the debacle, everything that could have made a bad situation worse was done and everything that could have alleviated a bad situation was not done; truly the worst of all possible worlds. Despite Enron’s bilking the system for billions, the company eventually went belly up with its chief executives now serving jail time. How can a company earning billions go bankrupt? It was easy when other business dealings had losses of even more billions than what were “earned” in California.

Real Lesson of California

The real lesson to be learned from the California electricity debacle is that rates become unstable when demand gets too close to supply. When supply is ahead of demand, rates are closer to marginal costs, which is beneficial to consumers. Deregulation means lower rates only as long as supply exceeds


demand. When demand gets too close to supply, rates for electricity—and prices for anything, oil, copper, gold, grain, you name it—do not escalate by a little, but by a lot. All commodity traders know about the hockey stick pattern. There is little to moderate prices as buyers attempt to outbid one another for what is perceived to be a commodity in short supply. Escalating panic among buyers is matched by growing greed among sellers. This, of course, is the classic economic signal to increase capacity. The problem is that capacity cannot be added in a fortnight.

The original regulation of electricity—determining rates by covering operating costs and guaranteeing a reasonable rate of return on investment—also guaranteed surplus capacity. Indeed, this has been frequently cited as one of the drawbacks of regulation: with a guaranteed return, the temptation to build excess capacity is overwhelming. This was not limited to the number and size of generating plants, but anything that could be thrown into the rate base. The drawback of letting the market decide electricity rates is that the market does not reward spare capacity (unless set aside as reserve capacity), but punishes the company that builds too much capacity by making it difficult or impossible to earn enough revenue to recoup its investment. But having a sufficient degree of reserve capacity of 15 percent over average peak demand to ensure reliability is also a necessity (PJM Interconnection) is organizing a market for reserve capacity).4 As a consequence, companies tend to use modest growth rates for projecting demand when deciding on investing in additional capacity as a means to avoid the mistake of building too much capacity. The market system not providing a decent return on excess capacity minimizes building of too many generating facilities. This also forces supply to be closer to demand leaving little room for spare capacity to accommodate system shocks.

There is a lesson to be learned about spare capacity from Colombia. Colombia has hydropower plants that supply a large portion of its needs. It is by far the lowest cost source of electricity. But droughts affect hydropower output. To accommodate this potential shock, utilities have entered into contracts for backup natural gas electricity generating capacity to be built, but not operated as long as hydropower is available. Operators of these natural gas plants are paid regardless of hydropower output. Electricity rates reflect money set aside for idle capacity just in case it is needed. Some careful attention to this means of establishing spare capacity on a commercial basis should be given in market driven systems to reduce system vulnerability to shocks and avoid the pandemonium that breaks out when demand gets too close to supply.


1 “Ohm’s Law,” The Physics Classroom, Web site www.physicsclassroom.com/class/circuits/Lesson-3/Ohm-s-Law.2 Jack Foran, “The Day They Turned the Falls On: The Invention of the Universal Electrical Power System,” University of Buffalo, Web site http://library.buffalo.edu/libraries/projects/cases/niagara.htm.3 James L. Sweeney, The California Electricity Crisis (Stanford, CA: Hoover Press, 2002).4 Overview of the PJM Synchronized Reserve Market, PJM, Web site https://pjm.com/.../20140305-item-06e-draft-m11-v... and also http://www.pjm.com/markets-and-operations/energy/operating-reserves.aspx.

Documents

Early History of Electricity Web viewattached between the key and a Leyden jar, a primitive capacitor for storing an electrical charge. ... In recent years, high voltage (as high as