Electricity Deregulation:
How California Failed – and Why Virginia Won’t

Remarks of
Eva Teig Hardy
Senior Vice President - Dominion
to the
Greater Richmond Technology Council
Richmond, Virginia

February 13, 2001

I’m grateful to Bob Stolle and the GRTC for inviting me to talk with you today.

The GRTC deserves much credit for bringing together public and private organizations to create a dynamic high-tech community in Central Virginia – a critical sector of our economy.

My company, Dominion Virginia Power, falls in the category of blue chip – not dot-com. Our product is decidedly “Old Economy.”

But electricity powers both old and new economies. Its cost, availability and reliability are vital to economic growth – high tech or otherwise.

So the distinctions that Wall Street likes to draw between old and new economies are arbitrary and counterproductive. The Internet is a powerful market force shaping the entire business world.

Dominion Virginia Power, for example, sees many opportunities to serve its customers in new ways using Internet applications – from paying bills online to buying energy-related goods and services from retailers in complimentary businesses.

Clearly, this is no longer your father’s electric utility. We have changed dramatically to keep pace with the fundamental changes taking place in the world of energy.

The “new” Dominion – parent company of Dominion Virginia Power – has set its sights on being the leading provider of energy and energy services in the northeastern quadrant of the U.S. – home to 40 percent of the nation’s demand for energy.

Following our merger with Consolidated Natural Gas early last year, Dominion became the largest fully integrated electric and natural gas company in the nation – and the largest corporation headquartered in Virginia.

Full integration means diversity. We have operations across the entire energy production and delivery system – from the wellhead all the way to homes and businesses.

We are powered by a $29 billion network of assets that includes:

19,000 megawatts of electric generating capacity (with another 10,000 megawatts in development);
6,000-mile electric transmission network;
7,600 miles of interstate natural gas pipeline;
the nation’s largest natural gas storage system; and
about 3 trillion cubic feet of oil and natural gas reserves from Canada to the Gulf of Mexico.
We currently serve about 4 million retail gas and electric customers in five states – which gives us a strong foundation to pursue new growth opportunities as energy markets open more and more to competition.

And the move to competitive energy markets will continue – despite the debacle in California – albeit at a slower and more deliberate pace.

To date, 23 states – including Virginia – have enacted legislation to restructure their electricity markets.

The bottom line: The deregulation genie is out of the bottle and we’ve simply come too far to return to the old ways of doing business as regulated monopolies.

The jokes going around about California’ situation – from the hot tubs being cold… to the empty tanning salons… to the movie sets going dark… may provide some comic relief.

But the prospect of sustained high energy prices and continued power shortages in the state that accounts for about one-seventh of the nation’s economy is serious stuff.

When California faces blackouts, its major utilities teeter on the brink of bankruptcy, and big chunks of Silicon Valley and scores of other businesses shut down for lack of power, you’re closer to the realm of tragedy than comedy.

A number of companies in California have announced employee lay-offs, loan defaults and deferred business expansions. Imagine how tough it is to be an economic development official in California right now!

The “Digital Dominion” never looked so good – a message I’m sure officials from Virginia are sending to the West Coast at every opportunity.

If there’s a silver lining in this situation, it’s the opportunity the rest of the nation has had to learn from California’s mistakes and structure electricity deregulation in ways that will deliver cost savings, greater customer choice and improved service.

I thought an effective way to approach my topic – “How California Failed and Why Virginia Won’t” – would be through a point-by-point comparison of the major elements of the two states’ restructuring plans.

That way, you’ll be able to contrast the differences between the two states and draw your own conclusions.

Before we make these comparisons, I first want to provide a little background about the California situation.

Deregulation has received widespread blame for the current energy crisis on the West Coast. California Governor Gray Davis has called it “a colossal and dangerous failure.”

But the truth is, deregulation is part of the solution – not the problem – and I want to spend some time explaining why.

There is a widespread perception that California’s policymakers deregulated the electric utility industry. They did not do any such thing. What they did in the 1996 restructuring legislation was substitute a new regulatory framework for the old one.

They restructured the state’s power markets – and did so in a way that guaranteed failure.

Among other things, the state’s largest utilities were forced to sell much of their own power generation to give new competitors a chance to compete.

They were also prohibited from signing long-term contracts with power suppliers. Both would have been important hedges against sudden price spikes.

Instead of producing their own power or buying it through long-term contracts, the utilities were required to buy and sell electricity through two quasi-governmental bodies.

One is known as the Power Exchange, or PX. The other is the Independent System Operator, or ISO.

This requirement forced the utilities to shop for power in the volatile wholesale spot market. Initially they agreed – thinking that competition would steadily push wholesale prices down.

Instead of letting the markets work, California made matters worse by experimenting with a variety of price controls – at both the wholesale and retail levels.

The use of price controls became a key ingredient in the state’s energy crisis. That’s because California freed wholesale prices from all control and froze retail electricity prices at the same time.

That combination may work as long as supplies are adequate. But it’s a recipe for disaster if supplies grow tight, which they did beginning last summer during an unusual heat wave.

That’s when we started hearing about an energy crisis in California. Truth is, the state’s energy problems have been building for much longer than that. They simply weren’t on the media’s radar screen prior to last summer – and consequently, were largely out of public view.

Only when consumers began feeling it in the pocketbook – in the form of skyrocketing electric bills – did they sit up and take notice.

The situation took on crisis status when two developments converged last summer:

The West Coast heat waves I just mentioned, which created a big jump in demand for power; and
Power supply shortages and escalating natural gas prices – natural gas being California’s primary fuel source for power generation.
The lack of adequate power supply lies at the heart of this whole dilemma.

Not one major power station has been built in California for more than 10 years – despite an economy that grew by 34 percent during the 1990s.

There are two primary reasons for the power supply shortage. The first is red tape. For example, a power station that takes 2 years to plan and build on the East Coast can easily take 5 years in California due to cumbersome regulation and the nation’s toughest environmental laws.

The second reason is NIMBY – the “not in my back yard” syndrome that plagues industrial development everywhere – but which is especially bad in California.

One telling example comes from San Jose in the heart of Silicon Valley. There, the city council recently rejected a new power facility that would have lighted 600,000 homes.

Ironically, the plant had the support of groups as diverse as the Sierra Club and the NAACP. But it was opposed by Cisco Systems, San Jose’s largest employer. Cisco argued that the plant would be an eyesore next to an industrial park it was planning to build for its 20,000 employees.

And Californians wonder why they are experiencing severe power shortages and price spikes.

Economics 101 provides the answer: High demand chasing low supply, resulting in rising prices.

As wholesale prices soared last year, California officials responded by imposing price caps on parts of the wholesale electricity market – the power that utilities buy to resell to their customers.

Unfortunately, when supplies are limited, price caps only make things worse. They send artificial price signals through the marketplace and discourage new investment in generating capacity – exactly what California needs.

The key point I want to make is this: California’s energy crisis is a failure of government – not of markets. California never really deregulated, so competitive markets were never given a chance to work.

Instead of trying to fix its broken deregulation law, California appears headed for more government involvement in the energy business.

Earlier this month, Governor Davis signed a bill allowing the state to buy power on behalf of its struggling utilities. The state will issue up to $10 billion in revenue bonds to pay for long-term contracts with power generators.

It remains to be seen whether taxpayer financing of electricity purchases is in the best interests of California’s residents.

There is a risk that taxpayers could be exposed to huge electric rate increases a few years down the road to pay off those bonds.

Exactly when California’s dysfunctional electricity market will stabilize is anyone’s guess. Certainly not before 2002 or 2003, when some new generation is expected to come on line.

Turning to Virginia… Could the same fate befall our Commonwealth, as the January 23 cover of Time magazine asks?

Ladies and gentlemen, I ask you: When did Virginia ever do anything like California?

As we all know, there are no guarantees in life, but I think it’s highly unlikely. Let’s contrast the two states’ restructuring plans and see why.

Along with Pennsylvania, Ohio and Texas, Virginia’s electric restructuring law is widely regarded as one of the best in the nation.

Virginia’s 1999 restructuring law provides for a lengthy transition period to allow competitive markets to mature before consumers begin paying market-based prices.

Among its many consumer protections, electric rates in Virginia are frozen until July 2007 to guard against the price spikes and volatile energy markets Californians have been subjected to.

Californians have paid the price for an inadequate transition period. For example, price protections ended for customers of San Diego Gas & Electric in 1999 – just one year after customer choice began.

When power supplies tightened during the summer 2000 heat wave, consumers were left exposed to hefty price hikes. The same could happen to the rest of the state by the end of this year, when the price freeze is set to expire.

Virginia’s law established a strong system of legislative and regulatory oversight to monitor the transition to competition and make mid-course corrections if necessary.

A task force of 10 legislators and the SCC are charged with protecting consumers and fostering the development of robust retail competition.

California’s restructuring law contained no comparable provisions.

In addition, Virginia’s law created a 17-member Consumer Advisory Board from around the state to assist with the transition to competition. California never created a mechanism for consumers to have input.

Here in Virginia, customer choice will be phased in between 2002 and 2004 -- a measured approach that stands in stark contrast to California’s “all-at-once” free-for-all that began in 1998.

Adequate generation is key to robust competition and the ability to hold down prices. Unlike California, Virginia has ample new sources of electricity in various stages of development – about 8,000 megawatts, or enough to power 2 million homes.

Also working in Virginia’s favor is a political and regulatory climate that is more supportive of building the generating capacity needed to fuel economic growth.

Virginia’s Restructuring Act wisely did not require the state’s utilities to divest their existing generation and buy power from third parties through a state-run power pool, as in California.

Forced divestiture deprived California’s two largest utilities of valuable flexibility in the face of volatile market conditions.

Virginia’s law allows power distributors to sign fixed-price, long-term contracts for the electricity they buy. California prohibited this under the assumption that wholesale prices would steadily decline – as they had done in 1998 and 1999. Bad assumption!

Supply shortages led to an explosion of wholesale prices in 2000 and utilities were left holding the bag since the prices they could charge customers were frozen. As a result, PG&E and Southern Cal Edison have gone $12 billion in debt and are fighting off bankruptcy.

Finally, Virginia is conducting retail competition pilot programs to test the many new systems needed in a competitive market. California went immediately from traditional regulation to full competition without conducting a pilot to work out any bugs in the system.

Dominion Virginia Power’s pilot is called Project Current Choice. It is open to about 70,000 of our residential customers in Central and Northern Virginia.

A separate pilot program is available to larger commercial and industrial customers throughout the Commonwealth.

To date, more than 70,000 residential customers have volunteered to participate in the pilot, and 28,000 have switched to an alternate supplier.

14 electric suppliers have applied to do business in Virginia, and 11 licenses have been granted, with 3 still pending. These suppliers range from utility affiliates to electric co-ops to dot-com companies.

We think the pilot is a great opportunity to get some initial experience with new ways of buying and selling electricity before retail competition begins next year.

I hope that by contrasting key elements of Virginia’s Electric Utility Restructuring Act with California’s law, I’ve been able to convey that Virginia has a workable framework for implementing retail competition – while protecting consumer interests at the same time.

The most important thing that Virginia and the 22 other states that have enacted restructuring legislation learned from California… is how not to go about it.

The move to deregulation was prompted by the promise of cost savings, efficiencies, and improved service.

The industries that have gone before electricity, including trucking, airlines and telecommunications, have shown that free markets do foster innovation, enhance customer options and service levels, and speed the delivery of new products to market.

Electricity deregulation is a work in progress. Despite the disaster in California, I’m convinced that if done correctly, the initial promise will come true.

Rest assured, Dominion is doing everything we can to make sure Virginia gets it right – the first time.

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