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California electricity troubles: is Massachusetts next?

Most Massachusetts residents are well aware of California's electricity problems: consumers are warned to restrict their usage, prices are high and volatile, and rolling blackouts have occurred in some areas.

Are we in Massachusetts headed toward similar problems? The stage is set unless we take steps to intervene.

Ultimately, all consumers -- from private citizens to commercial companies -- will be able to choose from an array of competing power suppliers. But getting from the old regulated power industry to the new competitive one is proving tricky.

Right now, only new power suppliers -- those using new generating plants or old plants divested by utilities -- are allowed to set their own prices and compete for customers. Utilities that still own power plants may do neither. They must buy on the daily wholesale spot market, regardless of price, and they may not pass their costs on to their customers, whom they are still obligated to serve.

Several years ago, voters in Massachusetts (and in California) passed legislation meant to ease the transition to competition. It created a grace period during which both customers and utilities would be covered by a standard offer. Under that offer, utilities were forgiven their debt on certain existing power plants that are no longer competitive, and electricity users were guaranteed reduced prices for the duration of the offer. The offer thus protects consumers but leaves utilities with no means of recovering the volatile prices they must pay on daily spot markets.


One need only look to California to foresee the consequences of this arrangement. The new competitive suppliers will select the most attractive electricity customers -- the large industrial users. The small residential customers -- about a third of total demand -- will be left relying on the noncompetitive utilities that remain.

When the standard offer expires in the next few years, those residential customers will suddenly be exposed to highly volatile wholesale prices; and they will be absolutely unprepared (as San Diego customers were when their standard offer expired). Customers will have no long-term contracts to protect them from changing prices. And with no means of knowing when prices are high, they will be unable to save money by time-shifting their demand (for example, by doing laundry at midnight).

Meanwhile, the utilities must purchase from volatile electricity markets and sell their power at cost, a situation that has left California utilities nearly bankrupt.

Already, generating capacity in Massachusetts is running low. Indeed, at times supply has met demand in Massachusetts only because electricity was imported from Canada and New York.

Unless things change, prices could skyrocket, usage cutbacks could be ordered, and blackouts could occur -- all of which are being experienced in California.


How can we avoid such a fate? Two changes in regulatory and pricing rules are critical. First, we need to allow utilities to pass on their true costs to consumers. Second, we need to permit all power suppliers to establish long-term contracts with customers. True spot prices, and prices and quantities contained in long-term contracts, will serve as meaningful signals to all industry participants, giving them incentives to do what needs to be done.

One result will be the construction of new generating capacity and the development and use of new, environmentally sustainable technologies, since high spot prices and long-term contracts will encourage suppliers to invest in new plants.

More accurate price signals would also encourage the creation of companies known as load aggregators. Called load-serving entities, or LSEs, in Massachusetts and energy service providers, or ESPs, in California, these companies can sign long-term contracts with electricity suppliers and wire companies on behalf of groups of small customers. A lively market of such companies -- high-tech, profit-motivated, competitive -- would provide small customers a means of obtaining reliable service while protecting them from the risk of volatile electricity prices.

Continuous communication of accurate price signals to customers in real time would benefit all market participants. When electricity supply is low and prices are high, customers would be able to cut back their use and save money. Peaks in electricity demand would flatten out, and utilities could maintain less overall generating capacity.

We also need changes on several other fronts. More active intervention by New England's independent system operator, or ISO, would help. This entity runs the electric power system day to day and is in a position to develop the systems that can transmit the needed real-time price signals. In addition, the ISO needs new methods of supplying as many customers as possible when electricity supply is limited -- automatically adjusting demand during emergencies to balance it with supply.

Another concern is the delivery of electricity to consumers. Companies that transmit electricity over long distances and distribute it locally are still fully regulated, with prices based directly on cost recovery. Regulatory rules should be changed so that these wire companies can set prices based on the market value of their product and on their performance. Only then will they make the investments needed to ensure the reliable and efficient delivery of electricity.

Finally, there is a need for clear and enforceable rules for transfers of power from electricity markets outside the New England region. Trading between, say, Massachusetts and Canada is currently difficult because there are no predictable regulatory rules covering power delivery across large regions. Such rules must be developed to make possible well-defined electricity trades and to ensure delivery of electricity from other regions whenever it is needed.

In theory, the restructured electric power industry will work well. But it will take careful planning to ensure that the transition to a competitive market is smooth, efficient, and characterized by opportunities for regulatory, business and technical innovation.

Marija Ilic is a senior research scientist at MIT's Energy Laboratory. Petter Skantze and Poonsaeng Visudhiphan are doctoral students. Energy Laboratory editor Nancy Stauffer assisted in this article.

A version of this article appeared in MIT Tech Talk on January 31, 2001.

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