Long-Term Deals Have Chilled Electric Prices, if Not the Whiners

California’s energy prices started coming down last month, and critics began recanting their predictions of disaster and shrinking their forecasts of rolling blackouts. Maybe the only ones not surprised were Gov. Gray Davis and those of us negotiating the long-term power contracts for the state.

In January, the utilities were on the edge of insolvency. Many observers saw that the only way to keep the lights on was for the state to take over the purchasing of power. We were paying $250 a megawatt-hour then. For a few days in January, Duke Power charged an unconscionable $3,880 a megawatt-hour, and in May Reliant Energy charged $1,900. So few people thought that long-term prices would be anywhere near what we’ve achieved.

In fact, in February, many were taken aback when we were able to negotiate prices of $70 per megawatt-hour over the next 10 years. Now it’s July. Spot prices have come down, and critics now claim we paid too much for those same contracts. Sure, conservation has helped, and natural gas prices have gone down. New generation--enticed in part by the long-term contracts--is coming on line.

But the critics fail to see that we have lower prices largely because the contracts cut the amount of power we have to buy now on the spot market. In January we bought nearly all the power on the spot market. By June, with 41 long-term agreements in place, we were buying about half in forward contracts and half on the spot market. The impact was visible. In May, the price of power on the spot market averaged $271 a megawatt-hour. In June, this had come down to $99, driven down by lower demand on the spot market.

In May we purchased 4 million megawatt-hours on the spot market. In June, with long-term contracts and other measures in place, we cut that figure in half. Where in May the state paid an average of $64.5 million a day with three days exceeding the $100 million mark for power, in June on average it paid only about $34.5 million a day. The expected wave of rolling blackouts in May and June never came to be. There’s even a small power surplus now on some days when it’s unusually cool.

Does anyone believe that we would have done better by continuing to buy on the volatile spot market? State Controller Kathleen Connell and other critics say we panicked and paid too much for long-term contracts because of high natural gas prices. But they fail to see that we negotiated contracts precisely with the volatility of natural gas in mind. The erratic price levels of natural gas, spiking 1,000% from December 1999 to December 2000, played a big role in the increase in the price of power. So we hedged our bets. We negotiated about half of those long-term contracts at fixed prices, giving us long-term stability. But we set half to go up and down with the price of gas.

The current average price of our long-term contracts is 6.9 cents a kilowatt-hour. As natural gas prices get back down to reasonable levels, the contract prices tied to natural gas will drop, lowering that average rate. If natural gas prices rise, the long-term contracts will look good.

The critics are equally ill-informed on other aspects of the contracts. They’ve charged that the prices we negotiated fluctuate widely, up to $249 a megawatt-hour. But there’s a difference between the base load contracts for power at between 6 cents and 8 cents a kilowatt-hour and those for so-called peaker power at higher prices. You don’t need to be an economist to figure out that if you’ve got a peaker plant used only a few hours a year, the cost for electricity from that plant is going to be relatively high. But peaker power is only a small part of the contract package. Critics also charge that the contracts allow the generators too high a return on investments. Returns from market prices under the botched deregulation structure that Davis inherited are not as low as what you’d get on a cost-of-service basis.

We are not fully beyond the crisis yet, but we are making real progress as a result of Davis’ programs. It’s unrealistic, however, for anybody to think we could do at the bargaining table what the Federal Energy Regulatory Commission has failed to do as a regulatory agency. In effect, the house was on fire. We were like the fire department. But rather than recognize that the house was saved, critics like Connell spend all their time whining about the water damage.