California Power Contagion

By List, Peter | Global Finance, March 2001 | Go to article overview

California Power Contagion


List, Peter, Global Finance


While energy industry officials, utility executives, lawmakers, and bankers scramble to replace Band-Aid measures with a long-term cure for California's energy crisis, observers say the scope of the economic impact is enormous. Conservative estimates of the cost of California's power crisis run into the hundreds of millions of dollars for the state's businesses and into the billions of dollars nationally-if not globally.

As California suffers through electricity supply shortages, rolling blackouts, and soaring wholesale power prices, its two main electric distribution and supply utilities-Pacific Gas & Electric and Southern California Edison-have defaulted on some debt and other obligations, and have been driven toward bankruptcy. The companies' corporate credit ratings have been lowered to junk status by both Standard & Poor's and Moody's Investors Service.

The power situation in California evolved into a crisis largely because electricity distribution and supply companies were unable to pass on the high wholesale cost of power to retail customers, say observers. Pacific Gas & Electric and Southern California Edison had together racked up $12 billion in debt that they were not allowed to pass on to consumers because of the retail rate freeze adopted in 1996 when California deregulated power.

At the same time wholesale prices have risen because of high natural gas costs and a shortage of electricity generating capacity. Little new generating capacity has been built in the state over the past decade, despite growing demand. The problem was exacerbated by regulations preventing the utilities from entering into contracts to hedge their exposure to higher fuel prices.

As a result, deregulation efforts across the United States and Canada has slowed the development of new capacity as demand for electricity continues to increase. It is difficult to predict how and when long-term solutions will emerge, and observers say the more time it takes, the more costly it becomes.The impact is just beginning to be felt, but it has already captured world attention. Some economists have cited California's power crisis as an unforeseen event, akin to the oil embargo of the 1970s or the Gulf War in the early 1990s, with the potential to tip economic scales at a time when the US economy is already under cyclical strain.

NATIONAL IMPACT

In late January, Federal Reserve Board chairman Alan Greenspan expressed his concern that the crisis might have national economic repercussions: "The problems that we're now seeing in the energy area... around the country and, very obviously, with California's electric power production, are not aberrations but, in my judgment, a significant problem that this country is going to have to address, and address rather quickly, coherently, and cogently. If the energy structure of this country is inadequate or in some way excessively costly, it will undermine economic growth and therefore is a major issue that must be addressed"

International observers have seized on the ominous implications as well."California's problems are starting to show up in the broader economic statistics, adding to the sense of US national gloom;' comments Stephen Poloz,vice president and chief economist at Canada's Export Development Corporation. He notes that California, the world's sixth-largest economy, represents more than 13% of the total US GDP and that its contribution to the US economy has been even greater in recent years, given the rising importance of the high-tech sector.

"California's economic mth has outpaced the nation al average significantly in the past four years.This means that disruptions to California's economic activity matter a lot;' continues Poloz."Even if these disruptions implied that the California economy lost the equivalent of only one day's worth of activity during the whole first quarter, state GDP would be reduced by 1.7%.This would reduce reported annualized nationwide GDP growth for the first quarter by 1% and could make the difference between slow growth and a technical recession for the United States as a whole," he says. …

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