Power's Surge

By Daniel Eisenberg

Like most consumers, Mike Hawkins took electricity for granted. He paid predictable, state-regulated rates, and in return the local utility kept the juice flowing. But when Hawkins got his bill in June from San Diego Gas & Electric (SDG&E), he was in a state of shock--$135, nearly twice the previous amount.

The culprit was deregulation, which, students of the telephone and airline industries will tell you, doesn't always go according to plan. When states started breaking up one of the last subsidized monopolies a few years back, they hoped to usher in a wave of competition that would lower prices, improve service and increase the system's reliability. Newly liberated customers would be able to choose from a host of suppliers, some of whom generated the power while others just delivered it.

But so far, the radical shake-up of the $220 billion electricity industry has been short-circuiting. "This is a dysfunctional market masquerading as a competitive market," charges Michael Shames, executive director of the San Diego-based Utility Consumers' Action Network. Prices for electricity have been spiking up in some regions; capacity is lagging demand, threatening customers across the nation with brownouts and blackouts this summer. "The cookie jar is open, and everyone wants to get what they can," Hawkins says. "They've got it, we need it, and we're going to pay through the nose to get it."

That became clear last week on the other coast, when officials from New York City's utility Con Ed disclosed that bills in the Big Apple will probably be 30% higher than last year's, thanks to rising fuel costs and an increasingly tight energy supply in the region. Coming a week after a brief blackout knocked out 140 customers on Manhattan's tony Upper East Side--and a year after a major one crippled an entire Washington Heights neighborhood for 19 hours--the admission further sullied Con Ed's bad reputation. John Dyson, chairman of Mayor Rudy Giuliani's council of economic advisers, expressed the official outrage: "It's hard to believe a rate increase is justified [in light of] the energy outages."

In other deregulated parts of the nation, where retail electricity rates are frozen for a few more years, price isn't the problem yet. Instead, providers are having a tough time just supplying enough juice, as air-conditioners and other appliances consume electricity at an alarming pace. Silicon Valley, home to the energy-hungry new economy, has already experienced rolling blackouts. The situation across California has got so precarious that state officials are offering cash payments to big corporate users that conserve energy during a crunch; database power Oracle has spent millions to build its own generators. New England and the Southwest are also potential trouble spots.

How can power companies be short of power? Under deregulation, vertically integrated utilities like SDG&E and Con Ed (as in Edison, as in Thomas Edison, the man who electrified Manhattan) were allowed to sell their power-generation businesses and become middlemen that buy electricity on the open market from new generator operators and distribute it to their customers. "We work hard to find the best deal for our customers," says Steve Bram, Con Ed's senior vice president of central operations. "But we're at the mercy of the sellers." Those sellers, on the other hand, are at the mercy of--wow!--no one, and with capacity shortages driving up unregulated wholesale prices as much as 50 to 100 times the normal rate, they're doing quite well. "Owners of power plants can extract monopoly rents," notes Edward Smeloff, executive director of the Pace University Law School Energy Project.

The flurry of construction that was supposed to relieve the electric bottleneck has yet to arrive. Old-line utilities--which used to count on a guaranteed 5% to 7% profit--have been reluctant to invest in billion-dollar plants without understanding the vagaries of the free market, and upstart energy providers are still trying to figure out which markets are worth the hefty investments required. At the same time, the industry is plagued by an antiquated, balkanized transmission grid that wasn't built to wheel power from one region to another. "America is a superpower, but it's got the grid of a Third World nation," Energy Secretary Bill Richardson has warned. "If we don't work together and fix the problem, we'll all end up sitting in the dark."

As computers and high-tech equipment suck up more power--they now account for close to 10% of all consumption--electricity providers can barely keep up. Summer electricity demand in the U.S. has jumped 23% since 1992, while capacity has risen only 6%, so the industry's emergency-reserve capacity has slipped. With communities fighting new construction, very few major power plants have been built in the past 20 years. Yet by one Energy Department estimate, the country needs 1,000 new plants in the next two decades. As Steve Fleishman, an analyst at Merrill Lynch, notes, "The country underinvested in the energy sector in the last decade, and it's coming back to haunt us."

That doesn't mean it's haunting Wall Street. On the contrary, after a few years of dismal performance, the stocks of electric utilities--traditionally viewed as boring, safe investments more akin to bonds--have heated up this year, gaining around 5% in a choppy market. Warren Buffett and Bill Gates have made bets on the sector, investing in MidAmerican Energy and Avista, respectively. Stodgy, flat-footed utilities aren't going bankrupt, as predicted, but restructuring to tap the competitive markets. Given their background, though, it's not an easy switch. "These companies didn't consider themselves to have customers--they were called ratepayers," says Michael Egan, CFO of Peco Energy, the $5 billion Philadelphia-based giant that just merged with Unicom.

Generators like Calpine and Duke Energy (whose stock is up more than 20% this year) that sell their power to providers outside their home base are favorites. Peco and Louisiana-based Entergy, the nation's third largest power producer, have even embraced the once imploding field of nuclear energy, seizing on it as a lucrative way to produce power for the spot market. "Nuclear was viewed as an albatross--you just tried to survive it," says J. Wayne Leonard, CEO of Entergy. Leonard is spending $4.5 billion buying up nuclear plants at garage-sale prices. So far, his strategy seems to be working. The company is growing 10% a year. Its trading business, while accounting for 25% of its $10 billion in revenue, makes up half of earnings.

The warm reception on Wall Street could quickly cool if, as AG Edwards analyst Tim Winter quips, "the bureaucrats come back to make sure utilities can't make any money." Those aren't idle fears. The regulation-averse, Republican-led Senate just passed legislation to create an industry-oversight committee--this isn't an election year, is it?--to handle disputes and ensure the reliability of electricity nationwide. More ominous, in California the outcry has been so intense that utility officials recently lowered the price cap on rates that generators can charge on the open market. While that may help ease pricing pressure in the near term, it could easily backfire. Says Stephen Baum, vice chairman of Sempra Energy, parent company of SDG&E: "This would simply create a shortage. Those generators might just sell their energy elsewhere." If that happens, Mike Hawkins and lots of other Californians might not have any electricity bills at all to worry about.

--With reporting by Jay Branegan/Washington, Paul Krueger/San Diego, Stacie Stukin/Los Angeles and Daniel Terdiman/San Francisco

With reporting by Jay Branegan/Washington, Paul Krueger/San Diego, Stacie Stukin/Los Angeles and Daniel Terdiman/San Francisco