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E 22 P8 Energy The California Crisis

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The California Crisis and the Enron Debacle …

The California Crisis and the Enron Debacle
Will Deregulation Survive?

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  • 1. Special Presentation The California Crisis and the Enron Debacle Will Deregulation Survive ? IEEE Luiz Maurer São Paulo, SP March 22, 2002
  • 2.
    • Deregulation of power sector in 2001
    • Focus of this presentation
    • California and Enron in a snapshot
    • Enron involvement in the California crisis
    • Can we blame it on deregulation?
    • Have deregulation and Enron created any value?
    • Relevance of this discussion to Brazil
    • In conclusion
    AGENDA
  • 3. DEREGULATION OF THE POWER SECTOR IN 2001
  • 4. DEREGULATION OF THE POWER SECTOR HAD MANY SETBACKS IN 2001
    • California crisis
    • Enron collapse
    • Spillover effects on perceived “Enronites” – e.g. Calpine, losing US$ 2 billion
    • PG&E bankruptcy in San Francisco
    • Energy shortage in Brazil
  • 5. VERDICT HAS BEEN SIMPLE: BLAME IT ON DEREGULATION
    • “ Deregulation is a failed experiment”
    • California, first state to fully introduce wholesale + retail competition – was also the first one to fail
    • Enron, the champion of deregulation, following a death spiral which led to Chapter 11
    • Therefore:
      • General skepticism from the public
      • PUCs delaying retail competition
      • FERC more prudent in setting up RTOs
      • More discussions on how electricity should be traded, transmitted and paid for
  • 6. WHICH RAISES SEVERAL GENUINE QUESTIONS
    • Why did those things happen? Points in common?
    • Could it happen again and again?
    • Is deregulation something evil?
    • What are the alternatives?
    • Go back to the old good days of cost plus regulation and central planning?
    • Should states put an end on customer choice?
  • 7. FOCUS OF THIS PRESENTATION
  • 8. FOCUS OF THIS PRESENTATION
  • 9. CALIFORNIA AND ENRON IN A SNAPSHOT
  • 10. CALIFORNIA IN A SNAPSHOT
    • Started full deregulation in 1996
    • First problems in 2000 – price spikes directly affecting customers, reflecting supply-demand mismatches and T constraints
    • Winter widespread rolling black-outs
    • Financial distress imposed on utilities, forced to buy on a spot basis
    • Finger pointing – Enron as the scapegoat - personal issue between Mr. Gravis and Mr. Lay
    • Proposed solutions: State role as a buyer
    • Last season – problem mitigated, with customer response and [stranded] contracts (?)
    • Discussions on US$ 9 bi refund from cowboys
  • 11. ENRON IN A SNAPSHOT (I)
    • Reported losses in October, with significant write-offs
    • Raised investment community eyebrows, but explanations far from convincing
    • SEC investigation – need to report retroactively
    • Stock prices declining, triggering clauses of financial derivatives
    • Cash badly needed, stocks in a death spiral
    • Frustrated attempt to merge with Dynegy
    • Chapter 11 filing in early December, followed by massive corporate layoffs
  • 12. ENRON IN A SNAPSHOT (II)
    • Frustrated attempt to sell trading floor and EOL at a large premium
    • Class actions, Congress hearings, Powers Report
    • Scandals of all sorts, particularly related to special entities and Enron CFO
    • Key executives and board members fired
    • AA – criminal charges for obstruction of justice
    • Investigations on the way and will continue for months to come
    • After all, the largest bankruptcy in America
  • 13. ENRON INVOLVEMENT IN THE CALIFORNIA CRISIS
  • 14. ENRON IS PERCIEVED AS A SCAPEGOAT IN THE CALIFORNIA CRISIS
    • The most active proponent on deregulation
    • Learned the “tricks of the trade” to manipulate the wholesale market
    • Making money on gas and electricity – and created artificial constraints
    • Not the only one – but played a leading role
    • Strong proponent on no caps on spot prices
    • Gov. Davis: Where do I go to get my money back?
  • 15. ENRON DOES NOT DESERVE THE BLAME
    • Does not own generation facilities (except wind)
    • If claimed refund had merits -- < 0.5%
    • 1994 Hearings – warning that the proposed system would be capricious and lead to high pricing
    • State rejected Enron’s offer of long term power in 2001; later, sold to state at prices lower than average (US$ 181/MWh vs. US$ 243/MWh)
    • Intrastate pipelines are filled to capacity – 5,530 mcf versus 6,150 mcf entering the state
    • Enron is a net buyer – indeed to receive refund
    • And a lot of high prices reflect scarcity in supply or T constraints
  • 16. CAN WE BLAME IT ON DEREGULATION?
  • 17. CALIFORNIA IS NOT DEREGULATION
    • Several design problems – some anticipated
    • D/Cs not allowed to sign long term contracts
    • And were exposed to spot price volatility
    • But in most cases consumer rates frozen, creating imbalances for D/Cs, and financial distress
    • In places where rates reflected spot prices, lack of hourly metering did not help in peak shaving
    • Extremely complex market design – some rules conducive to price gouging
    • ISO stakeholder board not capable to change
    • Usually referred as a “botched deregulation”
  • 18. ONE CAN NOT HONESTLY BLAME ON DEREGULATION FOR ENRON’S DEMISE
    • “ Trading Natural gas and electricity, the core businesses, were solid ventures on deregulated markets” – from nothing in 94 to 900 TWh now
    • Many failed attempts to enter into new regulated businesses, mostly overseas
    • No modesty to admit they had different KSFs with diverse industry dynamics
    • Bulk of non-core assets under-performing – “less than decent rates of return”
    • Even decent rates of return would not have satisfied investors appetite – based on expected P/E ratios
    • “ Company managed to hide from investors and regulators its bad management and possibly corruption by shamelessly promoting its image”
  • 19. HAVE ENRON AND DEREGULATION CREATED ANY VALUE TO SOCIETY?
  • 20. “ ENRON WAS MOSTLY RIGHT ABOUT ONE THING: DEREGULATION”
    • “ Moving aggressively, it became the largest trader of electricity and gas derivatives
    • Enron had real insight into the role of new types of securities in deregulated power markets
    • Enron’s actions, while self-serving, were generally good for the economy as a whole
    • The company promoted greater competition in electric power. Enron battled against entrenched state and local electric power companies that opposed deregulation to preserve their monopolies
    • Enron’s total expenditures on political influence were tiny compared with the potential benefits to consumers from competition”
  • 21. “ TESTAMENT TO THE FLEXIBILITY OF THE U.S. ENERGY MARKET”
    • “ Enron could fail without disrupting gas or electric supplies”
    • There were no price spikes, electricity outages
    • Enron’s trading functions immediately assumed by others
    • “ Part of the reason the markets adjusted so smoothly to the Enron collapse was the liquidity and risk allocation provided by the wholesale markets Enron had helped create”
    • For most regions of the US, there is significant market liquidity with multiple buyers and sellers meeting consumer needs
  • 22. DEREGULATION HAS BROUGHT SIGNIFICANT BENEFITS TO US CONSUMERS
    • Recent study by Boston Pacific Co. indicates that 1985-99 adjusted prices declined on average by 30% for residential and 36% for large customers
    • Despite not being the sole factor, large prices decreased occurred when competitive pressure was greatest
    • Recent study from the US Federal Trade Commission indicates that retail marketing is in a transition period
    • “ In this hybrid environment of regulation and competition, many of the expected benefits have not emerged …
    • Nothing that has happened so far indicates that competition will not produce additional benefits to electricity customers”
  • 23. AND THERE ARE MANY SUCCESS STORIES OUTSIDE OF CALIFORNIA AND ENRON
    • Well functioning power pools in the US do not receive the same publicity as California
      • PJM – considered one of the most dynamic
      • New York
      • New England
      • MISO
    • 55.000 MW installed last year mostly in competitive environments
    • Other countries/regions have also developed vibrant markets
      • Europe – Nordic countries, UK
      • Australia, New Zealand
      • Argentina
  • 24. RELEVANCE OF THIS DISCUSSION TO BRAZIL
  • 25. ONE WAY OF TELLING THE STORY
    • Embarked on a restructuring program in 1998, towards privatization and deregulation
    • Alleged lack of incentives for expansion leading to a major rationing crisis
    • State companies not allowed to expand; private sector not comfortable with risks entailed by the new model
    • Supply demand imbalance, lack of investments, drought, demand growth, environmental problems, transmission constraints, etc.
    • On the surface, it bears a strong resemblance to California
    • Point in common: deregulation
  • 26. THE FLIP SIDE OF THE COIN
    • Model designed for Brazil is significantly different from California’s (Appendix)
    • Most reasonable observers agree that Brazilian reform is half-way through
    • The issue hinges on implementation, not design
    • It is widely known that some incentives are not in place, or still entail significant risks to investors – e.g. VN, FX, D/Cs willingness to sign PPAs
    • Less conspicuous but probably more important – penalties for under contracting
      • Penalty is MAE price exposure
      • This assumes that contracts among consenting adults will be honored, with no bail-outs
      • Rationing illustrated how sensitive the subject is
  • 27. THERE ARE SUCCESS STORIES ON THE USE OF MARKET FORCES
    • The way the rationing program was designed illustrates how market forces may help allocate a scarce resource
    • Quota system with penalties for those who exceeded this baseline – or bonuses for low income consumers
    • Penalties linked to MAE price – to avoid the California effect and affect utilities’ finances
    • Large clients allowed to exchange quotas
    • 9 months of rationing with minor black-outs
    • Recognized as a success story. Brazil saved US$ 10 billion by avoiding rolling black-outs
    • Demonstrable possibility to leverage demand elasticity
    • Customer choice created more appetite for retail competition, to be introduced in 2003
  • 28. IN CONCLUSION
  • 29. IT IS NOT FAIR TO BLAME IT ON DEREGULATION
    • For many, California should not be called deregulation – it is a “botched” re-regulation
    • Deregulation did not kill Enron – the deadweight of regulated businesses did – but no excuses to actions of management
    • Not fair to blame on Enron for California crisis
    • Enron collapse suggests need for greater financial and pension fund regulation – but never back to the old days of cost plus regulation in the power sector
    • Deregulation, particularly in the wholesale market, has worked in many countries/regions and has brought many benefits to customers
    • There are also good lessons to be learned when designing wholesale and retail competition
    • Brazil may leverage on those and on the lessons drawn from the market-based rationing program
  • 30. APPENDIX DEREGULATION MODELS IN BRAZIL AND CALIFORNIA
  • 31.  

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