Bay Area Economic Forum Quantifies California Power Crisis: Billions of Dollars and Thousands of Jobs.

Business Editors

SAN FRANCISCO--(BUSINESS WIRE)--April 20, 2001

The Bay Area Economic Forum, a partnership of the Bay Area Council and the Association of Bay Area Governments, finds in a new study that rolling blackouts this summer could be one-hundred times worse than last summer and could have a dramatically more serious impact on the Bay Area economy than rate hikes if immediate action is not taken to reduce demand and increase power generation. The study, The Bay Area--A Knowledge Economy Needs Power, commissioned by the Bay Area Economic Forum, the Bay Area Council, and the Association of Bay Area Governments, was prepared with the assistance of McKinsey & Company.

Sunne Wright McPeak, President of the Bay Area Council, remarked, "The energy crisis poses a greater immediate threat to the competitiveness of the Bay Area than other major infrastructure challenges that we are facing."

The probable 50% increases in commercial and industrial power rates will cost Bay Area business over $500 million in lost output a year and will cause 15,000 jobs to be lost over the next three years.

While customer cost is an important issue, the survey of over 500 Bay Area employers found that the reliability of power supply is even more critical. The survey was conducted with the cooperation of the Bay Area Council, Silicon Valley Manufacturing Group, Economic Development Alliance for Business, the San Francisco Chamber of Commerce, the San Jose Silicon Valley Chamber of Commerce, and the San Rafael Chamber of Commerce.

Based on the fact that the California Independent System Operator (CaISO) projects a significant summer energy shortfall, which practically guarantees widespread rolling blackouts, the cost to California's economic output (wages, salaries, and profits) could range from $2 billion to as much as $16 billion.

Unreliability of power would cut California's projected 3.5% growth in 2001 to 2.5% or less. For the Bay Area, the energy crisis could lower growth from a forecast 4.2% to under 3.2%. A 1% hit to the economy is enormous and few other forces could have such an impact. For example, the collapse of a foreign market, higher inflation, or a local labor shortage would be unlikely to lower growth by 1%.

"More than just high technology businesses are at-risk; lack of reliable power presents a clear threat to the broader economy, far overshadowing the impact of any price increases," noted Jim Robb of McKinsey & Company.

The scenario could worsen if the CaISO projections prove overly optimistic. If California experiences an exceptionally warm summer, one potential scenario, the negative impact on the economy could be 2-to-4 times worse, pushing the state into a recession.

"If unsolved the energy crisis could throw the state into recession and permanently change the perception of the Bay Area as thriving place to live and work," remarked Eugene Leong, Executive Director of the Association of Bay Area Governments.

According to the survey, lack of confidence in reliable power has already caused one in five Bay Area companies to consider relocation, a figure that would rise if blackouts were to become prevalent.

The study identifies the supply and demand imbalance as the root of the energy crisis. Although about one-third of the rise in wholesale prices is attributable to higher costs associated with producing and transporting power, up to two-thirds of the cost increase is due to the fundamental shortage in energy. As late as 1998, energy supply forecasts were far greater than what was actually constructed, due mainly to regulatory constraints and uncertainty.

Without consumer prices communicating scarcity to the users, demand has not fallen. Normally, prices bring supply and demand into balance; however, a number of flaws in the state's deregulation policy impeded the normal market response where supply adjusts upward or demand adjusts downward. This inflexibility has left California with only blackouts to ration the power supply.

"This crisis was brought on by California's failure to develop new capacity to meet steadily growing demand," affirmed Sean Randolph, president of the Bay Area Economic Forum. "The problem is real and, while generators may have taken advantage of this situation, it is largely of our own creation."

The study and related survey of 500 employers found, among other things:

-- Of the Bay Area businesses surveyed, 42% of the respondents say the crisis
has already lowered their profit margins and competitiveness.

-- Probable residential electricity rate hikes, coupled with increased costs
passed on by local businesses, will reduce Bay Area disposable income by more
than $1 billion a year.

-- Technology-based "new economy" industries are not primarily responsible for
the Bay Area's increasing energy consumption, accounting for only 10% of total
growth, and the intensity of energy use by industry, including the computer and
electronics sector, actually declined from 1995 to 1999.

-- Per capita residential electricity consumption, on the other hand, increased
8% between 1995-99, while per capita residential natural gas consumption
increased 17% during the same period.

"Energy efficiency has long been a priority for Bay Area businesses; the steady improvement has been remarkable," observed Carl Guardino, president and CEO of the Silicon Valley Manufacturing Group.

The solution to the immediate energy crisis looming this summer lies in a combination of both conservation through demand management and an increase in power generation that bridges the potential energy gap of 4,000 MWh. Absent aggressive action, the report predicts that California will experience endemic blackouts this summer, with average wholesale spot prices as high as $200/MWh in 2001, compared to $118/MWh in 2000 and $32/MWh in 1999.

The report proposes aggressive conservation measures in the near-term to forestall blackouts this summer, targeted particularly at contributors to peak demand. Reductions in residential and commercial air conditioning and commercial interior lighting, which account for 40% of peak load, have the greatest promise of reducing demand. Other aggressive methods for consummation reduction include incentives for overall conservation, time of use pricing, and real-time pricing.

In order to reduce the number of rolling blackouts, the report recommends that California:

-- Manage demand and consumption through progressive rate

structures.

-- Streamline permitting procedures to cut approval time required

by half.

-- Overhaul regulatory framework to reduce uncertainty.

-- Use temporary mobile generation.

-- Encourage some gas-fired plants to temporarily shift to liquid

fuels.

-- Develop a liquid forward market for power.

-- Address critical gas and electric transmission bottlenecks

into and within the state.

In the medium-term, price is the most effective means of bringing supply and demand into balance because market-based rates dramatically improve demand responsiveness to tight supply conditions. The report recommends combining consumer exposure to market-based rates and progressive residential rate structures and industrial rate structures that strongly encourage businesses to shift consumption away from peak hours.

This will serve to sensitize the consumer regarding market prices and change consumption behavior. Observing that in the summer of 2000 power use in San Diego fell 5% in response to higher prices, reserve margins would be higher and the worst effects of the crisis would be avoided if that behavior were repeated throughout the state.

The long-term solutions involve the supply side. The report recommends an aggressive construction program for new generation, finding that California must strengthen its energy infrastructure (both natural gas and electricity). The state desperately needs to attract investors to build more power plants, and must find ways to increase natural gas transmission capacity in order to get these plants the gas they will require. Unfortunately, this cannot be accomplished quickly.

Reduced electricity imports, due in part to the wholesale price caps imposed last summer, low hydro output brought on by dry weather, and increased demand have put serious strain on California's aging gas-fired power plants, the electric transmission system, and on the gas delivery system. The state clearly needs more supply.

The study emphasizes the importance of creating competitive wholesale and retail power markets in California and of correcting - but not abandoning - deregulation. While a case can be made for state ownership of the transmission grid, the report recommends that the operation of the network and most decision-making should remain in private hands and the role of procuring power should also be returned to private hands as soon as possible. As for the governmental role, it recommends consolidation of all regulatory functions into a single coordinating body to give clearer, more consistent policy direction.

"A functioning, competitive wholesale and retail power market is the best way to bring the most power at the lowest prices to the state," commented Jim Cuneen president of the San Jose Silicon Valley Chamber of Commerce.

The report The Bay Area--A Knowledge Economy Needs Power can be downloaded from www.bayareacouncil.org.