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Schwarzenegger May Return to Energy-Deregulation Model by Rebecca Smith, Staff Reporter Wall Street Journal - October 10, 2003

California, the first state to pull the plug on electricity deregulation, may now be the first to hop back on the deregulation bandwagon under new Gov. Arnold Schwarzenegger.

Aides to Mr. Schwarzenegger and the governor-elect's own position papers say the new Republican administration will take California back in the direction of open electricity markets, most notably by giving big energy consumers the right to choose among suppliers. Big users were stripped of that right after Gov. Gray Davis signed $43 billion of long-term energy supply contracts in 2001.

Those contracts were aimed at stabilizing a market that had been thrown into chaos by a combination of the poorly designed deregulation policies of former Gov. Pete Wilson's administration and aggressive moves by big energy traders like Enron Corp.

Mr. Davis "let a problem become a crisis," Mr. Wilson, now a top adviser to Mr. Schwarzenegger, said Thursday. The new governor "wants to move to a free market in power. That's still the future for the state."

Any such move by the Schwarzenegger team will be closely watched by other states. Many states backed away from energy deregulation in the wake of California's 2000-2001 crisis, which brought blackouts and billions of dollars in added energy costs, and felt their misgivings confirmed by this summer's blackout in the Great Lakes region, Northeast and Canada. Mr. Davis's handling of the California power crisis, coupled with the state's mushrooming budget deficit, fueled the recall effort that swept him from office.

Mr. Schwarzenegger's team aims to improve the original deregulation policies by placing greater emphasis on policing markets against abuse and positioning the state for greater investment in pipelines, transmission lines and generating plants. Joe Rodota, Mr. Schwarzenegger's policy director, said the state needs a "fresh approach" to modernizing its energy infrastructure and faces a possible energy shortage, in a few years, if it doesn't succeed.

The new administration also is expected to increase California's cooperation with neighboring states on energy issues like grid planning. Mr. Schwarzenegger has said he favors broadening the fuel mix for electric plants to lessen a growing dependence on natural gas, and exploring ways to slash the price of "overpriced power-purchase agreements" reached by Mr. Davis with suppliers.

One approach under discussion is to "buy out long-term contracts" that are keeping energy costs inflated, said Phil Romero, now dean of the business school at the University of Oregon in Eugene and who worked in Mr. Wilson's administration. Mr. Romero said it isn't clear where the buyout money would be found, given the state's budget distress.

The direction outlined by Mr. Schwarzenegger and his team represents a sharp departure from the approach taken by Mr. Davis, who was so bloodied by the energy crisis that he retreated almost totally from the state's market-opening experiment. He pulled back from regional cooperation on energy issues in favor of a California-first approach, and vested more power in California's big utilities to reassert state control.

The result has been a steady drift back toward a regulated model that, in many ways, was worse for consumers than what California had before deregulation. Energy prices are higher than ever and even Mr. Davis's defenders admit that the state remains uncomfortably poised between a regulated and deregulated system without attaining the benefits of either model.

One of the first tests of the change in energy direction could come this year in a case before the state Public Utilities Commission. One of the state's big utility firms, Edison International of Rosemead, Calif., has proposed that an unregulated subsidiary buy a big power plant and supply the electricity during the next 30 years to its utility unit, Southern California Edison.

Energy suppliers have objected to the deal because the contract wouldn't be competitively bid and because a protective order from the state utilities commission has prevented financial details -- including the price of the plant and the electricity it would produce -- from becoming public. If the state returns to a system in which big consumers are allowed to shop for cheap power or supply their own, the Edison contract could become a long-term burden that would have to be shouldered by someone, critics say.

The biggest stumbling block for Mr. Schwarzenegger: a Democratic-controlled state legislature that shares Mr. Davis's aversion to the kind of market competition that has proved disastrous for the state. But State Sen. Joseph Dunn, an Orange County Democrat who headed a Senate committee investigating market manipulation, said Mr. Schwarzenegger's decisive win and centrist positioning mean Democrats will give him a fair hearing "so long as he doesn't take a hard turn to the right."

Mr. Schwarzenegger, in his campaign position papers, says he thinks competitive markets, if properly policed, work better than state-controlled markets. He favors a somewhat contentious Federal Energy Regulatory Commission plan to create regional markets with standardized rules throughout the nation. This so-called Standard Market Design was proposed by FERC in July 2002 but is opposed by public officials in the Pacific Northwest and Southeast who don't want to cede power to federal authorities.