To California’s Energy Policy-Makers: Control the CAISO and Give Us Electric Rate Relief

Suppose it is really hot.  You go into a store to buy a bottle of water that usually costs you a dollar.  To your shock and dismay the store charges you twenty dollars.  You feel ripped off and you want to complain.  The California Attorney General tells you to complain to him because this type of commercial behavior is an illegal unfair practice, price gouging, and profiteering.  This is so outrageous that it almost never happens.

But with electricity, a service equally essential to each of us, this sort of price gouging and profiteering is a regular occurrence, justified and even encouraged by energy policy-makers at the CA Independent System Operator (CAISO) and the Federal Energy Regulatory Commission (FERC), who control the price formation of most of our electric energy.  The CAISO is a California non-profit corporation created during de-regulation to manage that part of the grid owned by investor-owned utilities.

The worthies at CAISO and FERC subscribe to a theory that electricity prices should escalate to astronomical levels – untethered from actual costs of production like fuel, operation, maintenance and reasonable profits — to reflect “shortages” in supply of this essential service.  We used to call it extortion.

In this theory – so-called “scarcity pricing” or “shortage pricing” — powerplants and the energy they produce appear and disappear like Cheshire cats in response to “price signals,” as stressed grid operators scramble in high drama to meet the requirements of providing electricity on hot days outside its “organized” market; and prices escalate into the stratosphere.  We have heard described in cinematic detail the activities of grid operators at the CAISO on September 6, 2022 when the state appeared to narrowly avoid rolling blackouts by asking us to voluntarily conserve and cook in the dark, while CAISO exported thousands of megawatts of power and prices escaped the pull of gravity. A recent bill in California’s Legislature describes these efforts as “inspirational,” although there is nothing inspirational about charging what the traffic will bear no matter how painful to the payers.

It needs to be understood that this “theory” has no basis in law; it is a fabrication of seller-side interests who, as insiders, are positioned to get captured staff and decision-makers to go along.  A similar move is being made to inject the academic notion of “opportunity costs” as a justification for astronomical prices into price formation in organized markets overseen by FERC.

There are several problems with the “scarcity pricing” theory from the standpoint of California’s hard-pressed ratepayers, and from the standpoint of California policymakers concerned with the affordability crisis we all face.   First, it is “goddammed expensive,” in the memorable phrase of David Freeman.  It provides incentives to create artificial shortages.  Second, it ignores the physical reality of the electric grid, which consists of real powerplants and transmission and distribution lines connecting them to load (end users).  They are not dreams.  An estimate of the amount of electric generation plants located in California (a physical inventory based on reports filed by every powerplant owner with the US Energy Information Agency (EIA Form 861)) puts the nameplate capacity at 86,000 megawatts, 60% more than needed to serve the highest recorded load (52,000 MW on September 6, 2022, which included 6000 MW of exports.)  (See the public-source database GridClue.)

There was never a physical shortage in 2020 or 2022.  There were sophisticated forms of economic and physical withholding to create the appearance of shortage.   The “search” for megawatts was a phantasm, concocted to justify the profiteering.  And the in-state inventory does not count thousands of megawatts located outside of California owned by California entities or under federal contracts with California entities dedicated to serving California native load.  The fiction of shortage, the drama of tight supplies justifying extreme prices — that powerplants appear and disappear in response to price signals, are only “visible” to the CAISO grid operators when they bid — is a matter of bad policy convention and bad practice.  They are correctable and correction can save ratepayers lots of money.

The bad policy and bad practice are very recent.   The California Energy Crisis of 2000-01, an outgrowth of California’s failed de-regulation experiment, was in part ended by FERC when it established a rule in the West that capacity had to be made visible (posted) and had to be offered to supply California load.  FERC eliminated the Must Offer and Must Post requirements in October 2016.  The Cheshire cat powerplant and its price-signal catnip date from that point.

Another problem with this theory is that it does not consider behaviors that create artificial shortages:  economic and physical withholding for the purpose of raising prices that were at the heart of the 2000-01 Energy Crisis.  They are making a comeback in the present, now that Must Offer and Must Post have ended.  The physical inventory described above (based on name-plate capacity) depends on the condition and operability of the powerplants.  California enacted a statute in 2001 that gives the CAISO and the CPUC powerful authority to prescribe and enforce operation and maintenance standards for all California powerplants.  We ended physical withholding as a matter of law and policy.

The CAISO and the CPUC failed to sustain this effort.   As a result, in the August 2020 Blackout the powerplant fleet operated at an abysmal level of availability, and specific large powerplants on the margin failed to operate at all. Powerplant performance improved in 2022, after the CPUC ordered expensive and secret new contracts to make the powerplants more contractually “visible” and available.   Why pay extra for performance required by law anyway?   Not because we like to, but because we let them.

Further, the CAISO promoted “exports” of power out of California at times of maximum stress in both 2020 and 2022, at the expense of serving California native load (customers).  In both of these instances the CAISO admitted after the fact that software “glitches” had contributed to “erroneous” exports and asserted that that the glitches have been corrected.  (Most recently on October 13, 2022)  The possibility that export practices had been strategic for the purposes of raising prices during the 2020 Blackout was suggested by the CAISO market monitor at FERC in October 2020, but later dropped and not included in any of the “root cause” reports to the California Governor and public.  Why the omission?

In the 2005 documentary film about Enron, The Smartest Guys in the Room, the architect of the CAISO, David Freeman, recounts a conversation with Ken Lay, Enron’s Chairman:

“I remember the conversation I had with Ken [Lay, Enron Chairman].  At the end of it he says ‘Well, Dave, old buddy, let me just tell ya….It doesn’t really matter to us what kooky rules California puts in place.  I got a bunch of really smart people down here who will figure out how to make money anyhow.”

We are watching this happen again in real time.

The fiction that powerplants appear to disappear and re-appear in response to and justifying extreme prices is the product of the CAISO’s approach to grid dispatch.  It is based on a computer algorithm (the so-called “organized market”) that dispatches powerplants in response to bids (offers to sell) that establish a “market clearing price” tht is paid to all market sellers without regard to their actual costs or bids at 5-minute intervals in an overlapping set of “auctions” of real and virtual supplies.  If this seems to you like a weird, convoluted and expensive way to operate a complex machine of physical powerplants (sources) connected by wires to end users (sinks), it is.  If it occurs to you that strategic bidding behavior by both “supply’ and “demand response” can influence how high the “market clearing price” will go, it does.  The “single clearing price” assures that Californians will always pay the highest possible price, including the extortionate prices reflecting “scarcity” pricing.

The CAISO, captured by energy sellers, prioritizes its financial and “market-making” role (enabling profit maximization by sellers and speculators) over its operational role to manage the grid reliably for the people of California.  Its fallback position on reliability – pay-for-protection (in technical terms an increase operating reserves (the margin of safety) by 50 percent at a significant (but still secret) cost) – was adopted by CPUC in 2021 in a sad repetition of the pattern of the 2000-01 Energy Crisis.  The CAISO thus creates both the affordability and reliability crises we face.  And addresses it by locking in elevated prices.

California has the highest electric rates in the continental United States.  Scarcity pricing at the CAISO is not the only reason but it is an important one that is driven entirely by policy, and can be corrected by policy.

What can we do?   We can begin to hold the CAISO to be accountable.

First, we can end scarcity pricing and replace it with hard price caps. This would repudiate speculation in energy services and the philosophy of shortage pricing — and the resulting extreme prices — replacing them with a price formation regime that returns to transparency, enforceable availability, and cost-based prices including reasonable, not speculative, profits.

Second we can begin to manage the grid based on maximizing end-user based resources (roof-top solar paired with storage, for example); and optimizing, for reliability not profits, the inventory of existing central station electric generation resources to meet California’s native load, taking into account our intention to simultaneously grow load to electrify transportation services and building environments and to decarbonize supply sources. This includes both enforcing current powers regarding operation and maintenance and constructing the new renewable powerplants and transmission connections we need in an orderly, transparent and affordable way under state law.  This is already happening in those portions of California’s grid that are not controlled by the CAISO, like the Sacramento Municipal Utility District (SMUD) and Los Angeles Department of Water and power (LADWP).

Third, we can empower the consumer advocates like the Office of Public Advocate at the CPUC to participate effectively and continuously at the CAISO to keep it focused on serving Californians when it gets down into the details.

These are beginning baby steps.  However, the seller side is already moving to negate them as possibilities.  Through a process called the West Wide Pathways Governance Initiative, jump-started last year by California agency heads appointed by Governor Newsom, efforts are being made to preserve the CAISO algorithm and to turn over the power to initiate price formation decisions, including reforms to eliminate scarcity pricing, to a new entity unresponsive to California.   This will be another battle.

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