$9 Billion Shakedown
Davis’s bullying of a power company.

By Ross Douthat, NRO
July 23, 2001 9:10 a.m.

or months, California's Gov. Gray Davis has been at war with a group of out-of-state power companies, accusing them of massive price-gouging during his state's disastrous, blackout-ridden winter, and insisting that they owe California nearly $9 billion in refunds. He has threatened to confiscate their assets, called company executives "obstructionists" and "the biggest snakes on the planet Earth," and declared that the "generators, mostly out of state … are trying to bleed us dry."

Now it appears that Gov. Davis has most of his facts wrong.

Earlier this month, Reliant Energy of Texas, one of Davis's favorite punching bags, released a report detailing its costs and profits for the last year which goes a long way toward rebutting the governor's insistence that price-gouging was to blame for the rising cost of power in 2000-2001. And three days later, after negotiations between the state and the power companies broke down, the judge in charge of mediating the dispute "cast aside" California's claim of a multibillion dollar debt, and suggested that whatever the power companies owe to the state may be less than what California still owes, in unpaid bills, to its electricity providers.

None of this should come as any surprise. Davis's battle with the out-of-state power companies began early this year, when he replaced the entire board of the California Independent System Operator (Cal-ISO), which had been slow to speak out on pricing issues. Shortly after the Davis appointees took over, they produced a report claiming that various service providers had reaped $6.2 billion in profits from excessive pricing — a number that has since climbed to the $8.9 billion figure that California is demanding today.

From the beginning, there were questions about the Cal-ISO report's methodology, as critics pointed out that the commission lacked information about the high fuel costs that companies were forced to pay to keep their gas-powered generators running through 2000-2001, when natural gas prices went through the roof. In addition, Cal-ISO was accused of failing to take into account the spike in demand for gas-generated electricity, caused by the drought conditions that have afflicted California recently. And while Davis has hammered away at the out-of-state companies, his experts have backed off their initial figures, with Cal-ISO acknowledging the limits of its methodology, and California's own expert witness in the negotiations lowering the refund amount to $3.7 billion.

Now it appears that the state is unlikely to get even that. The numbers produced by Reliant Energy — a Texas-based outfit that Davis has called "a big buddy of President Bush" — suggest that most of the tremendous spike in prices during the last year resulted from rising costs, rather than profiteering and price-gouging. In particular, the price of natural gas (which provides the fuel input for 49 percent of California's electricity) went sky-high in 2000, rising from $2.70 per million British thermal units (Btu) in 1998-99 to a remarkable $60 per million Btu in December 2000, the height of the crisis. Meanwhile, a three-year dry spell reduced reservoir and river levels, and dropped hydroelectric power production by 20 percent in 1999, thus boosting demand for fuel-generated power across the state.

The result was what Jerry Taylor and Peter VanDoren of the Cato Institute have termed a "perfect storm," in which the rising cost of natural gas combined with the rising demand for power from out-of-state providers to send overall prices soaring. In this climate, a company like Reliant saw its net revenue rise from roughly $300 million in 1999 to over $1.1 billion in 2000 — but in the same time period its expenses soared from $200 to $800 million.

This is not to say that the out-of-state companies' hands are entirely clean. For instance, there have been reports from insiders at Reliant and other companies that plants were ordered to throttle their generators up and down in order to exacerbate shortages and drive-up prices. Such maneuvers would explain why nearly 11,000 megawatts/hour of power — nearly a fourth of the state's capacity — were offline for "maintenance" during the first blackout in January, a number that has risen higher in subsequent months.

And a careful reading of Reliant's own report suggests that the company is glossing over the extent to which their profits rose during the crisis. Reliant has emphasized the fact that their operating profit was roughly the same in 2000 as in 1998, before the shortages began. But such an analysis ignores 1999, the other pre-crisis year, when their profits were significantly lower. In 1998 and 1999 combined, the company averaged a profit of $24.50 on each megawatt/hour of energy sold; in 2000 as a whole, this rose only to $28, but in the critical October-May period of rolling blackouts, it soared to $41 per Mwh. Reliant's executives attribute this spike to the logic of supply and demand, which is fair enough — but such a remarkable rise in profits during a period of shortages does lend credence to the charges of price gouging.

But even if one accepts that some unsavory market manipulation went on during the winter of 2000-2001, Gray Davis's claims that the companies reaped billions in profits are clearly absurd, and unsupported by the data. For instance, the initial Cal-ISO report suggested that Reliant would owe $750 million in refunds — but all told, price gouging or no price-gouging, Reliant only cleared about $120 million during the crisis. At the same time, many of the supposedly exorbitant bills that Davis has complained about have never been paid, with California still owing millions to Reliant and other out-of-state companies.

But none of this — not the backpedaling of his experts, not the new data about natural gas prices, and not even the dismissive language of Judge Curtis Wagner, the mediator appointed by FERC to settle the dispute — has shaken Davis's insistence that California is owed $9 billion, and $9 billion she will get. After Wagner suggested that the state would have to settle for around a billion dollars, Davis's spokesman declared that "we are still going to get the $8.9 billion … if we don't get it all from the commission, we will get the remainder [via lawsuit]." Added Davis himself: "If you think California will settle for $1 billion in refunds, we'll see you in court."

Such a strategy seems to make sense for the governor: Having scapegoated the power companies for so long, there is little reason for him to stop now, after a single setback. His tactic of blaming price-gouging and greed for California's disastrous situation has boosted his poll numbers considerably over the last few months, and built support for Davis's preferred "solution" to the energy crunch — namely, price caps. Never mind that this will do little to stabilize energy production at optimal levels: Californians, polls suggest, would rather have low prices and occasional blackouts than higher prices and high-quality service. As Taylor and VanDoren put it, "Governor Davis is imposing an East German policy on the electricity market because most Californians prefer it."

California will get what it pays for, then, and paying for electricity will be much easier if Davis can somehow pry a $9 billion refund out of the power companies. So he will keep pushing, and pushing, until Reliant and their competitors pay up.

Or at least until he wins reelection.