April 2001

The Calm Before 
The Perfect Storm

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2001/05/06)

The "Energy Crisis" which is now brewing is not the one the Administration would have us believe. That crisis is the "policy" explanation for various forms of assistance to the oil and gas industry.

The real one is the Perfect Storm coming out of the West and moving as fast as the summer thermal gradient. It is the confluence of three "climactic" influences: the failure of various forms of deregulation to produce workable, competitive markets in the Western states; the possibility that deregulation will be tarred as a cover for market manipulations both of power prices and of its ingredient, natural gas supply (as The New York Times strongly has inferred); and the exaggerated fuel use imbalance (toward natural gas, a fuel whose supply and sufficiency of transportation both are questionable) which is being produced by it.

It is a storm that has the capability to seriously harm the economy in several ways which even the vaunted $1.6 trillion tax cut likely cannot affect, even if it were spread more equally among the entire consuming public. It will result in higher power prices adversely affecting some industrial production. It will further harm consumer confidence by raising living expenses and diminishing available discretionary income. It will lead to a consumer-inspired, pro-regulatory backlash that will harm the prospects of the "new power companies" – the companies that have best responded to deregulation (thereby becoming the current favorites of the stock market), and the source of power industry innovation.

It has been argued that such a Perfect Storm is a cleansing force: that the emergence of clearly price-defined markets, at some point in time, will provide the right supply incentives and that sufficient capital and other energy transportation infrastructure improvement will flow into the energy marketplace. Far from a discrediting of deregulation, we are told we have a validation that California’s partial deregulation and effort to be responsive to all of the state’s constituencies, i.e. flawed deregulation, was foolhardy, and that the Governor’s battle to avoid raising rates is a validation only of the population’s parochial desire to have its cake and eat it too. It is a "giant too big to fail" scam.

But that was a more telling argument before investigative reporting on the sources of the crisis (and of the manner in which FERC investigated, or did not investigate the crisis) suggested that market manipulation (or at best legal, but dubious, exploitation) may well have been at play. Not because that exonerates the Governor’s now abandoned effort to freeze rates, but because it raises the issue whether, even if configured differently than California, deregulation can be self-policing, where either market power or power shortages prevail. If the public ceases to believe in deregulation – because the results it sees are not only distasteful but also demonizable – then various forms of price management may be anticipated, even though it is ultimately unrealistic to "put the genie back in the bottle." The result will simply be market distortions, c.f. oil regulation in the ‘70s.

When the Administration’s comprehensive energy bill solution arrives, if it addresses power at all, there are certain areas where one may expect skepticism of the broadest sort: PUHCA repeal; deprivation of states’ rights to protect consumers against deregulation and interstate retail wheeling; wholesale delegation of authority to FERC to police free market abuses; lack of focus on conservation issues.

It would be a great loss if intelligent, time-phased, price-monitored power deregulation were to stall out this long, hot summer. Deregulation also comprises part of very different potentially climactic events, the sunny emergence of expedited innovations: new power company models based on information age trading and consumer service; the development of new distributed generation technologies and facilitation of real time resource management-based, information system-based technologies; the newfound regulatory emphasis on use of incentives to reward actual system improvements (in areas such as transmission). Free market innovation has begun to unleash these forces, and creative Mergers & Acquisitions and structured finance transactions have the further potential to make them possible.

But this longer term, low pressure front will be no match for the high pressure force majeure imperiling deregulation, which is emerging in the Administration’s tactical passivity in the face of the California/Western catastrophe.

In evaluating refund possibilities, FERC chose to interpret the California situation as one of "bad times," i.e. periods of price spikes rather than "bad actions," i.e. overaggressive market behavior by some suppliers. Perhaps it was correct to do so. Certainly, witch hunts for "bad actors" don’t solve structural problems. But by eschewing efforts to help contain and channel the Western price situation (possibly, for example, as a quid pro quo for some give for state pricing and siting actions), FERC raises the probability of a re-regulation storm which may not be held back by the Rockies.

Tough love for California is one thing; free market absolutism, on the other, runs the risk of being perceived as ill-considered passion, not for Ronald Reagan but for Herbert Hoover, if it spreads to the energy economies of other states. The right question is: What actions can be taken in the short run in California that will shore up confidence nationally that market deregulation may continue as a creative structural force in the long run? That public confidence in deregulation is wearing thin and threatening to dump the new power companies in the whirlpool market vortex of the New Economy, just when the new power companies and Merger & Acquisition transactions emerging from deregulation have the promise to provide innovation comparable to that which telecom deregulation ultimately has provided.

It is, in short, the moment when the Administration should recognize that the "bad times" it is worrying about in California are the Calm before The Perfect Storm.

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.