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E 22 P8 Energy The California Crisis

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The California Crisis and the Enron Debacle
Will Deregulation Survive?

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E 22 P8 Energy The California Crisis

  1. 1. Special Presentation The California Crisis and the Enron Debacle Will Deregulation Survive ? IEEE Luiz Maurer São Paulo, SP March 22, 2002
  2. 2. <ul><li>Deregulation of power sector in 2001 </li></ul><ul><li>Focus of this presentation </li></ul><ul><li>California and Enron in a snapshot </li></ul><ul><li>Enron involvement in the California crisis </li></ul><ul><li>Can we blame it on deregulation? </li></ul><ul><li>Have deregulation and Enron created any value? </li></ul><ul><li>Relevance of this discussion to Brazil </li></ul><ul><li>In conclusion </li></ul>AGENDA
  4. 4. DEREGULATION OF THE POWER SECTOR HAD MANY SETBACKS IN 2001 <ul><li>California crisis </li></ul><ul><li>Enron collapse </li></ul><ul><li>Spillover effects on perceived “Enronites” – e.g. Calpine, losing US$ 2 billion </li></ul><ul><li>PG&E bankruptcy in San Francisco </li></ul><ul><li>Energy shortage in Brazil </li></ul>
  5. 5. VERDICT HAS BEEN SIMPLE: BLAME IT ON DEREGULATION <ul><li>“ Deregulation is a failed experiment” </li></ul><ul><li>California, first state to fully introduce wholesale + retail competition – was also the first one to fail </li></ul><ul><li>Enron, the champion of deregulation, following a death spiral which led to Chapter 11 </li></ul><ul><li>Therefore: </li></ul><ul><ul><li>General skepticism from the public </li></ul></ul><ul><ul><li>PUCs delaying retail competition </li></ul></ul><ul><ul><li>FERC more prudent in setting up RTOs </li></ul></ul><ul><ul><li>More discussions on how electricity should be traded, transmitted and paid for </li></ul></ul>
  6. 6. WHICH RAISES SEVERAL GENUINE QUESTIONS <ul><li>Why did those things happen? Points in common? </li></ul><ul><li>Could it happen again and again? </li></ul><ul><li>Is deregulation something evil? </li></ul><ul><li>What are the alternatives? </li></ul><ul><li>Go back to the old good days of cost plus regulation and central planning? </li></ul><ul><li>Should states put an end on customer choice? </li></ul>
  10. 10. CALIFORNIA IN A SNAPSHOT <ul><li>Started full deregulation in 1996 </li></ul><ul><li>First problems in 2000 – price spikes directly affecting customers, reflecting supply-demand mismatches and T constraints </li></ul><ul><li>Winter widespread rolling black-outs </li></ul><ul><li>Financial distress imposed on utilities, forced to buy on a spot basis </li></ul><ul><li>Finger pointing – Enron as the scapegoat - personal issue between Mr. Gravis and Mr. Lay </li></ul><ul><li>Proposed solutions: State role as a buyer </li></ul><ul><li>Last season – problem mitigated, with customer response and [stranded] contracts (?) </li></ul><ul><li>Discussions on US$ 9 bi refund from cowboys </li></ul>
  11. 11. ENRON IN A SNAPSHOT (I) <ul><li>Reported losses in October, with significant write-offs </li></ul><ul><li>Raised investment community eyebrows, but explanations far from convincing </li></ul><ul><li>SEC investigation – need to report retroactively </li></ul><ul><li>Stock prices declining, triggering clauses of financial derivatives </li></ul><ul><li>Cash badly needed, stocks in a death spiral </li></ul><ul><li>Frustrated attempt to merge with Dynegy </li></ul><ul><li>Chapter 11 filing in early December, followed by massive corporate layoffs </li></ul>
  12. 12. ENRON IN A SNAPSHOT (II) <ul><li>Frustrated attempt to sell trading floor and EOL at a large premium </li></ul><ul><li>Class actions, Congress hearings, Powers Report </li></ul><ul><li>Scandals of all sorts, particularly related to special entities and Enron CFO </li></ul><ul><li>Key executives and board members fired </li></ul><ul><li>AA – criminal charges for obstruction of justice </li></ul><ul><li>Investigations on the way and will continue for months to come </li></ul><ul><li>After all, the largest bankruptcy in America </li></ul>
  14. 14. ENRON IS PERCIEVED AS A SCAPEGOAT IN THE CALIFORNIA CRISIS <ul><li>The most active proponent on deregulation </li></ul><ul><li>Learned the “tricks of the trade” to manipulate the wholesale market </li></ul><ul><li>Making money on gas and electricity – and created artificial constraints </li></ul><ul><li>Not the only one – but played a leading role </li></ul><ul><li>Strong proponent on no caps on spot prices </li></ul><ul><li>Gov. Davis: Where do I go to get my money back? </li></ul>
  15. 15. ENRON DOES NOT DESERVE THE BLAME <ul><li>Does not own generation facilities (except wind) </li></ul><ul><li>If claimed refund had merits -- < 0.5% </li></ul><ul><li>1994 Hearings – warning that the proposed system would be capricious and lead to high pricing </li></ul><ul><li>State rejected Enron’s offer of long term power in 2001; later, sold to state at prices lower than average (US$ 181/MWh vs. US$ 243/MWh) </li></ul><ul><li>Intrastate pipelines are filled to capacity – 5,530 mcf versus 6,150 mcf entering the state </li></ul><ul><li>Enron is a net buyer – indeed to receive refund </li></ul><ul><li>And a lot of high prices reflect scarcity in supply or T constraints </li></ul>
  17. 17. CALIFORNIA IS NOT DEREGULATION <ul><li>Several design problems – some anticipated </li></ul><ul><li>D/Cs not allowed to sign long term contracts </li></ul><ul><li>And were exposed to spot price volatility </li></ul><ul><li>But in most cases consumer rates frozen, creating imbalances for D/Cs, and financial distress </li></ul><ul><li>In places where rates reflected spot prices, lack of hourly metering did not help in peak shaving </li></ul><ul><li>Extremely complex market design – some rules conducive to price gouging </li></ul><ul><li>ISO stakeholder board not capable to change </li></ul><ul><li>Usually referred as a “botched deregulation” </li></ul>
  18. 18. ONE CAN NOT HONESTLY BLAME ON DEREGULATION FOR ENRON’S DEMISE <ul><li>“ Trading Natural gas and electricity, the core businesses, were solid ventures on deregulated markets” – from nothing in 94 to 900 TWh now </li></ul><ul><li>Many failed attempts to enter into new regulated businesses, mostly overseas </li></ul><ul><li>No modesty to admit they had different KSFs with diverse industry dynamics </li></ul><ul><li>Bulk of non-core assets under-performing – “less than decent rates of return” </li></ul><ul><li>Even decent rates of return would not have satisfied investors appetite – based on expected P/E ratios </li></ul><ul><li>“ Company managed to hide from investors and regulators its bad management and possibly corruption by shamelessly promoting its image” </li></ul>
  20. 20. “ ENRON WAS MOSTLY RIGHT ABOUT ONE THING: DEREGULATION” <ul><li>“ Moving aggressively, it became the largest trader of electricity and gas derivatives </li></ul><ul><li>Enron had real insight into the role of new types of securities in deregulated power markets </li></ul><ul><li>Enron’s actions, while self-serving, were generally good for the economy as a whole </li></ul><ul><li>The company promoted greater competition in electric power. Enron battled against entrenched state and local electric power companies that opposed deregulation to preserve their monopolies </li></ul><ul><li>Enron’s total expenditures on political influence were tiny compared with the potential benefits to consumers from competition” </li></ul>
  21. 21. “ TESTAMENT TO THE FLEXIBILITY OF THE U.S. ENERGY MARKET” <ul><li>“ Enron could fail without disrupting gas or electric supplies” </li></ul><ul><li>There were no price spikes, electricity outages </li></ul><ul><li>Enron’s trading functions immediately assumed by others </li></ul><ul><li>“ Part of the reason the markets adjusted so smoothly to the Enron collapse was the liquidity and risk allocation provided by the wholesale markets Enron had helped create” </li></ul><ul><li>For most regions of the US, there is significant market liquidity with multiple buyers and sellers meeting consumer needs </li></ul>
  22. 22. DEREGULATION HAS BROUGHT SIGNIFICANT BENEFITS TO US CONSUMERS <ul><li>Recent study by Boston Pacific Co. indicates that 1985-99 adjusted prices declined on average by 30% for residential and 36% for large customers </li></ul><ul><li>Despite not being the sole factor, large prices decreased occurred when competitive pressure was greatest </li></ul><ul><li>Recent study from the US Federal Trade Commission indicates that retail marketing is in a transition period </li></ul><ul><li>“ In this hybrid environment of regulation and competition, many of the expected benefits have not emerged … </li></ul><ul><li>Nothing that has happened so far indicates that competition will not produce additional benefits to electricity customers” </li></ul>
  23. 23. AND THERE ARE MANY SUCCESS STORIES OUTSIDE OF CALIFORNIA AND ENRON <ul><li>Well functioning power pools in the US do not receive the same publicity as California </li></ul><ul><ul><li>PJM – considered one of the most dynamic </li></ul></ul><ul><ul><li>New York </li></ul></ul><ul><ul><li>New England </li></ul></ul><ul><ul><li>MISO </li></ul></ul><ul><li>55.000 MW installed last year mostly in competitive environments </li></ul><ul><li>Other countries/regions have also developed vibrant markets </li></ul><ul><ul><li>Europe – Nordic countries, UK </li></ul></ul><ul><ul><li>Australia, New Zealand </li></ul></ul><ul><ul><li>Argentina </li></ul></ul>
  25. 25. ONE WAY OF TELLING THE STORY <ul><li>Embarked on a restructuring program in 1998, towards privatization and deregulation </li></ul><ul><li>Alleged lack of incentives for expansion leading to a major rationing crisis </li></ul><ul><li>State companies not allowed to expand; private sector not comfortable with risks entailed by the new model </li></ul><ul><li>Supply demand imbalance, lack of investments, drought, demand growth, environmental problems, transmission constraints, etc. </li></ul><ul><li>On the surface, it bears a strong resemblance to California </li></ul><ul><li>Point in common: deregulation </li></ul>
  26. 26. THE FLIP SIDE OF THE COIN <ul><li>Model designed for Brazil is significantly different from California’s (Appendix) </li></ul><ul><li>Most reasonable observers agree that Brazilian reform is half-way through </li></ul><ul><li>The issue hinges on implementation, not design </li></ul><ul><li>It is widely known that some incentives are not in place, or still entail significant risks to investors – e.g. VN, FX, D/Cs willingness to sign PPAs </li></ul><ul><li>Less conspicuous but probably more important – penalties for under contracting </li></ul><ul><ul><li>Penalty is MAE price exposure </li></ul></ul><ul><ul><li>This assumes that contracts among consenting adults will be honored, with no bail-outs </li></ul></ul><ul><ul><li>Rationing illustrated how sensitive the subject is </li></ul></ul>
  27. 27. THERE ARE SUCCESS STORIES ON THE USE OF MARKET FORCES <ul><li>The way the rationing program was designed illustrates how market forces may help allocate a scarce resource </li></ul><ul><li>Quota system with penalties for those who exceeded this baseline – or bonuses for low income consumers </li></ul><ul><li>Penalties linked to MAE price – to avoid the California effect and affect utilities’ finances </li></ul><ul><li>Large clients allowed to exchange quotas </li></ul><ul><li>9 months of rationing with minor black-outs </li></ul><ul><li>Recognized as a success story. Brazil saved US$ 10 billion by avoiding rolling black-outs </li></ul><ul><li>Demonstrable possibility to leverage demand elasticity </li></ul><ul><li>Customer choice created more appetite for retail competition, to be introduced in 2003 </li></ul>
  29. 29. IT IS NOT FAIR TO BLAME IT ON DEREGULATION <ul><li>For many, California should not be called deregulation – it is a “botched” re-regulation </li></ul><ul><li>Deregulation did not kill Enron – the deadweight of regulated businesses did – but no excuses to actions of management </li></ul><ul><li>Not fair to blame on Enron for California crisis </li></ul><ul><li>Enron collapse suggests need for greater financial and pension fund regulation – but never back to the old days of cost plus regulation in the power sector </li></ul><ul><li>Deregulation, particularly in the wholesale market, has worked in many countries/regions and has brought many benefits to customers </li></ul><ul><li>There are also good lessons to be learned when designing wholesale and retail competition </li></ul><ul><li>Brazil may leverage on those and on the lessons drawn from the market-based rationing program </li></ul>