Institutions and Climate Change: Lessons from the California Energy Crisis in 2000-2001

1. Institutions and Climate Change:Lessons from the California Energy Crisis in 2000-2001 Prof. Tim Duane University of California, Berkeley duane@uclink.berkeley.edu February 7, 2002

2. Institutions and Collective Action • Institutions vs. Organizations • Governance vs. Government • Scales of Time, Space, andSocial Organization/Action • Theories of Social Action(anticipatory vs. crisis-driven)

3. Political Opportunity Taxonomy • Characteristic Features (benefits, costs): • Majoritarian (distributed, distributed) • Entrepreneurial (distributed, concentrated) • Client (concentrated, distributed) • Interest Group (concentrated, concentrated)Opposition will tend to be well-organized unless distributive cost issues are addressed

4. A Dynamic Theory of Policy • Phase (connectedness, social capital): • 1. Exploitation (weak, weak) • 2. Conservation (strong, strong) • 3. Release (strong, weak) • 4. Reorganization (weak, strong)Social cycle repeats itself (1-2-3-4-1-2…)due to success in solving the wrong problem

5. Climate Change’s Key Features • Incremental and cumulative effects • Uncertain magnitude and distribution • Diffuse benefits of avoiding risks? • Concentrated costs of mitigation? • Complexity and non-linearity? • Accessibility of issue for public?

6. Risk Aversion in Policy • Risk neutral principles for policy? • Risk prone behavior (“upside”) • Risk averse behavior (“downside”) • Uncertainty’s impact on risk profile • Influence of other factors on preferences

7. Factors Affecting Preferences • “risk” = probability x consequence • Voluntary vs. Involuntary (100x) • Control vs. No Control (5x) • Natural vs. Human-made (20x) • Delayed vs. Immediate (30x) • Ordinary vs. Catastrophic (30x) • Known vs. Unknown (10x)

8. Hazard vs. Outrage Problem

9. Evolutionary Developmentof Institutions and Policy • Policy entrepreneurs raise issue visibility • Information generation and diffusion • Democratic discourse on policy options(competing narratives and rhetoric) • Development of compensatory mechanisms(overcoming the ability to veto policies) • Adoption of policies to effect change(usually with a significant transition period)

10. What’s Missing from this Model? • Presumes central authority and capacityfor implementation of selected policies • Presumes predictive capacity and certainty • Fails to address non-linear discontinuities • Tends to legitimate a dominant narrative • No development of a conditional (if: then)“incident command” system for crises

11. A Few Lessons from History • Political institutions: reactive, not proactive • Institutional incentives often generate“unexpected” behaviors by private actors • These behaviors are often predictable,but assumptions often preclude analysis • Risk preferences are often ignored; instead,dominant narrative biases risk perception • Crises often result from the convergenceof several conditions with low probabilities

12. Illustrations from Recent History • Tahoe (cone of diminishing flexibility) • Savings and Loan Crisis and Bailout • Northern Spotted Owl and Old Growth • Florida Everglades and Florida Bay • California Energy Crisis • Threats to Homeland Security • Enron collapse and fallout

13. Lessons from the CaliforniaEnergy Crisis in 2000-2001 • Dominant narrative: competition is good,and state regulation is inefficient (“bad”) • AB 1890 was a political settlement toovercome sources of possible “veto” • Assumptions dominated any analysis(resulting behaviors were predicted) • Competing narratives were dismissed(no room for real democratic discourse)

14. Deregulation & “Restructuring” • Cost overruns and “oversupply” problems • PURPA’s impact on generation technology • Pressure from large industrial customers • Successful deregulation in other sectors • “The age of market triumphalism” • 1992 Energy Policy Act => Exempt Wholesale Generators/“market-based rates”

15. “Attack of the Killer Tomatoes” • CPUC initiated deregulation proposals • Legislature crafted a political compromise • Utilities would sell 50% of thermal plants • “Stranded costs” would be recovered through frozen retail rates (“headroom”) • Single market for all transactions (PX) • New operator of grid for reliability (ISO)

16. Prelude to the crisis: 1996-2000 • IOUs sold 18,348 MW for $3.326 billion • Low spot market prices (oversupply) + uncertainty (Prop 9 in 1998 + demand) + spot market structure = few new CA plants • CA added 1.2 million people in 1998-2000; + 3.7% in 1998-1999 + 5.0% in 1999-2000 • WSCC surpluses were consumed by rapid demand growth in the Desert Southwest and masked by high hydro in the Pacific Northwest; only average hydro in 2000

17. Factual Misunderstandings • “no new power plants in 1990s”: 5058 MW of non-utility-owned generation (by design) • “environmental regulations stopped plants”: plants were permitted by CEC but not built;BRPU contracts killed by IOUs and FERC • “price caps caused utility bankruptcy”:price floor designed at utilities’ behest; billions of $ transferred from “headroom” • “price caps constrained new development”:price caps were 10-30x spot market prices

18. Misunderstanding the Problem => Misdiagnosis and Treatment • A little knowledge is dangerous with only one data point (Econ 1 vs Antitrust 101) • Simple explanation: S < D => shortages (consistent with superficial symptoms) • Sophisticated market analysis: buried in theappendices of CEQA documents or reports by politically neutered “experts” (complex) • Result: only the symptoms were treated

19. Why the Patient Looks Fine Now • Diagnosis: compound fracture of the leg and blood everywhere (rolling blackouts) • Treatment: hook the patient up to an IV, then set the fracture and bandage the wound • Patient: vital signs are good; bone is healing • Ignored: the IV has delivered 10-12 billion units ($) and is still hooked up; commitment to keep the patient hooked up for 15 years

20. A Hypothetical Scenario... • Gasoline sells for $2/gallon at most stations • One station insists on charging $25/gallon • Every other station will simultaneously stop pumping gas unless the one station is paid • Once the station is paid $25/gallon (even if only for one gallon), every other station will simultaneously be paid $25/gallon (for all sales, even if they were charging only $2) • Some stations are shutting down frequently

21. The $64 Billion Question: • How long before you and your fellow citizens would take over the gas station? • Hypothetical understates electricity market manipulation by an order of magnitude: $3800/MWh vs. $30/MWh = $250/gallon! • 5-6 generators have 4-19% market shares (1973 Arab share = 5%; OPEC = 12%) • If power plants were gasoline stations, the people would have taken them over by now

22. The Limits of Political Discourse • Very few political leaders had the courage publicly to call for power plant seizures (Angelides, Burton, CPUC’s Dick Bilas) • Most Republicans cried “socialism” even at state ownership of the transmission system, while offering no viable plan of their own • Agricultural interests stopped state takeover of hydro plants, driving water costs up more • The public is still in the dark about costs

23. Implications for Climate Change • Assumptions must be challenged vigorously and repeatedly; analytic models = heuristics • Heretics must be given a prominent voice in discourse (not limited to the EIR Appendix) • Low probability convergent conditions must be incorporated into both risk assessment and development of conditional incident command system (if this occurs, then…)

24. Broader Institutional Principles • Institutional development will require attention to governance structures that transcend regulation/market dichotomy • All markets operate within a regulatory context (even if not through legal system); challenge is to define structure of markets • Resolution of distributive issues is key to policy adoption; veto power can dominate