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California's Giant Game of Chicken


It's hard to imagine, but the California electricity crisis has gotten even uglier of late. "They are the biggest snakes on the planet Earth," Governor Gray Davis recently said of the state's power suppliers, adding not long after: "If they do not cooperate I'll have no choice but to sign a windfall-profits tax or seize plants." California Attorney General Bill Lockyer adds that he may file a price-gouging suit against the state's power producers in the next few weeks. More ammunition came on June 5, when one producer, AES Corp. (AES), revealed that the Justice Dept. is investigating allegations that the company conspired to gouge customers. On June 6, the Democratic-controlled U.S. Senate said it's considering new legislation to impose price caps on California's wholesale-electricity rates.

Power companies are hardly taking the threats lying down. Increasingly, they seem intent on making sure state officials know there's a limit to how much they can be pushed around. On June 1, Mirant Corp. (MIR), a major producer recently spun off from Atlanta's Southern Co. (SO), confirmed that it will not begin construction of a newly permitted plant near San Francisco until the investment climate in the state improves. Duke Energy Corp. (DUK), another major California producer, says it might adopt a similar position with its proposed plant on Morro Bay in the central part of the state. "Our members are asking themselves: `Is it safe to build in California?"' says Gary Ackerman, executive director of the Western Power Trading Forum.

NO MYSTERY. As the California electricity crisis enters its second summer, the situation seems to be disintegrating into a giant game of chicken. Politicians are trying to pressure producers to cut prices and lower the roughly $5.5 billion tab they claim they're owed from previous power sales. The generators want to avoid being hit with wholesale price caps or dragged into court for price-gouging, a prospect that seems more likely every day. The result is continued uncertainty--and the distinct possibility that many new power plants might not get built. "We're looking at another summer of blackouts, high prices, and a tremendous amount of discord," says Lawrence Makovich, an electricity analyst at Cambridge Energy Research Associates.

It's no mystery why Governor Davis and other California officials are upping the pressure. The state is already on the hook for more than $7 billion in power purchases, and the prospect of another summer price surge could spoil the governor's plan to sell bonds to pay off the state's power debts. Since polls show that most Californians believe producers are to blame, bashing those businesses just as major rate hikes begin to kick in might also score points with voters. "It plays well at home," says a legislative aide in Sacramento.

The risk, though, is that the poisoned atmosphere could persuade power producers to shun the state just when California needs new plants the most. The state has approved new plants that will produce more than 11,000 megawatts of power, a 22% increase over current production capacity. That should be enough, according to a recent report from Deutsche Banc Alex. Brown, to balance California's supply and demand by 2003. But earlier this year, the California Energy Commission projected that 5,000 megawatts of new plants would be online by July. Now, the agency says only half that will be ready by then.

Noticeably absent from the list of new plant developers are Dynegy (DYN) and Reliant Energy (REI), two companies that have increasingly come under fire for alleged price-gouging. Both are active developers in other markets. "Stability is probably the biggest concern we have about making any new capital investment," says Dynegy Inc. President and Chief Operating Officer Stephen W. Bergstrom. "The rules keep changing even as we speak."

Therein lies the rub. Even if power companies are overcharging or otherwise gaming the market to their own benefit, as many have alleged, the state's politicians and regulators have little choice but to work with them to solve the state's power problems. Producers, too, clearly have little long-term interest in exiting what remains one of the country's largest power markets. This is a game of chicken neither side can win. By Christopher Palmeri in Los Angeles, with Peter Coy in New York and Wendy Zellner and Stephanie Anderson Forest in Dallas


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