`Purpa' Power: Carter-Era Law Keeps Price of Electricity Up In Spite of a Surplus --- Utilities Must Buy Output Of Alternative Producers At High Fixed Rates --- Sun, Wind and Cattle Manure
By Jeff Bailey
Staff Reporter of The Wall Street Journal

05/17/1995
The Wall Street Journal
A1
(Copyright (c) 1995, Dow Jones & Co., Inc.)

Corrections & Amplifications

MESQUITE LAKE RESOURCE FACILITY in California successfully generated electricity from cattle manure in 1994, and shut down only after its contract to sell power to Southern California Edison was bought out. A page-one article last Wednesday about alternative-energy sources incorrectly stated the plant ceased running in January 1993. Also, although the article said the idea of making fertilizer hadn't panned out, the facility's owners do plan to process the plant's ash residue into fertilizer. (WSJ May 24, 1995)

Remember alternative energy? It's the solution that won't die for the problem that did.

The problem was the price of oil, which seemed certain to rise to $100 a barrel. Enter the Public Utility Regulatory Policies Act of 1978, or Purpa, meant to encourage alternative sources of electricity. Part of extensive energy legislation passed during the Carter administration, it provided a system of generous payments to independent power producers and compelled utilities to buy the power.

Oil prices soon plunged, and the energy crisis receded. Purpa, however, remains, and its legacy is a curious and costly collection of power plants: a Mojave Desert solar field whose operators say dust from a 1991 volcano obscures the sun's rays; an incinerator that turned to a rusty mess after its chosen fuel, cattle manure, was muddied by pounding rains; and a California windmill farm that creates such a draft that golden eagles are sucked in and killed.

Elsewhere, the law produced highly efficient hydroelectric and natural-gas power plants but provided bizarre economic incentives. Some Pennsylvania and New York plants, for instance, get paid so handsomely for electricity in early years and so much less later on that the developer publicly contemplates walking away from them after only 15 years of operation.

In all, the hundreds of power plants qualified under Purpa now represent, in effect, a $37 billion roadblock to lower electricity prices. That is how much the plants will receive from utilities through the year 2000, over and above estimated market prices, as calculated by Resource Data International Inc., a consulting firm in Boulder, Colo. The U.S., meanwhile, has a glut of generating capacity. This glut plus major advances in turbine technology would, in an unregulated market, be driving electricity prices sharply downward in many regions now.

Of course, it isn't as though Purpa is the only thing keeping power prices from falling. Resource Data estimates that utilities have another $175 billion of deadwood on their balance sheets that regulators are letting them slowly recover from customers. This includes investments in nuclear power plants, long-term coal contracts at above-market prices and other costs.

Many utilities are thus highly vulnerable to competition, as state and federal officials begin to map out deregulation of the $200 billion-a-year electricity business.

But, well fed by Purpa, independent power producers aren't acting like the scrappy newcomers one might expect. Rather than argue for immediate price decontrol, they are lobbying to protect their lucrative power contracts under Purpa, and are perfectly happy to see utilities continue to recover their bloated costs as well. "We don't want our shareholders to suffer millions and billions of dollars of losses," says Lawrence W. Plitch, a vice president at WMX Technologies Inc.'s independent power unit. "And we wouldn't expect utilities' [shareholders] to, either."

The independents and utilities each argue that their costs were incurred in good faith, that is, in the assumption that the industry's nearly 100-year-old regulatory system would endure. That system imposes nearly all costs on customers, in exchange for reliable supply. It would be unfair, they say, to abruptly subject the industry to competition.

Critics, however, see this regulatory system as a continuing bailout of bad business decisions. They argue that pricing decontrol, though it could bankrupt some big utilities, would be a boon to the economy. A cut of one cent per kilowatt hour from the national average of about seven cents would save U.S. industry and consumers roughly $28 billion a year.

"Ratepayers have been buying overpriced electricity," says Robert Michaels, an economics professor at California State University at Fullerton and a consultant to companies that favor deregulation. "If we have a chance to save even $20 billion a year, let's do it."

Twenty-five years ago, the idea of costly electricity would have seemed absurd. Cheap fuel and plant efficiencies had steeply lowered residential electricity prices -- to 2.1 cents a kilowatt hour from about 20 cents early in the century. Nuclear power seemed to promise still more efficiency. Experts spoke of power becoming "too cheap to meter."

Then things went haywire. Many nuclear plants became expensive boondoggles. Oil prices surged. Interest rates did too, choking the capital-intensive industry. And some utilities, desperate to guarantee fuel supplies, signed coal contracts that, in hindsight, are far overpriced. Residential rates nearly doubled by 1978 and were headed much higher.

All of that, plus growing concern about pollution, made alternative energy look good. But the law that Congress passed to encourage it didn't merely make utilities buy the output of alternative-energy plants at market prices; the price it set was utilities' "avoided cost" -- the amount per kilowatt hour it would cost them to generate the power themselves. The calculations might include the cost of building a new power plant. Long-term contracts had to be signed with the independents, with prices based on forecasts of future generating costs.

Such estimates were often far from the mark. One California forecast had oil hitting $189 a barrel by 2000; it's at $20 today. A 1981 Southern California Edison study estimated the utility's 1995 avoided cost would be 16.73 cents a kilowatt hour; today, power changes hands on the wholesale market at two to three cents in large quantities. The Edison forecast would have translated into an average household electric bill of $192 a month in 1995 and $300 by 2000; today's average bill is about $65.

Meanwhile, some utilities, used to running monopolies, balked at buying power. So several states, notably California and New York, turbocharged Purpa. "They did something so totally foreign to a market," says Bill Booth, a Federal Energy Regulatory Commission official. "Instead of determining needed capacity and letting the market determine price, they set a price and allowed unlimited capacity."

It was a great deal, and word got around. Utilities intermittently tried to scale back, or even kill, Purpa's largess, but they had little credibility because of their own costly mistakes. Independent power producers built more new generating capacity than did utilities. Plants that qualified under Purpa now account for 7% of the electricity market.

How have these plants fared?

Solar power was one of the types Purpa encouraged. Promoters sold over $1 billion in partnership interests to finance big solar fields near Barstow, Calif., thanks not only to Purpa but also to state tax breaks. Today, the desert sun bounces off arrays of mirrors to heat piping filled with oil. The oil heats water into steam to power a turbine. On a bright day, with computers precisely aligning the mirrors, it is a brilliant spectacle.

But costly. The Southern California Edison unit of SCEcorp must pay an average of 15 cents a kilowatt hour to buy solar power, perhaps five times what it would cost on the wholesale market.

But the utility doesn't suffer. Edison passes the cost on to its customers. It's part of the $800 million above market prices that Edison pays for power each year because of Purpa.

The solar fields aren't working as well as hoped. Operators say this is because the atmosphere still contains fallout from the eruption of Mount Pinatubo in the Philippines four years ago.

At one field, 300 acres operated by Daggett Leasing Corp., 20% of the mirrors are broken. Daggett says they aren't worth replacing. High operating costs make the plant uneconomical, but the owners don't want investors' past tax benefits to be reversed. "It makes sense to keep going no matter what," says Eric Wills, Daggett's president.

Beyond sunshine, Purpa looks favorably on a broad category of fuels known as biomass: nut shells orchard prunings, household trash and methane drawn out of garbage dumps.

Also, cattle manure. As it hits the ground, however, this particular fuel is about 85% moisture. Worse, it gets stepped on and mixed with dirt, which doesn't burn. It is so corrosive it chews through the steel, porcelain and aluminum of the world's only commercial-scale manure-fired power plant: Mesquite Lake Resource Facility in El Centro, Calif. The plant was built in 1985 for $49 million.

Operators struggled for years to keep the manure plant lighted. Notions that the resulting ash would make great fertilizer didn't pan out; 350,000 tons of the stuff, fine as talc, piled up out back.

Then, in January 1993, record rains turned the normally tidy cattle feedlots of the El Centro area into muddy latrines. When the skies cleared and some of the muck was tried as fuel, it choked the plant out for good.

With it shut down, the electricity payments from Southern California Edison ceased. But recently the plant's owners negotiated a buyout of their 30-year contract that could bring them another $10 million from Edison and, hence, from Edison's electricity customers.

Wind has problems, too. The big wind farm in the Altamont Pass in California also was a financial bust for utility customers by the time it was completed, with Pacific Gas & Electric Co. paying a pricey 11 cents a kilowatt hour for the electricity. But the wind turbines -- thousands of them atop the hills east of San Francisco -- became a vivid symbol of the potential for environmentally friendly power.

That image has taken a bruising lately as a freezer at a U.S. Fish and Wildlife Service office fills up with carcasses of golden eagles, hawks and kestrels found at the site. The pass, which funnels cool coastal air into the hot Central Valley, is home to one of North America's largest populations of golden eagles, which find the windmills' latticed towers convenient perches for spotting ground squirrels.

One study concluded that more than 500 raptors were killed in the wind farm over two years, including 78 golden eagles. How? Probably they were pulled off their perch and into massive blades that, at the tip, spin at up to 200 miles per hour. Or, researchers say, maybe they flew right into the blades.

The biggest windmill operator, San Francisco's Kenetech Corp., launched a $2 million study aimed at preventing bird deaths plus a vigorous public-relations effort. It is painting the blades, hoping birds will see them. It is perch-proofing the towers. And, hoping to learn more about bird collisions, it brought in homing pigeons that researchers can observe flying through the Altamont Pass wind farm.

Pigeons aren't eagles, though, and a Fish and Wildlife agent, Cynthia Struzik, questions what help they will be. "The only similarity is that they all fly," she wrote to local officials.

Kenetech also has questioned the body count. It put out a report citing a study saying 57 million birds of all kinds are killed every year in collisions with cars and trucks. What does that have to do with eagles? "Nothing," concedes Clarence Grebey, Kenetech's PR chief. "There was internal debate about putting that in there."

Besides wind, solar and such, power plants fired by ordinary fossil fuels such as natural gas can qualify under Purpa if they are "cogenerators," producing small amounts of power from steam that normally would be vented. Companies can use the hot air to heat a factory or, as at a Procter & Gamble Co. paper mill in Oxnard, Calif., to blow Charmin bathroom tissue dry.

Selling most of the power to the local utility at above-market rates, the factories in effect are subsidized by utility customers. Oxnard wouldn't be economical for P&G without its power sales to Southern California Edison at about six cents a kilowatt hour. "We wouldn't even be here," says Stacey Roscoe, the plant's energy business manager.

Use of steam power representing just 5% of a generating plant's total energy output qualifies as cogeneration. So power contracts are sometimes secured in partnership with minor so-called steam hosts such as coin laundries, civic swimming pools and greenhouses.

Utilities say the steam hosts are sometimes an afterthought. Officials at Medina Power Co. in Allegany, N.Y., told federal regulators in 1990 that a 13.8-megawatt plant's steam host would be a distilled-water plant. Then in 1992, just a month before the power plant began operating, Medina told regulators that the steam would be used to heat an eight-acre greenhouse.

An official of Niagara Mohawk Power Corp. in Syracuse, N.Y. -- the utility required to buy Medina's electricity -- visited the Medina site more than a year later and there still wasn't a greenhouse, it said in a regulatory filing. It is seeking to strip Medina's Purpa qualification. Medina officials won't comment.

An even stranger situation arises from payment structures provided by some states. Consider the case of Sithe Energies Inc., an independent producer controlled by Compagnie Generale des Eaux of France. It built six plants in Pennsylvania and New York for a combined $368.5 million. Yet Sithe says it may abandon them after only 15 years of operation.

The reason: contracts that heavily front-load the payments from utilities. After an initial 15 years, the independents would get much smaller payments or conceivably have to repay money to utilities, while continuing to provide power.

But there is a loophole. If the future looks bleak, the independents can simply walk away. Utilities and other creditors would be left with only the power plant.

The utility buying power from Sithe's New York plants, again Niagara Mohawk, has similar contracts with other power producers. It estimates that overpayments -- the amounts that would be due back to the utility -- could total $7.3 billion, and asked state regulators to require independents to post collateral. The request was rejected.

Niagara Mohawk estimates it pays $400 million a year above market rates for independent power, sometimes reselling the power at distress prices of less than one cent per kilowatt hour.

Utilities in several states have mounted legal challenges to their contracts with independents, but mostly failed. They are also trying to buy out some contracts; some independent plants' operating costs are so high that it can pay them to agree to close down and take reduced payments.

In such a case, the utility saves, too; if it needs the electricity the plant was producing, it can buy it elsewhere more cheaply.

The big utilities, however, had a hand in creating the Purpa problem. That's because many of them built independent power plants themselves. Until recently Niagara Mohawk owned a unit that had stakes in 25 projects; it has sold it to another utility, CMS Energy Corp. in Dearborn, Mich. PG&E owns Purpa-qualified projects through a joint venture.

SCEcorp, Southern California Edison's parent, was perhaps boldest. It sold independent power to itself.

It has a unit, Mission Energy Co., that holds stakes in 13 plants that sell to Edison. Some weren't even in the utility's service territory. The California Public Utilities Commission staff took offense, alleging self-dealing. Edison, which denies the self-dealing charge and says its plants were less costly than others, made a $250 million refund to customers. It also agreed in 1992 not to do any more deals with Mission.

Mr. Michaels, the economics professor, has watched, amazed that a law designed to give a modest boost to alternative power has spawned such a big and costly system of power plants. "Had anybody expected Purpa to lead to all this," he suspects, "it never would have been passed."

(See related letters: "Letters to the Editor: More Power to the Purpa!" -- WSJ June 7, 1995)

(See related letters: "Letters to the Editor: Nuclear Power, the Hope of the Future" -- WSJ June 22, 1995)

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