Conference addresses the hot topic of energy

The recent blackout that left much of the Northeast dark, the energy crisis in California, the collapse of Enron, and extensive debate over deregulation of electric utilities have brought energy issues to the forefront of public concern.

These energy issues were discussed at a one-day conference organized by René Carmona, Paul M. Wythes ’55 Professor of Engineering and Finance in the Department of Operations Research and Financial Engineering (ORFE), and Paul Addis, chief executive officer of Louis Dreyfus Energy. The conference, titled “Price Risk and the Future of Electric Markets,” was sponsored by the National Science Foundation, ORFE, the Bendheim Center for Finance, and Mr. Addis.

Over the past two years, the U.S. electric and natural gas markets have suffered drastic damages. Opaque accounting practices and the collapse of Enron have frightened investors and left them with little trust in the market. Economists touted deregulation of the electric markets as a direct route to lower, fairer, and more understandable energy prices. Yet, experiments in deregulation have had disappointing results.
California was the first state in the nation to enact electric power restructuring. There, deregulation brought on an increase in retail prices, more complicated pricing structures, and a decrease in the leveraging power of small consumers.

One of the workshop participants, Richard Peters from the Boston Consulting Group summed up the situation as follows.

“If someone told me a few years ago that in 2003 Enron would be gone, many companies would be bankrupt, there’d be no liquidity in the market, and we’d be discussing Arnold Schwarzzeneger’s energy plan, I’d have had a very puzzled look on my face.”

The seminar began with a spirited talk by keynote speaker, Vernon Smith, the 2002 Nobel Laureate in Economics. Professor Smith’s speech kicked off three organized discourses, each about a major topic in energy policy, and each led by a panel of specialists. Summaries of their comments follow.

Photo by Tom Stillman Keynote speaker Vernon Smith Keynote speaker: Vernon Smith, professor of economics at George Mason University, 2002 Nobel Laureate in Economics Vernon Smith is one of the nation’s most vocal proponents of deregulation of the electric markets. Professor Smith, a casual yet dignified man with a long, graying ponytail, a bolo tie, two hands bedecked with silver rings, and a large, silver belt buckle engraved with kokopellis, was a vibrant and emotional speaker who had both his supporters and his opponents wooed. “The no-man’s land between the substation and the in-use plug in the wall is ripe for innovation,” he said. “And tomorrow’s technology is motivated by opportunity.” Professor Smith argued that complete deregulation will apply the rules of a true open market to the electric industry. This will encourage the development of new technologies that will improve reliability and encourage fairer pricing structures that will empower consumers to reduce their consumption. Acknowledging that current deregulated systems have not behaved in this manner, Professor Smith attributed the difficulties to faulty policy and a lack of traders in the industry. “What you need is an army of people looking for niches in the market,” he said. “That’s what’s missing in the electric industry.” Professor Smith argued that most of the problems with energy policy lie at the state level, and stem from the system of regulating the electric wires as opposed to the energy itself. “Electrons know not when they cross state boundaries,” he said. Professor Smith called the existing electric policy “backward-looking,” describing it as “the dead hand of the past blocking the future.”

Panel 1: The Structure of the Electricity Markets: Past, Present, and Future, and the Resulting Implications for Market Participants

Peter Cartwright ’52

Chair: Pete Cartwright ’52, founder and CEO, Calpine Co.
David Freeman, chairman of the California Power Utility:
“Dr. Smith’s talk assumes that the goal is to develop a market approach to energy policy… Was this industry really broken? Did it need to be fixed? …People don’t want newfangled gadgets, and they don’t want to go into the electric business for themselves. They just want smooth power at a steady rate.”

Jimmy Glotfelty, senior policy adviser of the Department of Energy secretary: Mr. Glotfelty suggested five ways to resolve problems: 1) independent transmission operation, 2) common regulations, 3) new technologies, 4) response to changing demand, and 5) regional infrastructure.

Nettie Hoge, executive director, The Utility Reform Network (TURN), a California public advocacy group: “There’s an argument out there that says California just got deregulation wrong, and if we’d done it right it would work. I wish that were true, but it’s not.”

James Sweeney, professor of management science and engineering, Stanford University: “Retail and wholesale regulations have to be compatible… The government mucking with the system is the problem…California businesses now face energy rates twice as high as businesses in other Western states.”

Robert Willig, professor, Woodrow Wilson School, Princeton University: Professor Willig suggested that a new plan that handles retail and wholesale regulation separately and differently could save billions of dollars on both residential and commercial energy.

Photos by Tom Stillman Nettie Hoge and Vernon Smith continue their discussion at the symposium.

Panel 2: Energy Trading and Risk Management

Chair: Richard Peters, Boston Consulting Group
Paul Addis, CEO, Louis Dreyfus Energy:“One of the essential parts of a market is failure…The supply side of the marketplace was largely freed from regulation, while the demand side remained largely regulated, with few incentives to ration demand. We created flawed structures virtually everywhere…Look at the 19th-century railroad industry. You’ll see this whole story has played out before. All free markets come with some agony, but we’ve found in the long run they work.”

Dan Gates, managing director, Moody’s: “Trading hasn’t died, but it’s reduced by about half… Moody’s is of the view that we’re going to continue struggling between the forces that want to go backwards and those who want to go forward.”

Vince Kaminski, senior vice president, Reliant: “Many countries have made great contributions to mankind by subjecting their citizens to all sorts of experiments. It’s good to have conferences like this to step back and discuss what happened…Participation of the end-users and producers depends upon their trust in the market. I hope energy trading will come back.”


Panel 3: Capital Intensive Investments in the Electric Market:

Chair: Joseph Fichera, CEO, Saber Partners LLC
René Carmona, professor of operations research and financial engineering, Princeton University:
Professor Carmona explained that universities can provide valuable services to professionals in finance and energy. Universities have time to study, run simulations, formulate models, and gather experts in related fields.

Robert Hoglund, managing director, Citigroup: “When Enron collapsed, everyone in the sector began looking around and thinking again about all the things they’d taken as givens…We need a vibrant wholesale market to bring things back.”

Rodney Miller, managing director, Credit Suisse First Boston: “[Deregulated energy markets] may not always make energy cheaper, but probably more efficient.”

Richard P. O’Neill, chief economic adviser, Federal Energy Regulatory Commission.: “We should be looking for efficiency, not competition.”