Jim, you might be interested in this, from Briefing.com:
18-Jan-01 12:25 ET
[BRIEFING.COM - Gregory A. Jones] The California power crisis continues
to grow in importance for the economy and thus the market. It is clear
that the problems will not be solved anytime soon. To briefly
understand the crisis, you must first forget most of what you have
heard from the media.
No doubt everyone has heard that the crisis is the result of
deregulation. You might also have heard that electricity prices in
California are capped by law. Those of you who passed EC101 might
question how a market with price caps could be called deregulated,
and you would be right to ask that question. Indeed, California's
problems are not with deregulation, but with ill-considered
re-regulation in 1996 (I know -- you are all shocked that the media
universally gets this wrong).
This re-regulation freed wholesale prices for electricity, but capped
retail prices. This was fine until rising demand for power outstripped
supply and the utility companies -- PG&E (PCG) and Edison (EIX) --
got caught paying more for power than they could charge customers. The
resulting demand/supply imbalance cannot be solved under the current
In a truly deregulated market, the increase in retail rates would
always dampen demand to the point where supply and demand were in
balance. But consumers of power have no reason to reduce consumption
when prices are fixed, and the supply of power is relatively fixed in
the short run given the time required to bring new power plants
California Governor Gray "I used to be considered a 2004 presidential
contender" Davis has declared a state of emergency so that the state
can purchase power, but this does nothing to solve the root problem --
the demand/supply imbalance. In the short run, only increases in retail
rates can accomplish that, and there does not appear to be the
political will to do that -- Davis is too busy blaming nonexistent
deregulation for the problems to realize that deregulation is in fact
the solution. The fact that he seems unwilling to allow PG&E and
Edison to slip into bankruptcy does not solve any problems, it only
means that the state will probably step in to take the losses that the
utilities had been suffering.
In short, there is no end in sight to California's power problems,
only a shift in the financial losses from the private to public sector.
The result is that the California economy will continue to suffer.
There are three principal sources of suffering.
First, there are the electricity price increases that have been
permitted. Though not enough to significantly crimp demand or stem
utilities' red ink, they have been significant and will reduce
spending on non-energy goods and services.
Second, there is the impact of the black-outs. They have not been
widespread to date, but it doesn't take many black-outs to
significantly reduce economic output (there is also time wasted
preparing for black-outs).
Third, there is the impact on business and consumer confidence.
At a time when the overall economy is already slowing, this blow to
confidence should not be underestimated. Many economists downplayed
the importance of the Gulf War in 1990/91, but saw with hindsight
that there were economic effects that went far beyond the first-order
response to higher oil prices.
While the Federal Reserve certainly can't do anything to solve
California's power problems, there is little question that they
were very aware of these problems and their potential economic impact
when they cut rates back on January 3. And California will no doubt be
a topic of discussion when the Fed meets on January 30/31. Before
anyone starts to view California blackouts as positive because they
might spur more aggressive rate-cutting, keep in mind that this
rate-cutting will be a response to a more dire economic situation,
which also implies a worse than expected earnings outlook. So net-net,
it's a negative for equities.
As with all such events, however, there are isolated winners. The
California crisis has seen two winning sectors in recent months. First,
there were the power wholesalers such as Duke Energy (DKE),
Dynegy (DYN), and Enron (ENE). But these stocks have been fading
recently, as initial excitement in response to rising prices for
wholesale electricity gave way to financial concerns as their
California customers face potential bankruptcy.
The other group is the alternative energy sector, which has tended to
behave as a monolith despite the nuances within this sector. There are
essentially three groups of stocks that stand to benefit. The first two
offer immediate solutions to California problems: microturbine and
Capstone (CPST) leads the list of microturbine companies -- these
microturbines can be purchased by companies to produce on-site power
using fuels such as natural gas, propane, and diesel (we recently
added CPST to our core portfolio). Capstone has plenty of company in
this business, including industrial giants such as Honeywell, Toyota,
Flywheel companies do not offer an electricity alternative, but they
do offer protection for mission critical operations in the event of
black-outs. Flywheels take the place of lead acid batteries in
providing power between the time of the black-out and the time at which
back-up generators kick in; usually a few minutes. Current flywheel
companies include Active Power (ACPW) and Beacon Power (BCON), though
BCON is not yet delivering a product.
Finally, we have the fuel cell space, which was addressed on these
pages last week. The good news for fuel cell companies is that they
offer the best possible solution, with a cleaner alternative energy
source. The bad news is that the products are not there yet. We are
probably still a few years away from seeing fuel cell products that can
address a problem such as the current California crisis. Companies in
this space include: Ballard (BLDP), FuelCell (FCEL), and H Power (HPOW).
There is no solution in sight to the California power crisis, as
California politicians appear unwilling to accept the only short-term
answer, which is an increase in retail electricity prices. And if the
problem worsens, it may spread beyond California to the entire Western
The crisis is already having an economic impact, and if the crisis
worsens, so too will the economic impact. This may mean a more
accommodative Fed, but it will also mean an even more dire economic
and corporate earnings picture so, in general, it is not good for
Winners in this crisis include the entire alternative energy sector,
though the microturbine and flywheel companies offer more clear
short-term solutions than the fuel cell sector.
Lights Out II
25-Jan-01 00:06 ET
[BRIEFING.COM - Gregory A. Jones] There haven't been any rolling
blackouts for the past couple days, so the market has largely ignored
the ongoing chaos in California. But the power crisis is far from over,
and anyone investing in the market or with a stake in the US economy
should be paying attention. Close attention.
As we discussed in our first brief on this subject, California's
problems are not easily solved. There is a supply/demand imbalance,
and neither side of this equation can be quickly changed. Supply takes
years to bring on line, and demand is difficult to rein in because
California's regulatory idiocy has taken away the only effective
dampener of demand -- higher prices.
The state's efforts thus far to solve the problem haven't really
amounted to solutions at all. They have primarily been engaged in
crisis management -- keeping the lights on from one day to the next.
Wednesday night saw another episode in this effort as the
state received 39 bids from electricity generators willing to enter
into,long-term contracts. Though seemingly good news, the critical
numbers were not revealed -- the amount of power that was offered
and the duration of the contracts.
Though the numbers may be sufficiently large to ease the near-term
crisis, there is good reason for skepticism given that the wholesale
energy companies were not pleased with the many restrictions placed
on the bidding. Furthermore, it is critical to note that greater
challenges lie ahead, as summer is the peak energy usage season in
California. The chances of these long-term contracts ending the crisis
altogether are not good -- this crisis will likely be more severe in
the summer.,And if that is the case, there is no guarantee that it
will be a California-specific problem. California is part of the
Western power grid, and it may yet turn off the lights from the Canada
to the Mexican border and east to the Rockies.
Harsh Economic Reality
Just as important as understanding the seriousness of the crisis is
understanding the seriousness of its economic impact. Most stories of
local economic disruptions are weather-related, where a hurricane
or blizzard cuts power for some small fraction of the population and
lasts only a day or two. California's power problems are of a far
With California's rolling blackouts, vast areas are left without power
for hours, with businesses often shutting down completely when this
happens, and sending employees home. In other words, economic output
comes to a virtual halt with these blackouts. When we talk about
recessions, we're talking about economic activity being perhaps a
fraction of a percentage point below what it was previously. When
output goes to zero, it's a problem on an altogether different scale.
It doesn't take many days of power outages to significantly affect
California's economy. And at 13% of the national economy, it doesn't
take much change in California to dent the macro economy.
Beyond the first order impact of the blackout is the very serious
issue of business and consumer confidence. A climate in
which everyone is waiting to see when the lights will go out next is
a climate that is not conducive to business investment and consumer
spending. It is certainly not a coincidence that consumer confidence
has been plummeting in the past two months as California's problems
have intensified. Even when the lights are on, it is almost certain
that California's economy is suffering from its power problems.
Finally, it must be recognized that the one true solution to the
problem -- rising retail energy prices to curb demand -- carries its
own set of economic consequences. Though this would be less
problematic than blackouts, the sharp price hike needed to rein in
demand will certainly hurt the California economy.
Greenspan Can Only Do So Much
The speed of information in the internet age has led to an investor
tendency to believe that the economy will also move more quickly, and
that cyclical slowdowns will be shorter. But there is a lot to worry
about on the economic front right now, not all of which will be solved
by a three week rebound in the Nasdaq or a couple Fed rate cuts.
Easy credit over the past few years appears to be producing an
overreaction in the other direction, with lenders now stepping back
from even sound credit risks. The equity capital markets have
similarly dried up as investors retrench after losing on hundreds
of failed IPOs over the past two years.
Add to these woes the possibility that 13% of the national economy
might well slip into a severe recession due to an energy shortage,
and there is indeed cause for concern. For all the talk of
Greenspan's omnipotence, he is utterly powerless to help California
keep the lights on. When he cuts rates next Wednesday, investors
will justifiably cheer but they should be restrained in their
enthusiasm, because no amount of rate cuts can save the economy if
the lights go off in California.
"Option traders never die, they just expire worthless."
This archive was generated by hypermail 2b29 : Fri Apr 27 2001 - 23:19:05 PDT