One evening last October, John Davies, a 37-year-old vice-president of Lethbridge Ironworks Co. Ltd., put on a shirt and tie and, along with 400 card-carrying Conservatives, attended Alberta Premier Ralph Klein's annual dinner in Lethbridge, Alta. The clean-shaven engineer dutifully paid $175 for some rubber chicken and the opportunity to ask Klein a question about the province's pioneering foray into electricity deregulation.
Normally these friendly affairs require the Premier to respond only to setups such as "Tell us how the government got out of the business of doing business"--one of Klein's proudest accomplishments. But Davies, a lanky fellow with a Lincolnesque wit, had a big government-made problem on his hands. At the post-prandial Q&A, he outlined it bluntly. Under the province's scheme to deregulate electricity, his company faced a 250% jump in power costs. He explained that such a dramatic increase could destroy the competitiveness of his 102-year-old firm, one of North America's leading iron foundries. "What am I supposed to do?" asked Davies.
The Premier, never at loss for an answer, replied that electricity prices were going up everywhere in North America.
Davies, an MBA who still does his homework, quickly retorted that that wasn't true. Electricity costs for his competitors in Manitoba and British Columbia hadn't moved one cent.
Looking flustered, Klein replied that the price hikes had nothing to do with deregulation because it wouldn't come into effect until January, 2001. At that point Davies was unceremoniously cut off.
The exchange alarmed Davies as much as it did the Premier. While the businessman learned just how little Klein knew about his own policy, the Premier got a signal that not all was well with the province's ambitious free-market experiment. His office even phoned Davies the next week to see if deregulation was some kind of "Lethbridge problem."
Far from being a local irritation, deregulation has short-circuited into a province-wide crisis since that dinner in Lethbridge. To ward off a deregulation disaster on the scale of California's--what Governor Gray Davis in January called "an energy nightmare"--the normally thrifty Klein has spent more than $2.3 billion to shore up the plan. Most of the rebates and price caps, interventions antithetical to the spirit of deregulation, are designed to temporarily shield homeowners and businesses from outrageous power bills, at least during the runup to a spring election. The Premier has blamed the tight power supply and high prices on everything from the Kyoto Accord on greenhouse gases to rising natural gas prices--on everything, in short, but the government's deregulation plans.
What makes the effect on business in particular so startling is that Klein has enjoyed icon status in conservative circles precisely because he is unassailably pro-business. That Klein's stature is now jeopardized, and that the economy he has worked so hard to nurture is so thoroughly rattled, can't help but concern Tory kin in Ontario, who also have embarked on a byzantine process of electricity deregulation.
Klein can't say he wasn't warned. Alberta's principal consumer and industrial groups loudly predicted two years ago that the deregulation program was badly flawed. "I could have picked three monkeys from the Calgary Zoo and they could have done a better job with deregulation than this government," says Dan Macnamara, the executive director of the Industrial Power Consumers and
Co-generators Association of Alberta
(IPCCAA), whose member companies consume 50% of the province's power.
Prior to deregulation, Alberta boasted one of the cheapest and most reliable electricity regimes in North America, ranking 25th out of 173 jurisdictions in price competitiveness, according to Canadian Manufacturers and Exporters (CME). The province is now so electrically hard up that it has resorted to buying high-priced power from B.C., Saskatchewan and, of all places, the city of Medicine Hat, whose independent-minded utility avoided deregulation. Only California and Hawaii now have higher industrial electricity rates than Alberta. The disadvantage could spell job losses as high as 30,000 in manufacturing alone in the next year, predicts Jayson Myers, chief economist at the CME.
"Deregulation is going to hell in a handcart," adds Brian McCready, vice-president of the Alberta division of the CME. "I'm being deluged by companies that say they are shutting down, putting their staff on night shift [when power is cheaper]or shifting production outside of Alberta. And all of it is terribly unnecessary."
Every corner of the economy has been affected. While hospitals are raising some unexpected cash by sending power from their emergency generators onto the grid, many grocery stores operate with half their lights on to save money. Energy costs were the main reason a major food-processing company put a $50-million expansion on hold. By early 2001, industries as varied as pulp and plastic were saying deregulation might force them to move, lay off workers or go bankrupt. When Chris Spearman, the Lethbridge accountant for the Black Velvet Distillery Co., announced to his Kentucky head office that his electricity costs were climbing from the usual $300,000 to $900,000 this year, its international VP asked him, "What the hell is going on up there?"
That's exactly the question that came to mind last year when John Davies calculated deregulation's impact on his third-
generation family business, which he runs with his brother. It forced him to choose between two nasty options: either put his 100 employees on a graveyard shift to take advantage of cheaper electricity prices, or move to Manitoba.
And that made Davies more than a bit peeved. He didn't think a firm older than the province, a firm that rewarded its workforce with generous annual bonuses, should quietly become a casualty of bad government planning.
Before Davies plunged into the deregulation debate, he'd watched the process evolve for five years as a detached observer. He liked what he saw at first. "I assumed that the government was doing the right thing." Deregulation promised more choice, lower prices and more efficient generation. Government web sites assured Davies that the whole process would be fair and "preserve and enhance the Alberta advantage of competitive electricity prices."
With little public debate, Klein's Tories introduced legislation in 1995. The Electrical Utilities Act got the ball rolling by setting up the Power Pool of Alberta, an exchange to buy and sell electricity. Ever since its creation in 1996, the Power Pool has recorded rising prices.
The impetus for deregulation was a combination of free-market ideology and gung-ho politics. The Tories had just privatized motor-vehicle registries and liquor stores, and assumed that deregulating electricity would be a piece of cake. Even California was doing it. And Alberta's big power consumers wanted it.
Cabinet ministers were impressed with the success of telephone deregulation across the continent, notes Allan Warrack, a University of Alberta business professor who was Utilities Minister under Peter Lougheed. Although new technologies drove that revolution, the Klein government thought a phone utility couldn't be much different than a coal-fired one. (Some 70% of Alberta's power comes from coal.) "The government saw an analogy between telecommunications and electricity that wasn't there," says Warrack. "No comparable technological breakthrough has yet occurred in electricity."
Rick Orman, Energy Minister in 1992 under Don Getty, says that his government, buoyed by the success of natural gas deregulation in the 1980s, wanted to unbundle electricity primarily to encourage new players to enter the market, both in conventional generation and in alternatives such as wind and biomass. Deregulation was the most complex and difficult issue he ever faced as a politician, he adds. "I can see why it became a back-burner issue."
The new legislation notwithstanding, deregulation sat on several back burners until 1996. That's when Klein assigned cabinet heavy Steve West the job.
Thanks to the zeal with which he cut staff and government services earlier in his cabinet career, Klein's former drinking buddy had earned the moniker Dr. Death. He had some experience with freeing up public assets. As the architect of the liquor- store privatization, Dr. West, a veterinarian by trade, promised "as pure a free-market system as you'll ever see." After firing 1,500 employees, he delivered something less: Liquor prices rose 5 to 15%.
Under West's steely direction, deregulation did some more simmering. The Electrical Utilities Act underwent several complex changes that never clarified just how power would be deregulated. Unlike in some provinces, there was no province-wide publicly owned entity to reckon with: Rather, the job was to break up a number of utilities, especially the three dominant ones. In the north, the heavyweights were city-owned Edmonton Power (now Epcor Utilities Inc.) and Alberta Power (now Atco Electric), a branch of Ron Southern's Atco Empire. In the south, energy conglomerate TransAlta Corp. was the main player.
West ran a one-man outfit that sought, but never achieved, consensus among electricity buyers and sellers. As time flew by, the utilities and potential new players in generation balked at the plan's lack of details and decided not to invest in new generation, even though electricity demand was growing by 3% a year. By 1998, the province was threatened with brownouts. As Joseph Doucet, a University of Alberta business professor, later put it: "When the government appears to be developing policy on the fly, investors hang onto their dollars."
Most problematic of all was the issue of divestiture. To introduce competition in electricity, the U.K., Australia and Argentina simply broke up their old state-owned utilities. But the Tories didn't have the stomach for such serious economics. The idea of forcing companies to sell off their assets is anathema to Canadian governments generally, never mind Conservative ones. Instead, West consulted London Economics Inc., deregulation specialists based in Cambridge, Mass., and came up with an idea never tried before: what the government called "virtual divestiture." It was presented as a "made-in-Alberta plan."
In practice, that meant creating competition at the retail level with complicated Power Purchase Arrangements (PPA), or what one oil executive quickly dubbed "Piss Poor Arrangements." West proposed that companies that wanted to get into the power-retailing (as opposed to generating) business bid at the Power Pool. Successful bidders would be issued pieces of paper that guaranteed certain amounts of power to sell to consumers. Generators would still own the car, but retailers would tell them where and when to drive it.
From the beginning, Dan Macnamara had reservations about this elaborate scheme. As executive director of the IPCCAA, he had a mandate to speak out on behalf of big industrial consumers. They didn't like what they were seeing. Macnamara felt the PPA idea favoured the existing utilities and wouldn't create real competition. In a letter to West in 1999, he warned that "the government is very unlikely to meet the stated objectives of the legislation...
we don't seem to be totally united on what constitutes a cliff, or, what we do, if in fact, we are at its precipice." According to Macnamara, West simply told him, "We're going forward."
When industrialists privately tried to warn Klein, they made little impression. "He said, 'I don't know what you are talking about. It's too complicated for me. Talk to Steve West,'" recalls one executive. Stung by the government's intransigence, Macnamara started making his case to the media. Shortly afterward, a government functionary phoned up Macnamara and testily told him, "We are unhappy with your comments in the media." Macnamara's reply was short: "Last time I looked, I was living in a democracy."
John Davies first suspected last July that deregulation might be heading for a resounding crash. A big electrical consumer, Lethbridge Ironworks had been spending $600,000, 5% of its revenue, on power annually, at rates averaging just over five cents a kilowatt-hour. In July, spot prices shot up in Lethbridge by 125%. Power that had averaged $20 a megawatt-hour five years earlier soared to $120 a megawatt, or 12 cents a kilowatt-hour.
But there was more bad news to come. In August, the government belatedly put the PPAs up for auction. Theoretically, the sale was a chance for taxpayers to recoup their investment in the regulated system by selling off key assets--or, specifically, 20-year blocks of generating capacity--to the new cohort of retailers. Yet the government set no goal for how much it hoped to fetch for the public treasury. Both consumer and industrial groups calculated that the auction needed to raise at least $3 billion, as well as introduce seven to 10 new competitors in the marketplace.
That never happened. Although 40 companies expressed interest in the process, only seven became bidders and only five came out buyers. The province's two big city-owned utilities, Epcor and Enmax (Calgary's new entrant), walked away with most of the power. Major players such as U.S. energy giant Duke Power Co. left the field to the incumbents. So the composition of the marketplace hardly changed at all. What's more, the auction only sold off two-thirds of the power supply, and that at rock-bottom prices: $1.1 billion. Macnamara couldn't believe it. "Had I known that Steve West was going to sell my Porsche for $10,000, I would have bought it back myself."
Every major industrial and consumer group in the province declared the PPA a failure. West, who had just become Treasurer, said nothing. The hot seat at the Ministry of Resource Development now belonged to Mike Cardinal, an undistinguished minister returning from a period of cabinet exile. (Neither Cardinal nor West would agree to be interviewed for this article.) Cardinal dubbed the PPA "an unqualified success." He added that the government would "never do anything to hurt Albertans." Some very happy power companies also smiled at the massive transfer of wealth from consumers to electrical producers.
In September, Davies requested quotes for 2001 from 10 new registered retailers. Only three replied, and their rates were as high as 19 cents a kilowatt-hour (a $2-million yearly bill), or more than three times what Davies's competitors were paying in Manitoba or British Columbia. In a meeting with Cardinal, Davies pointedly asked the minister how his company could remain competitive with a 250% rise in electricity prices. "Alberta may not be the place for all businesses," was the minister's response, Davies says. When Cardinal later admitted in a press release "that there is no road map for this process," Davies lost his cool. With the livelihood of his 100 employees at stake, deregulation had become "personal" for him.
Together with Spearman, the accountant at Black Velvet, and other members of the Industrial Association of Southern Alberta, Davies started to issue press releases on what they thought deregulation really meant for Alberta. Their "issues papers" accused the government of "sacrificing the Alberta Advantage," and even fingered Steve West as the man "principally responsible for the crisis." The group also set up a web site, which remains the best source of information on the deregulation scheme to this day.
Davies wasn't the only one finding problems. On Oct. 17, the Market Surveillance Administrator, appointed by the government to watch over electricity, released a highly critical report. Howard Ward found that deregulation created both an opportunity for market manipulation and a severe supply crisis. "Uncertainty associated with the original Electric Utilities Act" caused "reluctance to invest in new supply," he concluded. Ward also couldn't figure out why the government wasn't encouraging electricity conservation in a province experiencing historic supply shortages: "Significant demand-side response is essentially non-existent." At the time of the report, power companies hit industry with 50-70% price increases.
After his frustrating exchanges with Klein and Cardinal, Davies poured 30 hours into composing an eight-page summation addressed to the Premier, arguing that "Even if deregulation leads to a 20% reduction in costs over the long term, it will take businesses up to 15 years just to recuperate from next year's extreme prices."
Klein passed the Oct. 15 letter on to Cardinal, who, about a month later, advised Davies to buy a 10-year electricity contract and sit tight. Davies replied that if every business followed Cardinal's advice and bought prohibitively priced long-term contracts, then no competition would ever develop in the province. "Cardinal is talking out of his hat."
After five years of deliberation and just 58 days before deregulation's Jan. 1, 2001, startup, Cardinal tacitly admitted there was a problem by releasing a 10-point action plan to enhance electricity supply. It recommended buying more power from B.C. and better monitoring of the power market to avoid price manipulation. It also called for power conservation. Davies applauded the plan but noted that it came with no deadlines. Throughout November more and more groups challenged deregulation's tortured progress. Rural municipal politicians, the backbone of Tory support, overwhelmingly endorsed a resolution at their annual convention calling for a stop to deregulation. Klein baldly replied that power companies generally supported free markets. "The simple premise is that the more power and the more competition we have, the lower prices are going to be." To this day Davies believes that "was the genuine extent of Klein's knowledge on deregulation."
Much as he may have believed that premise, reality kept confounding Klein. Most analysts continued to predict that prices would remain high for a further four years, thanks to power deficits and a paucity of new generation projects. In meetings with local MLAs, Davies and Spearman predicted that when homeowners saw their free-market electricity bills in 2001, "you guys will be dead in a spring election." As Davies watched one MLA's face turn white, he finally realized the government had no idea "what a monster it had created."
By now Davies was in Alberta's normally Klein-friendly media every day. He and Spearman challenged Klein and West to a publicly televised debate, but received no reply. Davies calculated that B.C. Hydro made about $85 million in one three-month period from selling power to Alberta, and asked if this was smart policy for the province. He also fielded about 10 calls a day from businesses that couldn't understand why the government hadn't told them anything about deregulation.
With all this attention, Davies's original self-interested anger had turned into a public-service project: He was now a spokesman for industry. In fact he's done such a good job of countering government rhetoric that the Klein camp has accused him of being financed by the Liberals. Davies says he can't even remember what party he last voted for. "The government doesn't understand that I'm motivated by something more basic--the will to help my business survive."
At the end of November, Klein broadcast the government's own confusion by issuing the first of three weekly announcements on the scheme. He first promised to suspend all rate rider surcharges (a $500-million bill for homeowners) until 2002, after the next election. The next week, he offered homeowners a monthly $20 rebate. The week after that brought a rebate to industry that amounted to 1.8 cents a kilowatt-hour--what Davies called "a drop in the bucket." To fund this giveaway, Klein drew from the proceeds of the PPA--money that belonged to Albertans anyway. "Now we won't even get it in hand before it goes back to utility companies," noted Davies. When Liberal MLAs in the legislature described deregulation as bungled, Klein tartly asked them to return their rebates and accused them of being anti-free enterprise.
At the beginning of December, the government held another auction to sell off the remaining third of the province's power. Companies such as Sears Canada Inc., Hudson's Bay Co. and the Calgary Airport Authority bought high-priced ($116 a megawatt-hour) electricity directly rather than face the prospect of being gouged by retailers. Small companies couldn't afford to bid; many big ones stayed away because of skyrocketing prices.
After the second auction, businesses had just a few days to sign up with retailers and wade through 50-page contracts, or face a so-called default rate. Davies again received quotes that would have put him out of business. And no default rate was forthcoming.
In December Klein tried to dampen the growing outcry by introducing an eight-cent per kilowatt-hour price cap for homeowners. This unexpected intervention in the marketplace shocked the utilities. Don Lowry, CEO of Epcor, quickly denounced the move, saying it would cost power companies nearly a billion dollars, given production costs. "We can't run with these kinds of rules," said Lowry. "It's kind of Ralph's own national energy program."
That comment, of course, went off like a bomb. The NEP, a nasty federal intervention, cost Alberta thousands of jobs and billions of dollars in revenue. After a phone call from Peter Elzinga, the Premier's chief of staff, Lowry apologized for the comparison the very next day.
But the stinging remark won power companies a series of private meetings with Klein, West and Cardinal. The price cap was changed to 11 cents. Klein also doubled the $20 rebate for homeowners and the 1.8 cent per kilowatt-hour subsidy for industry. At this point Macnamara disgustedly declared deregulation "a street fight with no rules. It's like going to Vegas to the craps table. There is nothing left of a normal business environment."
Nevertheless, Cardinal proudly described 11 cents per kilowatt-hour as a "fair" rate for consumers. That prompted Davies to do some calculations. Because 70% of Alberta's power is generated by coal-fired plants (and coal has not gone up in price), he estimated that five cents a kilowatt-hour, or $50 a megawatt-hour, would be a realistic price in a regulated environment. "So how do we justify electricity at $117 when the price should be no more than $50 based on costs?" The answer, of course, was simple. Prices were now market-based, and tight supply kept them flying upwards.
Throughout December, hundreds of businesses wrote angry letters to the Premier while anxiously waiting for a default rate. In a holiday interview with The Edmonton Journal, Klein said he was worried about all the anger but noted that "you can't put off an election just because there are difficult challenges." In other interviews he dismissed as "allegations" charges that deregulation had sent prices soaring; any uncertainty in the market would be short-term, he said. He then blamed unforeseeable factors such as rapid economic growth, natural gas prices and scheduled plant shutdowns for the power crunch. He also defined good government as an agency on "autopilot."
While Klein talked about autopilots, the chaos of California's free-market adventure in electricity worsened, with bankrupt utilities and blackouts. Although Californians used only 3% more electricity in 2000 than they did in 1999, deregulation added $10 billion (U.S.) more to their bills. After pronouncing deregulation "a colossal and dangerous failure," Governor Davis declared a state of emergency. Most analysts now agree that the state faces severe price volatility and supply uncertainty for years to come. In other words, deregulation could well plunge California into a recession. "We allowed ourselves to run out of electric generation capacity and we tolerated lazy regulation," notes Michael Shames, executive director of the Utility Consumer Action Network in San Diego. He argues that the culprit is not deregulation per se but a sort of "blind faith in the marketplace."
Davies says that to avoid a California-sized catastrophe, the government must postpone deregulation until there is a supply surplus of at least 20%. He notes that jurisdictions such as Norway successfully deregulated because they had hefty power surpluses. The view is echoed by former energy minister Rick Orman, who points out that deregulation was first mooted when power was cheap and abundant. "Deregulation should have happened when supply and price were not an issue." But Davies also wonders if electricity is a true commodity. It can't be stored and can only be transported with difficulty. There are also few substitutes. "Have you ever tried running your can opener on steam?"
In January, Davies again met with Cardinal and gave him an earful. Just about every industrial association leader headed to meetings in Calgary and Edmonton to deliver grievances and recommendations. The plastics industry said they would be slaughtered by high prices. Grocery stores warned that deregulation would cost them $268 million. Manufacturers of pressure vessels--key to the oil and gas industry--complained about the unfairness of long-term power contracts. Without even digesting the torrent of dissatisfaction, the government replied with another market intervention: a complicated $336-million credit scheme for small business.
To date Alberta has achieved none of its original goals for deregulation. It has taken a well-functioning oligopoly and turned it into a dysfunctional oligopoly. It has transformed what was once a power surplus into a power shortage and made Alberta dependent on juice from regulated provinces. It has given industry some of the highest power rates in North America and transferred an estimated $5 billion from consumers to power companies. Last but not least, it has betrayed the aim of preserving and enhancing the Alberta Advantage.
Andrew Roman, a Toronto lawyer specializing in electricity deregulation, shakes his head at the Alberta mess. Rate riders, price caps and other such interventions shouldn't be part of deregulation's vocabulary, he argues. "To call what is happening in Alberta deregulation is wrong. It's government restructuring of a regulated industry, and you can do it well or do it badly." California, he adds, has done it really badly.
Roman has other problems with Alberta's model. He still doesn't understand what a PPA means. "Nobody knows what these paper things are." Nor has the province created a climate for new generation. (Analysts estimate the province is four plants short of meeting current demand, while only three are scheduled to come on-stream in the next three years.) "One cure would be a recession but nobody wants that." All in all, Roman predicts things will get worse before they get better.
Unlike California, Alberta has a $7-billion budget surplus to fall back on. On Feb. 1, Klein declared that he would grant Albertans a "shield" of subsidies against rising electricity and natural gas prices. "No one will be hurt," he promised. If enacted, Klein's new deal could--in Spearman and Davies's analysis--effectively transfer $4 to 5 billion of public wealth to the power companies not just once, but every year for four years. But throwing money around won't fix the market, warns Allan Warrack, Lougheed's Minister of Utilities. Like Davies and many other Albertans, he still believes that deregulation, if done right (and the devil is in the details), can work. The bottom line is to do no harm, he adds. "I'm not convinced deregulation is impractical, but it's clear to me that it's impractical for these guys."