Energy Remains a Litmus Test on Davis as Manager

It was after midnight on Jan. 10, 2001, when Gray Davis emerged from the U.S. Treasury building in Washington to face a group of shivering reporters.

The California governor revealed few details of the closed-door, seven-hour session with federal officials and energy company executives on his state’s power woes. But he sounded an upbeat note: “We can see light at the end of the tunnel,” he said.

In fact, many lights would soon go out, and Davis would be forced to take actions he had avoided for months.

Seven days later, as parts of California grappled with the first in a series of rolling blackouts, Davis unleashed the full powers of his office to stave off calamity. Declaring a state of emergency, he authorized the Department of Water Resources to buy vast quantities of electricity and vowed other actions to combat the crisis.

Yet today, as Davis fights for political survival in Tuesday’s recall election, many believe his response was tardy and weak. And with rivals on the campaign trail attacking his performance, the governor’s actions as the crisis unfolded have come under new scrutiny.

Between January and May 2001, Californians endured seven rolling blackouts, an ordeal that cost the economy billions of dollars, drove two major utilities to the brink of financial ruin and projected the image of a state unable to manage a basic public service.

An Aug. 23 Los Angeles Times Poll found that 34% of Californians who favored the recall pointed to the governor’s management as the reason, with 19% specifically citing the energy crisis.

“Do we want a guy who’s a poor leader when we need really good leadership?” asked Peter Navarro, a UC Irvine economics professor. “The energy crisis was his litmus test, and he failed miserably.”

Davis himself conceded at a campaign forum in early September that he did not move soon enough to avert the power meltdown, noting: “I think I was too slow to act in the energy crisis.”

But after an initial stumble, Davis said, he worked effectively to turn the lights back on. Others agree, saying he championed conservation, signed long-term electricity deals that brought stability and tried -- albeit in vain -- to prompt federal regulators to crack down on market gaming by energy companies.

“He made the decisions he had to make to protect the state from blackouts and to protect the ratepayers from 400% rate increases,” said Susan P. Kennedy, a Davis advisor now on the California Public Utilities Commission. “When I look in hindsight, I don’t know what he could have done differently.”

Some Missteps

Nonetheless, an examination of Davis’ approach to the debacle and interviews with policy experts suggest that a governor renowned for his hands-on control made several missteps:

* Davis pinned excessive -- and futile -- hopes on a federal rescue as conditions worsened in the crucial months of late 2000.

* Even as wholesale prices soared, Davis clung to unrealistically low goals for how much he was willing to spend on energy. Indeed, a last-ditch effort by the Clinton administration to broker a solution ended angrily, with participants, including Treasury Secretary Lawrence Summers, seething at Davis’ refusal to budge.

* Davis failed to seek long-term contracts to guarantee energy supplies soon enough. When he finally endorsed the idea, the state was forced to accept agreements that cost billions of dollars more than they would have the previous summer.

* Davis brushed back requests by the utilities to raise rates. As their costs mounted, Edison International’s Southern California Edison unit moved to the edge of bankruptcy and PG&E; Corp.’s Pacific Gas & Electric filed for Chapter 11 protection.

The utilities’ cash crunch “was reality,” said William W. Hogan, an energy economist at Harvard University. “When you don’t face reality, you make the problem worse.”

Day-to-day decisions on energy regulation would not normally involve a governor. But as temperatures rose in spring 2000, the situation confronting California became far from ordinary.

Surging wholesale prices in May and June prompted Sempra Energy’s San Diego Gas & Electric to pass on huge rate increases, sparking a consumer revolt. On June 14, a Bay Area power failure raised early questions about the behavior of energy suppliers in the newly deregulated marketplace.

On Aug. 2, the heads of two state entities, the Electricity Oversight Board and the Public Utilities Commission, warned Davis of trouble to come. But the governor took no significant action at the time.

Focus on FERC

Rather, the Davis team focused much of its hopes on the Federal Energy Regulatory Commission, the panel that oversees wholesale energy markets. At the state’s request, the commission took up the issue and ruled Nov. 1, 2000, that prices were not reasonable. But they proposed only modest rule changes that lacked the teeth to end the problem.

Eight days later, Davis sent a scolding videotape to a FERC meeting.

“You agree with us that California has a problem.... You agree rates are not reasonable and just. But you are not willing to do anything about it,” he said.

He did not persuade them.

“Everybody was saying he is just trying to shift the blame to FERC, but for God’s sake, it was FERC’s responsibility,” said Barry Goode, Davis’ lawyer. “They just didn’t do it.”

Davis arguably had more sway over the state PUC. Technically independent, the PUC was headed by Loretta M. Lynch, a Davis appointee. The panel resisted pleadings by the utilities to allow retail rate increases and discouraged their efforts to enter long-term energy contracts that would be free of commission review.

For his part, Davis elected to stay largely out of the fray. On July 31, 2000, the state received an offer from Duke Energy Corp. to provide about 4% of California’s electricity needs for five years, starting that Sept. 1, at $50 a megawatt-hour. Even though short-term prices were running at more than double that amount, Davis and his advisors evidently had concerns about locking in for the long term at the $50 level.

At times, the governor’s personal style did not help his cause. Such was the case in January 2001, during the waning days of the Clinton administration, when senior White House officials organized an eleventh-hour summit to address California’s ordeal.

By then, the state’s utilities were bleeding money, with PG&E; losing cash at the rate of $3.3 million an hour.

On Saturday, Jan. 13 -- just three days after Davis said he saw light in the tunnel -- Cabinet officers and their aides gathered in the Department of Energy’s “Situation Room.” Davis, legislative leaders and others gathered in the governor’s Los Angeles office. The two sides were linked by video phones.

Participants say Davis frustrated the Washington mediators by refusing to pay more than $50 a megawatt-hour -- the price that had seemed so high in the summer but now looked great.

At one point, Davis excused himself, saying he would be back in a few minutes. He was gone more than an hour, two observers recalled. Baffled by the governor’s disappearance, Treasury Secretary Summers and White House economic advisor Gene Sperling ate pizza as they impatiently waited for his return. (Summers, Sperling and Davis declined to be interviewed for this story.)

In the course of the tense get-together, Summers upbraided Davis that the numbers he was demanding could not possibly lead to any deal.

“It got angrier as every hour went by that night -- and that’s the last thing the Clinton administration did in that effort,” one person who was there recalled.

To Davis’ detractors, a basic failing was that he was disengaged from the details of the problem and overly cautious to act.

Michael Kahn, who advised Davis throughout the crisis, maintains that there was a disconnect between the public image of the governor and the private reality.

“His leadership style tended to be very, very strong and very, very firm in private,” said Kahn, who served as chairman of the Electricity Oversight Board. “But publicly he was very cautious. He wasn’t positive how things were going to play out.”

On Jan. 17, four days after the stormy conference call with the Clinton administration, Davis finally confronted the crisis head-on.

State of Emergency

Declaring a state of emergency, he approved power purchases in the short-term market, slashed red tape to rush new power plants online and endorsed long-term electricity purchases that would prove to be quite expensive.

“The governor could have acted quicker and more decisively, particularly in the beginning,” said Jerry Bloom, a partner in the Los Angeles law firm of White & Case who specializes in energy issues. “But once he understood the severity of the problem, he did show leadership.”

At this point, power for $50 a megawatt-hour -- a “nickel” in industry parlance -- was a long-gone dream. Davis instructed his power emissary, S. David Freeman, to aim for deals at less than $60 a megawatt-hour. Freeman, former general manager of the Los Angeles Department of Water and Power, said he had to exceed that limit by about $10 a megawatt-hour. In all, the state signed agreements totaling $43 billion.

“We did get taken to the cleaners to a certain extent,” Freeman said recently. “But it was still the right thing to do. We paid more than we should have paid, but it provided the route to recovery.”

For all the controversy, the deals “essentially solved the California crisis, albeit at a substantial cost to consumers,” Frank A. Wolak, a Stanford University economics professor and chairman of a market surveillance committee for the California grid operator, wrote in Electricity Journal.

At the same time that Freeman was signing the wholesale power contracts, Davis and the Legislature were struggling with the plight of the utilities and their demands for retail rate increases.

For months, Davis steered clear of the politically unpopular move, famously declaring at one point: “Believe me, if I wanted to raise rates I could have solved this problem in 20 minutes.”

In early April 2001, however, as the utilities’ combined debts reached $13 billion, he endorsed a rate hike. PG&E; filed for bankruptcy protection the next day.

Dan Richard, PG&E;’s senior vice president for public affairs, said the decision to file for Chapter 11 was not intended as a slap at the governor; it was mere happenstance. The call to enter federal Bankruptcy Court had been made a few days before Davis’ speech.

Either way, PG&E;’s decision weakened Davis’ hand with Edison. Desperate to avoid a second utility bankruptcy filing, Davis’ negotiators and Edison swiftly agreed on bailout terms, including the state’s purchase of Edison’s transmission lines for $2.76 billion.

But Davis could not get the deal through the Legislature. Edison later arranged a rescue plan with the PUC that did not include selling the power lines.

The state would suffer a one-two punch of rolling blackouts May 7 and 8, and fears rose that the summer could bring dozens more.

Turning Point

And then something remarkable happened: Prices began to fall. The energy crisis was easing. Experts point to various reasons, including falling prices of natural gas, which is used to produce electricity.

Also given credit was Davis’ effort to promote conservation, including an initiative to provide 20% credits to consumers who reduced usage by 20%. By June 2001, peak usage fell as much as 14%, according to the California Energy Commission.

“I was surprised at how big the conservation savings were during the summer of 2001,” said Severin Borenstein, director of the UC Energy Institute, maintaining that the savings were instrumental in easing the crisis.

There was also some effect from Davis’ effort to shepherd power plants through the bureaucracy -- though just how much is debatable. Aides note that 9,000 megawatts were added during Davis’ tenure -- enough to serve nearly 7 million typical homes. But industry experts say that perhaps as few as 1,500 megawatts are clearly traceable to the governor’s emergency push.

“A number of the projects were already in the pipeline,” said Jan Smutny-Jones, executive director of the California Independent Energy Producers Assn. Still, he credits Davis with “some extraordinary efforts to get power plants sited.”

Even the long-aloof federal regulators got into the act. In mid-June, several weeks after electricity prices had begun to fall, freshly installed FERC commissioners approved a wholesale rate cap for California. They also signaled a new willingness to police the wholesale market, a factor that may have influenced generator conduct for the better.

The state has not suffered a rolling blackout since May 8, 2001, despite a flurry of hot, high-demand days this summer.

“No one noticed a thing this year, which is the way the system is supposed to function,” said Richard Katz, an advisor to Davis.

On Aug. 15, just a day after the Northeast suffered the most widespread power shortage in U.S. history, Davis got on the phone with reporters in Sacramento to tout the success of his energy policy: “California never experienced anything like the East Coast saw yesterday.”

What Davis did not say was that the East Coast never saw anything like the California energy crisis of 2000 and 2001.