Deregulation Will Survive Enron
Enron got one thing right. New technology is dramatically changing the energy business, especially electricity. Unfortunately for its investors, the new technology isn't the one Enron championed.
In fact, Enron didn't champion energy technology at all. To be sure, it was once an energy company that pumped real gas to real customers. But Enron's genius, while it lasted, was to get out of the still-regulated market for energy and into the largely deregulated market for contracts.
The company moved into commodities trading—gas in 1989, electrons in 1994, and bandwidth in 1999. The profits on the trades—of cubic feet of gas it didn't extract or burn, of kilowatt-hours it didn't generate, and of fiber-optic lines it didn't light—sent Enron's revenues soaring. The company extended its trading operations into pulp and paper, plastics and metals, too. Dynegy was interested in buying Enron mainly for what it saw as the company's "crown jewel"—EnronOnline.
When Trust Collapses
EnronOnline's trading floor was a sophisticated dot-com, basically, engaged in commodity barter and arbitrage. It was a trading house, a mercantile exchange, a broker, and a part-time bank. But as such institutions sometimes do, it ended up writing new paper faster than it inspired new trust. When trust collapses, paper houses collapse. If there's anything new to this story, it's that the collapse can happen especially fast now that electronic media make it so easy for traders to move their online trust elsewhere. It happens to all sorts of people. Mypets.com. Priceline.com. Enron.
Enron's collapse, we're now told, following on the heels of California's power woes, portends the collapse of electricity deregulation as well. That's ridiculous. Will we now re-regulate AT&T, WorldCom, and Alcoa because Enron also traded bandwidth and aluminum? Equally ridiculous is the talk of re-regulating electric power. Some real deregulation would have to come first. We certainly haven't seen much yet.
The first ostensible "deregulation" of power markets took the form of the 1978 Public Utilities Regulatory Policies Act. It required utilities to connect their grids to non-utility sources of such "new" technologies as windmill farms, wood and trash plants, and the like—and to pay premium prices for the tiny trickles of electricity from these ridiculously uneconomic technologies. Deregulation? The whole scheme centered on new layers of regulation—of wires, contracts and prices—piled on top of the old. The basic idea was that small power sources would compete with big utility power plants, echoing the history of PC-beats-mainframe.
This first round of so-called deregulation was supposed to impel a great surge in distributed generation. But when it comes to propelling gigawatts of electrons down wires, big plants are, on average, far cheaper to run than small ones. In the end, the 1978 "deregulation" impelled $40 billion of wasted utility investment. Enron took a little piece of that action too. Its wind farms generated negligible revenues and endless headaches, all of which Enron had been trying to unload for quite some time before the collapse.
The second chapter of deregulation created a more significant opportunity, and Enron, to its credit, grabbed it. The Energy Policy Act of 1992 really did deregulate something important—the prices that utilities could charge each other for power they shipped across state lines. Just as expected, this lead to a lot more trading of power between utilities, and spawned power brokers like Enron. Enron's collapse won't change any of that—its business will be picked up immediately by the dozen-plus other major arbitrageurs of wholesale electrons.
So the right thing for regulators to do is to just forget about Enron. They should turn their attention, instead, to a new and much bigger deregulatory opportunity now at hand. One way or another, it's going to impel fundamental change, in both the structure of the power industry and in its regulation.
Digital systems require power that's far more stable and reliable than what can be delivered over the long, exposed wires of utility grids alone. So money is now pouring into back-up power technologies, from desktop "uninterruptible power supplies" that keep a single computer running, to massive arrays of batteries and diesel generators integral to AOL's main data centers in northern Virginia. These systems aren't initially deployed to replace grid power around the clock. Their primary purpose is to ride through outages that typically range from fractions of seconds to, very occasionally, hours or a day or so. But as these new electron engines and electron caches proliferate, they create new opportunities to transform standby systems into virtual power plants that can come on line as needed, whenever the economics become attractive.
More than 50 gigawatts of distributed power capacity, mainly diesel generators, now stands ready and able to serve the factories, hospitals, banks, offices and shopping malls that have deployed it. That's already a lot of capacity—by comparison, U.S. utilities collectively own some 800 gigawatts of capacity. And new standby capacity is being added at rates approaching new grid capacity.
At the same time, the technologies for interconnecting, switching and controlling the flow of power from multiple sources is improving very fast. Unheralded by Wall Street, high-power silicon devices—"powerchips"—have come of age, and can control big flows of electrons (electricity) in much the same way microprocessors—"smartchips"—control tiny flows of electrons (bits). A single silicon powerchip can switch a kilowatt in microseconds. A 300 megawatt powerchip-based switch has come on line in Marcy, N.Y., controlling power equal to two Boeing 747s in one, small innocuous building. Such devices represent the first truly fundamental change in the hardware of power since Edison and Westinghouse.
Today, barely 10% of grid electrons flow through power processors, most of them located on customer premises. But that number is growing inexorably. Build a data center for a hospital or a bank, and the new microprocessors immediately require complementary arrays of power processors, along with generation and storage capacity, to keep all the silicon reliably lit. Not windmills to wean us from foreign oil or save the planet. But, rather, gas-fired jet turbines, diesel engines, spinning flywheels and huge arrays of lead-acid batteries, to save the digital microprocessor.
New Market
The roughly $30 billion a year market for power reliability already eclipses utility spending on power plants and wires, and is largely unregulated. "Interruptible power" contracts that utilities are already permitted to sign with their largest customers—the likes of Verizon or Goodyear—already allow the utility to hand over part of its own traditional responsibilities to privately owned, on-premises generators.
What serious deregulators must do now is allow a new generation of Enrons to build much larger markets around such arrangements, and extend them right down to the level of the residential consumer. Not markets for wholesale kilowatt-hours (the old Enron's focus) but markets that look to all the finely granulated attributes of power—not just quantity but quality, too. Utilities and their customers will develop a wide range of new contracts that differentiate the price of power on the metrics of reliability and time of use, just as quickly as regulators will let them.