Wall Street Journal May 7, 2001
Page One Feature
Texas May Face a Glut of Electricity, But It Won't Help in the Rest of U.S. 
Pride and Policy Make State a Magnet For Power Plants and an Island Unto Itself
By ALEXEI BARRIONUEVO and RUSSELL GOLD 
Staff Reporters of THE WALL STREET JOURNAL

While California struggles to keep its lights on and New York City braces for possible electricity shortages this summer, Texas utilities could soon face the opposite problem: a power glut.

Texas' wide-open spaces and relatively weak zoning and environmental rules have helped make the Lone Star state a magnet for power-generation companies as it prepares to deregulate its electricity market next year. The result: Texas' electricity-production capacity this summer is expected to exceed its peak power demand by 11,000 megawatts -- nearly enough to light up New York City. By the summer of 2002, the excess may be closer to 15,000 megawatts, enough to power 15 million homes. And with 27 new generating plants under construction, more than any other state, some power producers fear that overbuilding ultimately could send Texas' wholesale electricity prices into a tailspin.

A Grid Apart

All this sounds like good news for the electricity-starved East and West Coasts -- but it isn't. That's because the U.S. is divided into three major power grids -- with the West on one, the East on another and most of Texas on a third, with very few links to the rest of the country. In the world of electricity, that makes Texas "an island with a couple of little footpaths over to it," says Larry Makovich, senior director for electric power research at Cambridge Energy Research Associates, a Cambridge, Mass., consulting firm.

Some Texas utility executives argue that their state's island status is principally an accident of geography. But no one disputes the fact that good old Texas pride -- and a deep-seated skepticism toward federal regulation -- also played a role in shaping the state's grid. So, too, did a renegade utility's desperate 1976 bid to save itself from a corporate breakup and the resulting four-year legal battle, which the industry later dubbed the "Texas Range War."

Texas' isolation isn't expected to end anytime soon. If Texas became fully interconnected, its big utilities say, the state could become more susceptible to blackouts, if other regions drew off too much power. "From a reliability standpoint, it would be a degradation to the Texas grid," says Steve Schaeffer, a senior vice president at Reliant Energy Inc., the former Houston Lighting & Power Co.

Competing Interests

Moreover, the utilities estimate that building the transmission lines needed for a full connection to the nation's other grids would take at least three years and cost Texas ratepayers about $600 million. They don't want to invest that much money to sell power to California or New York to ease what they view as temporary imbalances.

Some in the state also believe low rates and excess power could give it an advantage in persuading businesses to locate there. "America will be shy enough electricity that this will be one of our greatest inducements for growing Texas," says Matthew Simmons, president of Houston investment bank Simmons & Co.

Texas is an extreme example of the haphazard way electricity grids developed in the U.S. Until the 1960s, most power plants were built near the customers they served. Then, utilities began building larger, more-efficient coal and nuclear plants, connecting them with their neighbors to ensure that if one of these big plants went down, there would be a backup ready to keep the power flowing.

'No Big Money'

But the old-line Texas utilities, which have long benefited from the state's plentiful supplies of fuels such as natural gas and lignite coal, were reluctant to join in this wave of interconnections. Back then, in the mid-to-late 1970s, electricity outside Texas was generally more costly. And surrounding states weren't planning big enough plants to back up the huge new ones Texas was building to power its fast-growing cities and energy-thirsty petrochemical industry. "There was no big money to be made by shipping power one way or the other over the lines," says Reliant's Mr. Schaeffer.

By confining their grid to Texas, state utilities also avoided oversight by the Federal Energy Regulatory Commission. Thus, FERC couldn't force Texas to send power out of state in case of an emergency.

The state's dominant utilities -- Texas Utilities Inc., the Dallas-based predecessor of what is now TXU Corp., and Houston Lighting -- went to great lengths to ensure there were no interstate connections. The switches at a hydroelectric plant on the Texas-Oklahoma border were wired to prevent power from flowing between the states. Elsewhere along the border, a system of relays was installed to prevent unauthorized interstate transmissions.

Only one big utility didn't like the setup: Central & South West Corp., a Dallas holding company that owned power plants in both Texas and Oklahoma. In 1976, it faced a crisis. If it couldn't show that its plants in both states were interconnected, it ran the risk of being broken up under a federal law. The law, which barred holding companies from owning unconnected utilities in separate states, was decades old. But, until then, it hadn't been strictly enforced.

On May 4, 1976 -- eight days before the Securities and Exchange Commission was set to consider the matter -- Central & South West took an extraordinary step. At 5:30 a.m., it sent one of its line crews to secretly rewire a substation in Vernon, Texas, near the Oklahoma border, allowing power to flow freely between the two states. For a few hours, the grids were connected by a minuscule thread. Later that morning, officials at Central & South West phoned other Texas utilities to tell them the company was engaged in interstate commerce.

Texas' other major utilities reacted angrily. "The sons of bitches are trying to steal my lignite!" Texas Utilities Chairman Louis Austin bellowed, according to former Texas Public Utility Commissioner George Cowden, who recalls Mr. Austin making the remark during a private meeting between the two men.

Around noon, Houston Lighting cut its system off from the rest of the state's utilities. Texas Utilities followed suit hours later. By day's end, the state's utilities had broken the grid into a half-dozen pieces.

That same day, one of Texas Utilities' chief lawyers, a 6-foot-6 former college-football star named J.A. "Tiny" Gooch, dispatched one of his company's crews to disconnect the link Central & South West had made between Vernon and Altus, Okla. "They made it so it was physically impossible to [connect] it again," says Mr. Gooch's son, Gordon, then a lawyer representing Houston Lighting. The elder Mr. Gooch, who died in 1986, is considered the patron saint of Texas' electrical independence.

At an emergency meeting of the utility commission three days later, Mr. Austin of Texas Utilities expressed disgust at the prospect of having to burn Texas lignite and natural gas to satisfy "Yankees," according to a transcript. And, he added: "I don't like federal regulations." (Mr. Austin died in 1997.)

A wire reputed to have formed part of Central & South West's brief Texas-Oklahoma interconnection later was cut into pieces, encased in Lucite and given out as paperweights by Dallas law firm Worsham, Forsythe & Woolridge, which represented Texas Utilities.

Alan Erwin, a state utility commissioner in 1976 who still has the souvenir on his desk, used the wiring episode as fodder for a 1979 novel, "The Power Exchange," in which a winter storm cripples Northeast power production and the nation turns to Texas for electricity. Texas refuses to ship the electricity, fearful that other regions would drain it of "what little cheap fuel was left." Ultimately, Texas becomes a scapegoat and ends up seceding from the union.

Real-Life Compromise

In reality, the outcome was less dramatic. The grid conflict wound its way through many courtrooms. Central & South West -- recently acquired by American Electric Power Co. of Columbus, Ohio -- lost almost every round. After about four years, the utilities hashed out a compromise, at the urging of the federal government.

Rather than link the Texas grid to the East, so that electricity could flow freely across state borders through alternating-current cables, they agreed to build two direct-current lines. Operators could control the flow over these bridges, which at peak capacity could carry a mere 820 megawatts. The parties to the deal, which included the federal government, agreed these links wouldn't bring the Texas grid under federal jurisdiction. Today, Texas power continues to be regulated in Austin, not Washington.

"It's just a Texas thing," says Pat Wood III, chairman of the state utility commission and a recent Bush administration nominee to FERC. "We want control of our own destiny."

That independent attitude has extended in recent years to Texas' business-friendly approach to deregulating its power industry. Unlike California, with its stringent emissions and zoning rules, Texas has made it quick and easy for power companies to locate their plants almost anywhere they can find a place to hook up to the grid. Last year, Texas completed a major upgrade to alleviate bottlenecks on the grid, and it has six similar projects under way. Unlike most other states, it decided to charge grid users a flat rate to move power anywhere in the state, so they could put plants in low-cost rural areas, far from their customers.

Those policies, as well as projections that the state's electricity demand would grow by a robust 3.5% a year, set off a flurry of power-plant construction, beginning in 1998. Since then, $11 billion worth of power plants have been completed or started in Texas, and more are on the drawing board.

By contrast to California's approach to deregulation, which largely failed to bring new plants online, Texas' strategy "encouraged an overbuild," says Mr. Makovich, of Cambridge Energy Research Associates.

Consider tiny Seguin in south central Texas, where Constellation Energy Group Inc. of Baltimore is building an 800-megawatt gas-powered plant in a former cornfield. Fifteen miles to the west, Texas Independent Energy LP of Dallas recently finished a 1,000-megawatt plant. About the same distance to the north, American National Power, a Houston-based unit of Britain's International Power PLC, is building a 1,100-megawatt plant.

If generators don't get cold feet, Texas is on track to have a capacity surplus of 9% this summer and 11% by summer 2002, says Cambridge Energy Research Associates. That's in addition to the 15% surplus that most experts consider an adequate cushion. Some areas of the country, including parts of the Southeast, Upper Midwest, New York City and the West, are struggling with razor-thin capacity margins. After factoring in a similar 15% cushion, the West has an 8% capacity deficit and the Upper Midwest has a 4% deficit.

As a result, while electricity futures prices for summer are running at as much as $400 per megawatt hour in the Northwest and around $100 in the Northeast, Texas futures prices are averaging only $72 to $74 per megawatt hour.

Calpine Corp. of San Jose, Calif., is making the boldest wager that overcapacity and a lack of export possibilities won't sink Texas's wholesale electricity prices. The company has six plants under construction in the state, two of which are expected to come on line next month. And it plans to add an additional five plants over the next two years. Altogether, Calpine plans to spend about $2.8 billion in the state, its largest investment outside California.

"People from day one probably thought Calpine was crazy," says Darrell Hayslip, a company vice president. "But so far, we are absolutely convinced that this is the right bet." He says Calpine's newer gas-fired plants are 40% more efficient than older plants in the state, a third of which are at least 30 years old. Calpine expects that edge to force rivals to retire older plants, thus keeping electricity prices from sagging.

Duke's Doubts

Others aren't so sure. After initially planning new plants in Texas, Duke Energy Corp. began to worry that the state was getting overbuilt. Last May, Duke, of Charlotte, N.C., sold its 80% stake in a plant under construction in south Texas to Calpine. "We sized up the market early, and then realized too many followers were doing the same thing," says Jim Donnell, president and CEO of Duke Energy North America.

If the electricity situation outside Texas grows too grim and too much supply sinks prices in the state, there could be "renewed pressure" for Texas to study interconnection options, says John Stauffacher, vice president for regulatory affairs at Houston-based Dynegy Inc., which has 1,000 megawatts of capacity in Texas.

Calpine, for one, wouldn't mind sharing Texas power with the East and West. "I would love to be able to wheel power from Texas to California," says Mr. Hayslip. But, so far, the Texas utilities haven't budged in their opposition to exports.

A few generators are trying to find the best of both worlds. Tenaska Inc. of Omaha, Neb., is building plants at the border between the Texas and eastern grids. Though utilities aren't allowed to be connected to both grids at once, the plants are designed to allow the company to switch between grids as demand and prices warrant.

In rural Grimes County, about 90 miles outside Houston, Tenaska plant manager Frank Carelli boasts that his 830-megawatt plant could disconnect from one grid, connect to the other and be back at full power within an hour. A similar Tenaska plant is slated to begin operations this month in Rusk County, near the Louisiana border.

Write to Alexei Barrionuevo at alexei.barrionuevo@wsj.com and Russell Gold at russell.gold@wsj.com 
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