Introduction to the Fifth Power Plan

The Council’s first power plan, adopted in 1983, was developed in the aftermath of the region’s
effort to construct five nuclear power plants. Although only one of the power plants was
completed, the costs of these plants were the primary reasons for a 66 percent real increase in
retail rates in the region in the early 1980s. This caused demand to plummet and caused
economic hardship for many in the region. In response to this experience, the Council’s first
plan brought innovations to electricity system planning. These included recognition of the price
elasticity of demand in forecasting and methods for assessing and managing the risks associated
with capital-intensive, long lead-time generation. It also furthered electricity policy innovations
such as treating conservation, the more efficient use of electricity -- as a resource comparable to
generation.

The Fifth Power Plan has many parallels. It comes on the heels of the 2000-2001 Western
electricity crisis. This crisis manifested itself in extremely high wholesale power prices (Figure
1-1) and the threat of blackouts that persisted for almost a year.

1400
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Figure 1-1 – Daily Average Firm Prices at Mid Columbia

The high wholesale prices eventually caused retail prices to increase by 25 to 50 percent. Many
utilities entered into long-term contracts for power supply at high prices at the height of the
crisis. As a consequence, although wholesale prices have returned to normal levels, retail rates
have not yet returned to pre-crisis levels (Figure 1-2).

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 0.07

$/Kilowatt-Hour (nominal)
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Figure 1-2: Average Retail Rates – All Sectors

Similarly, demand remains well below pre-crisis levels (Figure 1-3). Most of this is due to the
fact that much of the electricity-intensive aluminum industry remains shut down. However,
other industries and economic activities have also been affected.

10

5
Percent Chnage in Loads

0
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Figure 1-3: Percent Change in Regional Loads from Same Month in 1999

The challenges we face as a region are similar to those we faced when the first power plan was
published: to build on the lessons of the recent past and to provide leadership in planning and
policy that will help assure the region an adequate, efficient, economic and reliable power supply
in the years ahead.

May 2005 1-2

WHAT CAUSED THE WESTERN ELECTRICITY CRISIS?
The Western electricity crisis has been referred to as the “perfect storm” – the result of the
confluence of a number of adverse trends and events. It had its roots in several years of under-
investment in generating and conservation resources. It was triggered by the onset of poor hydro
conditions in the later spring of 2000 leading to the second-worst water year since 1929. It was
made much worse by a deeply flawed electricity market design in California and opportunism by
some of the participants in that market. And many believe it was prolonged by the reluctance of
the Federal Energy Regulatory Commission to impose West-wide price caps.

The poor hydro conditions in 2001 resulted in almost 4,000 average megawatts less hydroelectric
energy available than in an average year, and even less compared to the relatively wet years of
1995-1999. The reduced hydro generation affected not only the Northwest, but California and
the Desert Southwest as well. Net exports from the Northwest Power Pool Area1 for May
through September averaged 2,700 average megawatts less in 2000 and 2001 than in the
preceding three years.

However, the poor hydro conditions and the flawed California market were unlikely to have
triggered the Western electricity crisis had it not been for the extremely tight resource situation
in the Northwest and West leading into 2000. Here in the Northwest, the critical water load-
resource balance was increasingly negative (loads greater than regional resources) throughout the
1990s (Figure 1-4).2 By the year 2000, the deficit had reached 4,000 average megawatts.

1
The Northwest Power Pool Area encompasses Alberta, British Columbia, Washington, Oregon, Idaho, Montana,
Wyoming, Utah and Northern Nevada.
2
“Critical water” is the historical volume and temporal pattern of river flows that results in the lowest energy
production from the hydropower system.

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 3000
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Figure 1-4: Northwest Load/Resource Balance – Critical Water

During most of the late 1990s, the development of generation in the Northwest and, for that
matter, the rest of the West, was effectively at a standstill. Similarly, utility investment in
conservation during that period was less than half the cost-effective levels identified by the
Council.

Concerned by the growing deficits, the Council undertook a study of regional power supply
adequacy. That study, released in early 2000, estimated that the probability of being unable to
fully serve Northwest load (the “loss of load” probability) would climb to 24 percent by 2003,
even when accounting for the ability to import power in the winter and to draft reservoirs beyond
normal limits in emergencies. The analysis also indicated that 3,000 megawatts of new resources
would be necessary to bring the loss of load probability down to the acceptable industry criterion
of 5 percent.3 What the report failed to emphasize was that the probable leading indicator of such
resource scarcity would be price volatility. The prices of 2000-2001 brought that lesson home
very clearly.

Contributing Factors
Neither the Council’s study nor any of the other indicators of growing resource inadequacy
stimulated a rush to develop new resources. Some new resources were under development.
However, they were not enough, soon enough, to avert the crisis. Why did the Northwest and
the rest of the West allow loads and resources to get so far out of balance?

Naive Faith in “The Market”

One explanation is the infatuation with the competitive wholesale power market that was
prevalent in the late 1990s. Why should a load-serving entity build new resources or enter into
long-term contracts when the invisible hand of the competitive market would take care of
long-term supply? A long period of low spot market prices seemed to validate this view.
However, it should have been clear that the market was not taking care of supply. Deficits

3
Northwest Power Supply: Adequacy/Reliability Study Phase I Report, March 2000.

May 2005 1-4

continued to grow, but very few new power plants were being built. Wholesale prices in the
years immediately preceding the summer of 2000 were generally below what it would take for a
new generator to fully recover its costs, in part because of greater-than-average hydro production
during that period. Few independent power producers were willing to undertake the risk of
building a plant without having a significant portion of a plant’s capability committed to long-
term contracts. This was particularly so in the Northwest where good hydro conditions can
depress market prices for extended periods.

Fear of Retail Competition and Stranded Costs

Another factor keeping utilities from making commitments to new resources was fear of retail
competition. During the mid-to-late 1990s, there was a great deal of discussion of retail
competition. Some states, such as Montana and, on a more limited basis, Oregon, opened their
retail markets to competition. Others were considering it and there was speculation that
Congress might impose retail competition. In the face of these developments, utilities were
concerned that if they were forced to open their service territories to competition, they might lose
customers to competitors and their investments in new resources would be “stranded,” i.e., the
utility would not be able to fully recover costs of new resources or long-term contracts.
Consideration of the growing deficits should have suggested that a reasonable level of
investment in new resources would not become stranded. Nonetheless, concerns about retail
competition and stranded costs undoubtedly played some part in retarding resource development.

Uncertainty Regarding the Role of Bonneville

Another contributing factor was uncertainty with regard to the role Bonneville would play in
serving future Northwest loads. Most utility and DSI contracts with Bonneville were to expire in
October of 2001. Decisions about the signing of new contracts for subsequent service did not
begin until 2000. This meant that both Bonneville and its customers were uncertain about who
would have the responsibility for acquiring new resources until the Western electricity crisis was
practically upon us. In the end, Bonneville found itself in the position of having to acquire 3,300
megawatts in a relatively short time during a period of extremely high prices. Had there not been
the uncertainty, Bonneville or the utilities may have taken steps to acquire resources earlier that
would have lessened the impacts of 2000-2001.

Failure of Planning
Finally, it seems clear that planning in the 1990s, including that of the Council, failed to fully
appreciate and factor into its decisions the risks facing the industry. In particular, these included
the risks associated with reliance on a potentially volatile wholesale market and risks associated
with gas-fired generation that depends on the also volatile natural gas market. If planning had
done a better job of reflecting the risks and their potential impacts, might load-serving entities
have taken action to mitigate those risks? In February of 2000 the Council released a report that
put a spotlight on the region’s worsening resource condition. However, by then it was too late to
elicit much of a response from the region.

THE RESPONSE TO THE CRISIS

Ultimately, Northwest utilities, independent developers, businesses, governments and citizens
responded to the electricity crisis with ingenuity and effectiveness. There were three primary
responses: new generation, both small-scale and larger conventional generation; load reduction

May 2005 1-5

through both efficiency improvements and, primarily, demand reduction; and changes in the
operations of the hydroelectric system.

Generation
By December of 2001, almost 1,300 megawatts of new permanent generation had entered
service, approximately 1,100 megawatts of which was gas-fired combustion turbines. Another
almost 3,800 megawatts was under construction, almost 2,900 megawatts were permitted, and
over 10,000 megawatts were in the permitting process. The great majority were gas-fired plants,
and most of those were combined-cycle units. However, there were several hundred megawatts
of wind power developed as well. The developers were primarily Independent Power Producers
(IPPs). This pattern was seen throughout the West.

One of the surprises was the amount and speed with which smaller-scale generation appeared in
the region. This generation primarily came in the form of trailer or skid-mounted reciprocating
engine generator sets and small gas turbine generators. Between the beginning of the crisis and
December 2001, over 700 megawatts of temporary generation came into service in the region.
More was planned. With the fall in market prices in the summer of 2001, much of the temporary
generation was retired. Of the 700 megawatts put in service, over 180 megawatts was “retired”
by December of 2001 and almost all was retired by December 2002.

At the present time, approximately 4,000 megawatts of new capacity has come on line in the
Northwest since January of 2000. An additional 1,400 megawatts is partially complete, although
construction has been suspended. With the exception of approximately 500 megawatts of wind,
the great majority of the generation is gas-fired. While the amount of new generation is
impressive, most of it effectively “missed the party.” By the time the generation became
operational, prices had fallen and along with them, the profits anticipated by the developers. At
present there are hundreds of megawatts of under-utilized new generating capacity in the region,
most developed and owned by independent power producers. The good news is that the capital
risk associated with this capacity is borne by the investors rather than the consumers of the
region. The bad news is that the credit ratings of independent power producers have declined
precipitously. The industry is not dead, but it has been severely wounded.

Load Reduction
Demand for electricity in the region began falling in late 2000. By 2002, loads were 2,800
average megawatts below loads in 2000 on an average annual basis, a drop of 13 percent.4 This
load reduction was accomplished through two means: efficiency and, primarily, demand
response.5

In 1999, Northwest utilities implemented 37 average megawatts of efficiency improvements in

their customers’ homes, offices, stores, factories, farms and so on. This was a little more than
one third of what the Council estimated to be cost-effective in the Fourth Power Plan. Although

4
Demand reductions on a monthly basis were even more dramatic. July 2001 loads were 4,675 average megawatts
lower than the same month in 1999, a 22 percent reduction.
5
“Demand response,” as will be discussed later, is a change in the service (level, quality or timing) that is chosen
voluntarily by the consumer, which reduces electricity use or shifts it to a different time. If the change in service
were imposed on the consumer involuntarily it would be “curtailment.”

May 2005 1-6

high wholesale prices began hitting in May and June of 2000, annual savings for 2000 were only
increased by about a third as it took some time to ramp up efforts. However, for 2001, efficiency
savings increased to 150 average megawatts. Much of the savings came as a result of rebates on
efficient compact fluorescent lights. Over 9 million were sold in the Northwest in 2001.
Fortunately, the groundwork for this program had largely been laid in the preceding years so that
the program could be rolled out relatively quickly. It’s not clear that we could do that again.

While the efficiency response was impressive, demand response made up the great majority of
the load reduction. Demand response means a reduction in electricity use unrelated to the
efficiency of the facility, equipment or process. It can be accomplished through a reduction or
cessation in the electricity-using activity (e.g., making sure unnecessary lights are turned off,
only running one shift in a factory or shutting down entirely) or by switching to a different
source of electricity (installing self-generation) or a different energy source altogether (e.g.,
switching to direct use of natural gas). All three methods were employed in 2000-2001.

Demand response was accomplished through a number of different inducements. These included
appeals to the public-spiritedness of consumers by public figures, price signals, and utility
“buyback” offers – offers by utilities to pay for reduced consumption. The governors of the
Northwest states raised the visibility of the severity of the electricity situation and made public
appeals for cutbacks. Some industrial customers exposed to market prices responded in a variety
of ways to the sharp increases in wholesale prices, including fuel switching, self-generation,
cutbacks and shutdowns, albeit at some significant economic expense. Sixty-three percent of the
load reductions came about through various forms of buybacks, over 90 percent of which came
from the aluminum industry. In the residential sector, programs like “20-20” and its variants
offered ratepayers a percentage reduction in their bill for reducing their consumption by the same
percentage relative to the same period in the previous year. None of these load reductions came
cheap, but they were cheaper than the alternative of paying the market price for the electricity.

As impressive as the load reductions were, they came too late to avoid several months of extreme
wholesale prices. As shown in Figure 1-5, load reduction did not really begin taking effect in a
significant way until more than seven months after the onset of wholesale prices that were
several hundred percent higher than normal. Had there been a more rapid response of loads to
wholesale prices, it might have partially mitigated the high wholesale prices that the region was
experiencing. Similarly, had investment in conservation continued at cost-effective levels
throughout the 1990s there would have been at least a couple hundred megawatts fewer loads
exposed to the high prices.

May 2005 1-7

 3000 50

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Figure 1-5: Percent Change in Mid-Columbia Spot Prices and Northwest Loads from
Same Month in 1999

Hydro Operations
The third leg of the response to the electricity crisis was changes to the operation of the
hydroelectric system that increased generation. The most significant change was reduction in
bypass spill at the John Day, The Dalles, and Bonneville projects. Bypass spill (running water
over a dam’s spillways instead of through the turbines) is intended to reduce injury and mortality
of out-migrating juvenile salmon and steelhead. However, from a power supply standpoint, spill
is energy lost. Most of the spill reduction took place in 2001. In total, reducing spill called for
in NOAA Fisheries’ 2000 Biological Opinion (BiOp) added an additional 4,500 megawatt-
months to the region’s energy supply, much of that coming in late spring and early summer when
power prices were still at extremely high levels. It also allowed storing additional water in
Canadian reservoirs in case poor water conditions continued into the winter of 2001-2002.

The use of spill reduction also highlighted the conflict between fish and power. Some viewed it
as an example of the power system being willing to violate fish operations instead of making the
needed investments in an adequate power supply. Others viewed it as a reasonable and prudent
step given the high cost and poorly demonstrated biological effectiveness of spill. The debate
continues today.

THE CHALLENGES GOING FORWARD

It is tempting to believe that the factors that led to and prolonged the Western electricity crisis
are no longer of concern. Have we learned our lesson? Certainly the possibility of additional

May 2005 1-8

jurisdictions moving to retail competition is much diminished if not eliminated. There is also a
renewed enthusiasm on the part of many utilities and their regulators for the vertically integrated
utility where the utility owns generation and is less reliant on “the market.” Similarly, many
utilities now have experience with demand management programs that could, if maintained,
serve them in good stead should another crisis begin to emerge.

In many respects these are positive developments that represent a retreat from excesses of the
late 1990s. However, we believe it would be a mistake to think it could not happen again. It
seems likely that we will have sufficient resources for several years. Combine this with a few
years of good water and the resulting low market prices could make the lessons of the past few
years fade unless those lessons have been built into the structure of our electricity system.

It is likely we will continue to see a mix of vertically integrated utilities, a federal power-
marketing agency, local distribution utilities and competitive wholesale suppliers in the regional
power system for the foreseeable future. This mix will have elements of federal, state and local
regulation and competition. This mix results in uncertainty regarding roles and responsibilities
and lacks some of the elements necessary for it to function effectively. The challenge for this
power plan is to provide insights into what will make such a system function effectively and
equitably not only now, when the experience of 2000-2001 is fresh in our minds, but in the
longer term.

Vision for the Northwest Power System

Our vision is a well-functioning (adequate, economical, efficient, reliable) electrical system
comprised of a mix of independent and utility-owned generation, regulated transmission and
distribution, and an effective consumer demand response mechanism. It is a system in which
efficiency and renewable resources compete on an equal footing with conventional generation
and that includes environmental considerations when making resource decisions. It is a system
that recognizes the risk inherent in the power industry, and plans and implements actions in ways
that effectively manages that risk. The characteristics of that system are:

1. Resource Planning and Adequacy

• The region puts in place resource adequacy standards or targets and the necessary
monitoring and planning functions.
• Resource planning includes robust assessment of risk and the options for risk
mitigation.
• There are clearly defined responsibilities and accountability for resource adequacy,
reliable power system operation, and transmission system expansion.
2. Market Rules and Regulation
• The wholesale power market is transparent, with open transmission access and fair
rules for all participants, including the demand side of the market.
• There are reasonably consistent wholesale power market and transmission access
rules across the integrated electrical grid.

May 2005 1-9

 • There is active market oversight and monitoring to ensure efficient operation and to
prevent market power abuse ensuring the accountability of market participants to the
consumers ultimately served by those markets.
• The system preserves state authority and accountability over retail electricity markets
to ensure fair and reasonable consumer prices for monopoly customers.
• Electricity pricing and regulation provide adequate incentives for efficient utilization
and expansion of the region’s generating resources and transmission system.
• Electricity pricing and regulation provide incentives for efficient uses of electricity by
consumers; promote cost effective demand-side measures, including customer-owned
generation as alternatives to transmission system expansion; and do not create
barriers to cost effective distributed generation or renewable resources.
3. Conservation, Renewables and High Efficiency Resources
• The region continues to pursue and acquire cost-effective conservation, renewables
and high efficiency resources through regional, Bonneville, utility and state programs
that supplement competitive market incentives where necessary.
4. Fish and Wildlife
• The region fulfills its fish and wildlife protection and mitigation responsibilities as
they relate to the hydroelectric system effectively and efficiently.
5. The Bonneville Power Administration
• A sustainable role is defined for Bonneville in which it markets the existing Federal
Columbia River Power System resources on an allocation basis, provides equitable
benefits to the residential and farm customers of the region’s investor-owned utilities,
and meets additional load growth only through conservation and bilateral,
incrementally priced contracts with individual customers or groups of customers.

Focus for the Fifth Power Plan

The Fifth Power Plan can help the region achieve this vision. The challenge for the Fifth Power
Plan is two-fold. The first relates to the Council’s traditional power planning role. It is to
develop more robust planning methods for assessing and managing the risks inherent in the
industry structure and to use these methods to develop resource strategies that will meet the
region’s electricity needs at lowest cost with acceptable risk.

The second and related challenge is to provide insights into the resolution of some of the key
issues affecting the industry in the Northwest that are impediments to achieving the vision.
These issues include at least the following:

• Determining what constitutes resource adequacy and identifying the incentives

(regulatory or financial) for assuring resource adequacy;
• Contributing to improving the way we plan and pay for transmission system
expansion, and how we ensure transmission is operated reliably, efficiently and
equitably;

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 • Identifying the necessary and sufficient steps to enable effective demand side
participation in the market;
• Identifying the means of sustaining investment in cost-effective conservation and
renewable resources;
• Determining the value of resource diversity for the region and the means of achieving
it;
• Determining how to meet the requirements for power and fish recovery effectively
and efficiently; and
• Helping define the future role of the Bonneville Power Administration in power
supply. Experience of the last few years suggests that Bonneville is, by nature of the
requirements and constraints under which it operates, ill suited to managing the
financial and political risks of a large role in resource development. An alternative is
required that limits Bonneville’s risk exposure in resource development while still
ensuring that cost-effective conservation and renewable energy and fish program
goals continue to be met.

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