The energy shortage in California has been in the news throughout early 2001. Discussion concerning the crisis, who is to blame, and how it will be resolved has generally focused on a few key factors. Initially, demand has increased sharply over the last decade. Economic growth in California was particularly strong during the 1990's boom economy, and rapidly expanding firms need more energy. Secondly, as has been widely reported, California did not really do anything to respond to this increase. Long-term supply did not keep pace. No major power plant was built to help increase supply. Now, with a sharp in-state mismatch between supply and demand, the utilities are forced to look elsewhere for power and are bearing substantial costs from buying on the spot markets.
The California situation is a classic aggregate planning problem. As noted in the introductory paragraph, this is a situation with a mismatch between capacity and demand. If it is to be solved, generation of electricity must be matched up with usage.
A number of the proposed solutions to the problem have revolved around the supply side. New power plants would help, though that solution is long-term and will obviously take some time to bring to fruition. California could continue to buy surplus power from other areas. The problem has been that a legal barrier to long-term contracts has required the state's utilities to purchase imported electricity only on the short-term spot markets—which have been extremely volatile throughout the crisis. Finally, some observers have suggested temporarily loosening state and federal pollution control standards, allowing current power plants to generate higher volumes of power.
One of the major issues in this crisis is the fact that power cannot be stored as inventory. When produced, it must be used. Thus, power plants cannot run at high levels during down periods of demand, storing up power for peak periods. Electricity must be generated for immediate use.
A sideline to this complication is that available capacity must be equal to the highest demand level. Even if a moment of peak usage lasts only a short time each day and may be substantially higher than usage at most other times of the day, plans must be in place to generate enough power (or buy enough power) to meet that peak.
As a result of this, as the Wessel article points out, "[f]or more than 25 years, clever economists and clearheaded regulators have been urging utilities to charge lots more during peak hours…" This odd situation of dramatically uneven demand, no inventory, and an absolute requirement to meet peak demand make aggregate planning difficult. The situation also illustrates how important the often-ignored options of demand manipulation can be to the framework.
On the one hand, demand can be reduced by simply lowering overall usage. The Emshwiller article talks about Dr. Arthur Rosenfeld, a former physics professor at the University of California, Berkeley and now a member of the California Energy Commission. Dr. Rosenfeld advocates returning to conservation approaches popular during the energy crisis of the 1970's. One option is the installation of white rather than black roofs, a step that can reduce air conditioning energy needs by up to 40%.
On the other hand, demand can be reallocated. Dr. Rosenfeld also advocates the use of digital meters. Such meters can be connected to utilities and provide real-time information on usage. With such information available, the utilities can then turn around and price at different levels throughout the day, as usage and capacity levels require. Such differential pricing can help convince customers to shift usage from high-demand, high-cost times to low-demand, low-cost times.
Going back to the Wessel article, Southern Company's Georgia Power Company is an example of a utility that already uses these meters. 1,600 large customers receive daily quotes with 24 separate prices for each hour of the day. Some even receive hourly quotes. Pricing can be as much as 50 times higher during peak periods.
In response, big power users have developed very creative strategies for reducing their energy bills. An insulation producer moved to a Wednesday to Saturday manufacturing schedule. A supermarket lowers freezer temperatures during cheap periods, increasing them during expensive periods. Similarly, another manufacturer runs production lines during cheap periods, building up inventory and shutting down during the peak, pricey periods. Some utilities have even gone to the extreme of paying customers to reduce or eliminate their consumption during peak periods (akin to airlines paying off "bumped" ticketholders on overfilled flights). Regardless of the differences in circumstances, utilities and regulators in California would be well-advised to look to all these examples for insights into how to resolve the current crisis. As with any aggregate planning problem, strategists need to avail themselves of all alternatives, then play with the different combinations of capacity adjustment and demand adjustment to determine a feasible, cost-effective plan.
| 8:00 am | 9:00 am | 10:00 am | 11:00 am | |
| Demand (mwh) | 1500 | 1800 | 2100 | 2000 |
| Capacity (mwh) | ||||
| Grid electricity | 1600 | 1600 | 1600 | 1600 |
| Out-of-state Electricity | 300 | 300 | 300 | 300 |
Consider each of the alternatives discussed above. Explain where and how each would affect the aggregate planning scenario posed by the table.
Think about what you would do if you had charge of California's power situation. What steps would you take, given all the choices available on both the capacity and demand sides, to help resolve the problem? What priorities would be most important to you? Are environmental considerations still important? Are business customers more or less important than residential customers? Does it depend on the time of day? The time of year?
Emshwiller, John. "California's Shortages Rekindle Its Efforts to Conserve Electricity", The Wall Street Journal, February 20, 2001, pA1, A8.
Wessel, David. "Capital: California Sheds Light on Regulation", The Wall Street Journal, February 8, 2001, pA1.
- Scott Erickson