The next morning, as the blackened face of the capitol building continued to smolder, Gray Davis declared a state of emergency. At that point, he was simply stating the obvious. Amid the smoke and carnage, the lawmakers were able to pass the bailout plan.
* * *
During the spring of 2001, a story line emerged about the electricity crisis that eventually hardened into conventional wisdom. It was a story about legislative stupidity and incompetence. This narrative was cemented by Gray Davis’s bailout plan. The state was obligated to buy electricity for the utilities but prohibited from changing any of the underlying market dysfunction. Wholesale prices continued to soar. The traders continued to profit, and the state opened its treasury to pay for it all. Between January and June, the state bought about 30.8 million megawatt-hours at the price the market demanded. The price to taxpayers was roughly $9 billion.
And even with this, the grid remained unstable. Utilities ordered rolling blackouts, cutting power to neighborhoods and shopping districts and leaving traffic signals dark. Taxpayers were heavily subsidizing a Third World electricity grid. The state had created the deregulation scheme, so many citizens blamed the state. The politicians hadn’t listened closely enough to the free-market evangelists at Enron. Now the overcomplicated mousetrap was destroying itself.
This narrative was misleading. The biggest misconception was that the state had deregulated the wholesale market for power while imposing “price caps” on electricity rates for consumers. It sounded like an absurdly designed system, and it reeked of pandering to voters—in this case electricity customers—who wanted a free ride. It also helped explain why the big utility companies were going bankrupt, because they couldn’t pass on their high costs. Of course, it was the utility companies that had pushed for the rate freeze, and they had done so with the expectation that the frozen rates would deliver them outsized profits over several years. In San Diego, the rate freeze had been lifted, and it didn’t change much beyond shifting the exorbitant prices directly onto the broader populace.
Another misconception was that the deregulation law’s complexity was somehow to blame for the high prices. News stories mentioned that there was a Power Exchange market and an ISO market and there were price caps and different rules for imported and exported power. It made the system handbook sound like a plate of spaghetti that distorted the market and made high prices almost inevitable. In fact, it was the traders and power generators who decided to game the system using the complex rules as a way to hide their behavior.
Finally, there was little discussion of the fact that federal regulators had the authority to combat the crisis but chose not to use it. California’s deregulation law called for FERC to police any market manipulation, and it was FERC that decided not to penalize traders and generators in late 2000 when it discovered that prices were unjustly high. FERC refused to intervene for months as the crisis worsened.
Another part of the narrative remained entirely absent. In all the stories and headlines that were generated about the California power crisis, one name remained notably absent: Koch Industries. This wasn’t accidental.
* * *
On November 20, 2000, Koch Industries was given the chance to expand on its parking strategy in California. PNM offered Koch a new contract to park power over the summer of 2001, a time when prices were expected to be high. The offer must have been enticing.
PNM’s signature was on the contract but Koch’s was not. Koch walked away from the parking scheme, just when the strategy was arguably the most promising.
Other firms ramped up their market-gaming schemes as electricity got more expensive. But Koch appears to have cut back. It seems that Koch imposed a sense of discipline, and a long-term point of view, that eluded its competitors. Enron, for example, feasted on manipulative trades—not only parking, but also gratuitously manipulative trades with names like “Fat Boy” and “Death Star”—in part to help it meet company-wide quarterly earnings targets. Koch Industries had no such concerns.
Back in 1968, when the oil gauger Phil Dubose joined Koch Industries, he joined a company that thrived on exploiting gray areas. But skirting the law had drawn the attention of the FBI and the US Senate, and Charles Koch had learned a lesson from that. His trading team would not aggressively push into legal gray areas. They didn’t need to. Koch had enough advantage using its inside information to trade in the dark, lightly regulated derivatives markets. Getting caught up with blatant market manipulation would only serve as a distraction.
This was certainly the case in California. There were plenty of politicians complaining about market manipulation, even if FERC had stepped aside. It wasn’t hard to imagine that, down the road, there might be more investigations, maybe even a US Senate hearing or two.
Koch’s priorities in the winter of 2000 were telling. PNM’s trading team was persistently trying to convince Darrell Antrich and his team to park more power with the firm. But Koch wanted something else entirely—Koch just wanted PNM’s information. Darrell Antrich and his team turned the table on PNM. Amid the golf outings and meals, Antrich tried to convince PNM that the real gold mine lay in sharing inside information about outages, transmission, and weather forecasts. In the end, Koch won. PNM signed an information-sharing agreement in late January of 2001. This strategy helped Koch avoid the attention that soon settled on Enron, which became the public face of market manipulation when it was exposed. Koch had engaged in market manipulation on a far smaller scale, but it had done it nonetheless. Because it was willing to remain anonymous, virtually no one knew about Koch’s role in the crisis.
* * *
The California crisis ended in April, when FERC decided to intervene. FERC issued an order on April 26 that addressed one thing: the issue of “market power,” or the ability of power traders and merchants to manipulate markets. It imposed a firm price cap in the hourly ISO market.
FERC also ordered that refunds be paid to consumers if it found that prices had been artificially inflated, reversing its decision in November. FERC ordered all power generators within the California system to offer electricity in the real-time markets if they had it, rather than exporting it or holding it off the market. In June, FERC issued a follow-on order that intensified the crackdown. It greatly expanded the pool of trades that were subject to price caps, including “bilateral” trades that happened outside the ISO market (these were one-on-one swaps that were like derivatives contracts).
After these orders were issued, the crisis abated. Market prices fell gradually at first, then dropped dramatically in June, even as the warm summer months hit the state. The conditions that traders blamed for the crisis had not changed. There were no new power plants built, there was no significant change in demand for power or a change in the weather. But the crisis ended. The prices fell again.
Enron declared bankruptcy in December of 2001. Koch, Shell Oil Company, and other traders who also manipulated markets fought the charges in court. The battle dragged on for years. Thousands of pages of documents and court testimony were generated as the companies and regulators fought over complex and arcane maneuvers like parking power.
Koch claimed it was innocent of manipulation. The company accurately pointed out that it was accused of far less manipulation than many of its competitors. In one court filing, Koch was found to have illegally exported 175 megawatt-hours of power during the summer of 2000. Shell, by contrast, illegally exported 1,657 megawatt-hours. While Koch’s parking trades were small, there was overwhelming evidence that Koch had manipulated markets, evidence based on Koch’s own internal documents. A panel of FERC commissioners ruled in 2014 that Koch’s parking transactions, while proven, were so small compared to its competitors that the FERC could not prove there was a “pattern” to its behavior, sparing Koch the harsher penalties imposed on Shell and other companies. Koch settled the charges over the manipulation in late 2015 with a payment of $4.1 million to California. Koch Energy Trading was later sold to Merrill Lynch. Darrell Antrich continued to work on the trading floor in Houston, after Merrill Lynch took over.