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California Blackouts, Systemic Risk And Lessons From The Financial Crisis

In the past week, California’s independent system operator for the state’s electric power network (CAISO) resorted to rolling power blackouts in response to spikes in demand that were on the edge of the system’s capacity to meet them. The blackouts on August 14 and 15 hit the state as it was also dealing with wildfires and the enduring effects of the coronavirus. The blackouts were ordered to fend off potentially far more disruptive unplanned outages in the Golden State.   

The problems in California stem from three inter-related causes:

1.      A heat wave permeating throughout California that has pushed up demand for cooling homes and businesses;

2.      A changing composition of the state’s electric power system that has shifted the dynamics of supply and demand over the course of the day;

3.      Challenges throughout the interstate network used to meet California’s balancing needs.        

As to be expected, opinions vary on where to apportion the blame for the blackouts – with CAISO, the state policymakers and regulators who established rules that place constraints on CAISO’s operations, the pandemic, or all the factors contributing to climate change? 

Let’s unpack this a bit, then consider its parallels to the 2008-09 financial crisis and how that was addressed for some possible guidance here.      

Boy It’s Hot Out

California and the rest of the western states are enduring a brutal heat wave, with temperatures in Death Valley, California hitting 130 degrees last Sunday, the hottest recording there in over 100 years. Las Vegas hit an all-time record of 114 degrees on Monday and the rest of the region is sweltering as well.

With those high temperatures, the demand for cooling has surged, especially in the late afternoon, but also persisting into the evening when demand usually drops off. On Friday, August 14, the first day it issued a rolling black-out, CAISO served a peak load demand of about 47 gigawatts (GW) of electricity. While this is not a record – they served over 50 GW as recently as 2017 – it was 35% higher than the demand peak from the previous Friday. This has led CAISO to scramble for supply to meet these demand spikes, drawing on in-state resources and imports from other states.             

California’s Energy Profile Has Shifted

California is in the middle of a fairly dramatic change in the way its power is produced and used. It is the first state to impose quantitative limits on greenhouse gases through its cap-and-trade program, limits which apply to power generation as well as heavy industry and transportation. In tandem, California has among the world’s most aggressive policies for decarbonizing the power sector, requiring 50 percent of generation to be sourced by renewable energy by 2025, and 100 percent from zero-carbon sources by 2045. In pursuit of these goals, California now gets about 13 percent of its electricity from solar energy, 7 percent from wind and 19 percent from hydropower. These are annual averages; there are times of the day where solar energy is California’s largest source of power generation.   

System balancing problems can arise in the late afternoon and early evening when the peak demand flow for cooling coincides with the ebb in solar power generation, a phenomenon known as the “duck curve”. This can be a double whammy as buildings with rooftop solar start to draw more from the grid to meet demand while the large scale solar farms on the supply side start to wane. Energy storage is a solution here – the use of batteries and other technologies like pumped hydro storage to draw power when solar energy is abundant and dispatch it when it is scarce. But, although storage performance is going up and costs are going down – there is not yet enough on the California grid to adequately handle the need. 

To the intermittency problem, now add the COVID-19 pandemic. With more people sheltering and working from home, total electricity demand has declined slightly, but the spatial and temporal pattern of electricity use has changed in ways that were not fully anticipated just a few months ago. 

Traditionally, these temporal balancing challenges have been handled by ramping up quick-start power plants such as natural gas units. And throughout this week, gas units have been called upon heavily to meet demand, serving over half the peak load on August 14. Yet, these units are starting to get pushed out of the market both by competition from low marginal cost renewable sources and by the decarbonization policies referenced above, so there is concern in some corners that the natural gas ramping strategy is losing steam. Natural gas generation capacity declined about 4 GW (9%) from 2010-19 as wind and solar added about 14 GW of capacity. So it is not really an issue of having enough capacity, but when it is available.             

It Helps To Have Connections

California gets about one-third of its electricity from other states via the Western Interconnection (WECC), which links electricity supply, demand and transmission through 14 western US states, two Canadian provinces and part of one Mexican state. This resource allows California and the other jurisdictions to operate in balance, by shifting power surpluses in one place to meet deficits in another place.

While pooling power like this has been in operation for a long time and has clear advantages for risk management, it also ensures, for better or worse, that conditions in one part of the region affect those in other parts. And when the entire region is facing a heat wave, it means they all share common times when demand is high , which makes it more challenging to find surplus supply within the region to meet that common demand.   

This week’s experiences have borne this out. On the first black-out day, August 14, peak load occurred at 5 pm, but peak stress on the system was around 7-8 pm, as the contribution of non-hydro renewables dropped from 10.1 GW at 4 pm to 3.1 GW at 8 pm. To fill the gap, CAISO dispatched more generation from gas units and large hydro plants, drew more imports from other states, and issued rolling blackouts. This coincided with a big spike in wholesale prices. At 8pm on August 14, the wholesale market price for CAISO increased 15-fold from its 4pm price. Had more surplus energy been available elsewhere in the region, prices would not have risen anywhere near that high.    

Systemic Risk

It certainly makes sense for California to meet its power demand by deploying a mix of resources within and outside state boundaries and for other states to supply California needs at a competitive price. These are the gains from trade. However, this does open the door for systemic risk that lurks below the surface largely ignored until it emerges and causes significant disruption.

In this regard, California’s situation has some similarities in nature (though not scale) to the global financial crises of 2008-09. As with the earlier crisis, procedures in place to handle common localized risks by drawing from a wider pool were undermined by systemic factors that correlated the risks rather than diversified them. In the financial crisis, the correlated risks stemmed from the securitization of mortgages and the under-appreciated risks of mass defaults when economic headwinds collided with rising interest rates. Securitization is a means to minimize a lender’s risk of default from an individual loan by pooling it across a large bundle of mortgages and reaping the benefits of diversification. The problem arises when the pool’s risks are not diversified against large macroeconomic shocks.

In the case of California’s current electricity conundrum, reliability risks are hedged by importing electricity from other states and, in most circumstances, neighboring states can easily provide the power. But with the entire west broiling in a heat wave and all states facing higher demand, the risk is now more correlated and systemic. CAISO’s rolling blackouts are a means to minimize the damage that would otherwise arise from unplanned system outages.

Two threat multipliers bear notice here. One is climate change, which raises the underlying systemic risk of highly correlated power scarcity within the region, not to mention the frequency of wildfires which have plagued the California power system in the last few years. The other is the move toward electrification of everything (e.g., vehicles, building heating and cooling, industrial process), which is ironically targeted at mitigating the climate problem to begin with. That it can do, but it also raises the stakes for reliable delivery of electricity.    

Some Fixes

If we stretch the financial crisis analogy a bit further, a key to its resolution was to enhance liquidity or the ability to convert assets into cash flow. The analog here is to more effectively utilize the West’s generating (and demand response) assets to more efficiently move electricity around to meet the region’s demand. This will be even more critical as California and neighboring states take on more ambitious decarbonization targets.

This is not exactly a new thought. Historically, WECC has been reliable but somewhat unwieldy by nature, managed by dozens of different balancing authorities using a range of transactions. In 2014, CAISO established a western Energy Imbalance Market (EIM), which uses a bidding process to balance markets in real time (every 5 minutes) by moving electricity to and from California and partner utilities in other western states.

CAISO is now in the process of expanding its EIM to include a day-ahead market which can enhance its ability to adapt to possible imbalance problems 24 hours in advance. The EIM is a bottom-up voluntary mechanism – utilities can opt to join if they think it will benefit them. This stops short of creating a Regional Transmission Organization (RTO) linking California and the West, a more top-down mode of market and transmission coordination that exists in much of the rest of the US. A debate persists about whether an RTO or expanded EIM is the right way to enhance regional connectivity in the West, but there is little debate that more connectivity is needed.   

While pooling regional assets is important, it does raise the systemic challenges alluded to above, so localized improvements are also needed to counterbalance those risks. This includes deployment of localized energy storage – batteries and other technologies – and more automated demand response mechanisms to forestall the need for rolling blackouts. Battery storage has been scaling up as performance improves and costs come down, but the pace will have to pick up to meet the balancing challenges seen this week, which seem only more likely to recur with energy and climate systems in a state of transition. And California and other states may need to look at dispatchable zero-carbon sources such as advanced small modular nuclear, green hydrogen, and natural gas units with carbon capture and storage, that can ramp quickly to meet the balancing needs of a diversifying grid.

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