Deregulation leaves California powerless

By Ron Recinto
Redherring.com, January 11, 2001

As California goes, so goes the nation. At least, that's what power entrepreneurs hope will happen, since the Golden State's sudden propensity for brownouts might yield a major shift in the way the energy business works nationally.

California turned to deregulation hoping a free market would ease rising prices. That worked for a while, but now electricity costs are skyrocketing, with wholesale prices going from $30 per megawatt hour a year ago to about $400 per megawatt hour today. With utilities still constrained from passing on costs to consumers, two of California's biggest utilities, Pacific Gas & Electric (NYSE: PCG) and Southern California Edison (AMEX: SCE/Q), say they are billions of dollars in debt and face bankruptcy.

A problem of this magnitude should, with luck, accelerate the exploration of new and innovative ways to further energy generation and exchange.

Tim Woodward, a managing director at Nth Power Technologies, a venture capital firm focused exclusively on the energy industry, calls the California energy crisis "the best marketing that could have ever happened" for venture capital in the sector.

CHARGED UP

Several technologies could ultimately benefit, including fuel cells, distributed energy solutions, and distributed storage. Technology that helps generate cleaner power may also do well.

Other potential winners include software that can determine the best times to use energy from the utility grid and how to better manage the usage. And some VCs tout small-scale turbines, microturbines that can generate up to 5 megawatts of power and can be targeted at specific power-hungry business or residential areas. This level falls below certain regulatory limits.

Of course, none of these technologies are going to be short-term winners. Some California politicians are currently glowering at the whole notion of deregulation. But the trend seems unstoppable: 12 states have already opened their markets, and another 12 have legislation in the works. Analysts estimate that 90 percent of states will be fully deregulated within five years, opening up even more of what is already a $330 billion-per-year market in the U.S. And as each state opens its electricity market to competition, more consumers will be able to choose their suppliers.

TELECOM TWO

One venture capitalist likens what's happening in the power industry now to what went on years ago when the telecommunications industry deregulated. Tom Chung, a partner with Insight Capital Partners, a New York venture capital firm focused on technology that improves energy companies' business processes, says that right now VC firms and investors are looking at funding carriers, the network, or new types of energy generation.

"The pace of deregulation will drive how much existing companies need to innovate," Mr. Chung says. "And that day is coming soon."

But "soon" does not mean tomorrow. First, the deregulated system must sort itself out. Governments may jump back into the fray, utility companies may consolidate. In the short term, there will be chaos and confusion, which may make it more difficult for entrepreneurs.

"In the near term there might be a little step back with all the regulatory problems going on," says Mr. Woodward. "Some investors are waiting to see how things resolve."

Ultimately, though, when effective deregulated systems emerge, investors will see a full-force market in the sector, Mr. Woodward says.

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