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  The worst was yet to come.

  * * *

  Throughout the autumn, electricity traders continued to game the system, using incomprehensibly complex schemes to shift megawatt-hours away from the day-ahead power exchange and into the hourly ISO markets. As winter approached, outside events conspired to help these traders, as if invisible gremlins had been released into the state to wreak havoc. A natural gas pipeline ruptured in Southern California, interrupting key fuel supplies. A storm hit the coast and clogged intake valves for a nuclear plant with seaweed, forcing the facility to go off-line and taking its megawatt capacity with it.

  This created a destructive feedback loop—every time power prices rose, it gave traders more reason to manipulate the markets, which caused prices to rise yet further. By the time January rolled around again, the state found itself in a summer-like environment of high demand, limited supply, and exorbitant prices.

  The market dysfunction began to take its toll on the state’s three big utilities. The state had forced them to sell their own power plants, so they had no choice but to buy all of their power on wholesale markets. The rate caps prohibited the utilities from passing the higher costs on to consumers. The frozen rates were designed to be a floor price, but now that wholesale market prices had skyrocketed, the frozen rates were suddenly a price cap. No one had expected this. Losses were approaching $10 billion for two of the three big utilities: San Francisco’s PG&E and the Los Angeles area’s Southern California Edison Co. There was simply no way that the utilities could keep passing on power to their customers at such a deep cost without declaring bankruptcy.

  Steve Peace found himself in the odd position of knowing more than anybody about California’s dysfunctional markets but being able to do little or nothing at all about it. Because he was no longer on the Energy Committee of the state senate, Peace wasn’t in a position to intervene. And even if he was, there was very little that the senate could do. He was left to watch as state legislators and electricity regulators scrambled to keep the system afloat. The scene might have looked familiar to him. It wasn’t completely dissimilar to a vignette about halfway through Attack of the Killer Tomatoes!, when the US Army was scrambling to destroy the marauding tomatoes. The camera panned across the army command center, which was a scene of chaos. Papers were spread everywhere; soldiers were working at makeshift tables and shouting back and forth at one another. They bickered and scrambled around, powerless against the tomato menace.

  There was a similar fatalism playing out at the ISO offices near Sacramento. The traders looked shell-shocked, walking around with their cheap Styrofoam coffee cups while lights blinked on a wall map of the state transmission routes. There was nothing the traders at ISO could do: they were price takers who had to pay whatever it took to avoid a blackout.

  It was only then, as ISO was being gouged, that Steve Peace could have seen one of the biggest mistakes he had made while negotiating California’s deregulation laws. During all the marathon hours of debate and negotiation, the lawmakers had not paid enough attention to one vital issue: the issue of market power. Market power was a concept that animated lawmakers who crafted the New Deal, and it referred to the ability of companies to demand higher prices even when the laws of supply and demand did not justify them. Monopolies had market power. Utilities had market power. The traders at Koch and Enron now had market power. What the lawmakers didn’t take into account back then was the peculiar nature of commercial electrons and electrical power. Unlike other commodities such as corn and oil, electrons cannot be stored. They must be transmitted and used in real time as they are created. This made the electrical grid particularly vulnerable to market power. The grid had to be expertly orchestrated to match supply and demand almost perfectly: if enough electrons weren’t forced down the wires to meet demand, then the system could shudder, and blackouts could result. In other words, system reliability dictated that demand must be met in real time—buying that last megawatt of power to meet demand was a necessity rather than a luxury. The market for that last mega-watt hour was a seller’s market, and the savvy trader could exact a ransom price.

  The only entity with the authority to correct the dysfunctions of market power was the state. And that’s what forced the state of California to finally intervene in the electricity crisis. As it happened, the Republican governor who pushed for deregulation in the 1990s, Pete Wilson, had left office. He was replaced by a Democrat named Gray Davis. It would be up to Davis and the state legislature to solve the mess that deregulation left behind. Gray Davis was a popular, if somewhat bland, governor. He was a career politician, elected with 58 percent of the vote. Electricity deregulation wasn’t his specialty, but a few months into his term, it was clear that Davis wouldn’t be dealing with anything else.

  * * *

  The weekend of January 12, 2001, was a long holiday weekend. It was also the last three days before the state’s electric grid might fail. The big utility companies had major debt payments due the week after the Martin Luther King Day holiday, and it was becoming apparent that they didn’t have the money to pay. The consequences of a default for the big utilities were difficult to predict but would almost certainly be catastrophic. Mandatory blackouts would cut power to hospitals, airports, shopping malls, and homes.

  Gray Davis formed a war room in the state capitol and worked there through the weekend. He set up a live satellite link between California and the Federal Energy Regulatory Commission offices in Washington. California’s state lawmakers were on hand through the weekend to write emergency legislation that Davis could sign when markets opened up Tuesday morning.

  Davis quickly discovered that energy traders were not willing to compromise. Market prices were nonnegotiable. They would get their money. A Texas-based trading firm called Dynergy made clear that it would rather see one of the state’s biggest utility companies, Southern California Edison, go into bankruptcy than forgive the utility for its debt. The state needed to craft a bailout bill that was friendly to Dynergy’s terms. “If we can’t get this bill through in the next two days, this will start to unravel,” Dynergy president, Stephen W. Bergstrom, told the Los Angeles Times. “When and if they . . . default on Thursday, it puts us in a position where we have to take them into bankruptcy, and I’m sure others will be right beside us.”

  FERC also refused to compromise in important ways. The agency was in limbo between the Clinton and Bush administrations and wasn’t inclined to intervene. This left Davis and the state legislature with one option. The state would use its credit rating and money to step in and keep the broken market system afloat. The legislators found a clever way to do this: they could use a relatively obscure agency to buy electricity supplies and pass them on to the utilities.

  Over the weekend, Davis and his team spent hours negotiating over what price the state would pay for the electricity. Davis tried to negotiate for a discount. He wanted to pay 5.5 cents per kilowatt-hour over three years. The traders and their industry group said they wanted at least 8.5 cents per a kilowatt-hour over three years. Davis had no leverage, and the traders knew it.

  Negotiations carried on through Monday and then into Tuesday. The debate was largely over how much the state would have to pay. The figure would clearly reach into the billions. Throughout Tuesday afternoon, the state legislature debated an emergency bailout bill in the same room where Stephen Peace helped write the original deregulation measure so many years before, when almost nobody could be bothered to attend his hours-long hearings. Now the situation was suitably disastrous enough to draw the attention of the national press. By late Tuesday evening, it appeared that the legislators had come to a rough understanding of what the final emergency legislation might look like. State assembly leaders started whipping votes into line. They fashioned a bailout before the utilities went under.

  Around this time, a truck driver named Mike Bowers steered his semitruck off the freeway and onto the side streets of Sacramento. He had a record of mental illnes
s and a long criminal history. For reasons that were never entirely clear, Bowers accelerated his rig to seventy miles an hour and drove it into the side of the capitol building. The truck hit the capitol building like a missile. When the cab slammed into the white stone walls, the fuel tanks exploded, sending a ball of flame climbing over the face of the building. Somewhat miraculously, Bowers was the only person who died that evening.

  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.

  In California, cynicism toward the state of California became a near-permanent posture of the electorate. Governor Gray Davis was the first casualty. In 2003, Davis was thrown out of office after a statewide petition forced a recall election. He lost the special election to a man with no government experience: the movie star Arnold Schwarzenegger.

  Steve Peace’s life in politics was also ended by the crisis. He was forever known as the coauthor of the disaster. Peace had accurately diagnosed the problem as events unfolded. During the crisis, he made an odd habit of approaching the lectern in the state capitol and simply saying: “FERC. Enron.” It was a statement of desperation; he was trying to say that the system was being gamed by traders and abetted by weak regulators. Ultimately, it just made him sound unhinged. His statements were vindicated by the evidence, but only years after the fact. By that time, he was living back in San Diego. He is CEO of Killer Tomatoes Entertainment, which manages a franchise of movies based on the original (including Return of the Killer Tomatoes! and Killer Tomatoes Eat France!).