How California made liquid smog

July 25, 2012

By Wayne Lusvardi

How did a 1996 Federal Environmental Protection Agency “mandate” to clean up smog result in the California Energy Crisis of 2001 and the “wet drought” from 2007 to 2010?

This is a question that California water experts never seem to ask. But it is a question worth answering if California is going to understand how the cost to improve air quality conditions in California’s urban air basins got loaded into the price of water.  Neither can we understand what California’s new Green Power mandate and Cap and Trade Pollution Emission Trading Program are without first understanding what happened during the Energy Crisis of 2001.

The End of Abundant Water?

G. Tracy Mehan III, a former U.S. EPA official and professor at George Mason University School of Law, in the July 16 issue of the Weekly Standard reviews water economist David Zetland’s “The End of Abundance: Economic Solutions to Water Scarcity ( Press, $24). Zetland holds a PhD in economics from the University of California, Davis, is very knowledgeable about state water issues and blogs at

Mehan agrees with Zetland that it would be better to price water based on its market scarcity than its socialized cost, as is currently done.  I also advocate water markets.  But this does very little to help voters or policy makers understand how water is really priced in California. Mostly ideology substitutes for a real world understanding of the Byzantine-like California water pricing system.

I spent 20-years handling water, energy, land use and valuation issues for one of California’s largest water agencies.  I disappointingly found both  Zetland’s book and Mehan’s review of it to reflect the view of outsiders who don’t seem to understand how a welfare-economics water system works.

Allow me first to say I am a fan of Zetland’s market approach to water and his blog  When Zetland solicited for informal peer reviewers for his book, I responded.  I don’t come near the qualifications of either the book’s author or its reviewer.  But I have been swimming inside the fish tank of California water and energy issues for some time.  Others have been pressing their nose up to the glass of California water system aquarium to study it from the outside.  As sociologists say: “What you see is from where you sit.”

To Understand Water Pricing, You Need to Understand 2001 Energy Crisis

To understand water pricing and the court-ordered “drought” in California that lasted from 2007 to 2010, you must first go back to the state Energy Crisis of 2001.  This is because, loaded into the cost of wholesale water is the cost to improve air quality conditions in California’s urban air basins.

The original cause of the California Energy Crisis was not Enron, deregulation or cost-based water pricing.  It was the 1996 Environmental Protection Agency’s mandate to clean up urban smog by 2001 or face a cut off of federal highway and education funds. The only way to comply with this federal “mandate” was to shut down old polluting fossil fuel power plants along the California coast owned by Pacific Gas and Electric, San Diego Gas and Electric, and Southern California Edison.  These obsolescent power plants were subsequently divested to private operators and converted to cleaner natural gas fuel power plants.  By the summer of 2002, the San Gabriel Mountains northeast of Los Angeles were not hidden in plain sight anymore behind a curtain of smog.

California was not running out of energy in 2001; it was running out of clear sky.  The real crisis was not energy, but how to pay off the unpaid corporate bonds –- called “stranded assets — on the mothballed power plants. Everybody wanted smog eliminated, but no one wanted to pay for it.  Federal environmental policy became “clean air at any price.” It ended up as energy and water and air pollution credits at nearly any price.

The initial solution to the energy crisis in 2001 was to give a quasi-monopoly to natural gas suppliers, mainly in Texas. The unstated idea was to try to pay off the bonds on the old power plants by loading the extra cost into electricity rates. This policy was erroneously called “deregulation.” It failed. The plug was pulled on deregulation when a Democratic Legislature and governor came into power and replaced it with a system of energy price caps. Energy caps have never worked for very long wherever they have been tried.

Retail electricity prices were eventually capped, resulting in an induced energy pricing fever in wholesale power rates. This bubble in energy prices was intentionally created in an attempt to pay off the unpaid bonds on the mothballed power plants.  But price caps also failed miserably and even resulted in some fatalities due to rolling blackouts.

Finally, some $42 billion in unpaid corporate bonds were rolled into price premiums loaded into long-term energy contracts, mainly to run the pumps for the California State Water Project.  Smog reduction was indirectly paid for by inflated water rates. Not the Public Utilities Commission, the California Energy Commission, nor the Independent System Operator, but the California Department of Water Resources was tasked with these long-term water contracts to pay off the $42 billion bond.

How 2001 Energy Crisis Created a “Drought”

By 2007, a man-made drought resulted from an environmental lawsuit to protect the purportedly endangered Delta Smelt fish in the Sacramento Delta. In 2010, an appeals court ruled that the allegation that the Smelt was endangered was bogus.

By manufacturing a drought, California not only protected a bubble in water rates that securitized the payoff of long-term bonds to reduce smog. They also brought about even higher regional and local water rates. These higher local water rates have not been repealed anywhere in California after the court-ordered drought was ended in 2010.

Loading the cost to clean up the air into water contracts avoided having to go to the California Public Utilities Commission for an electric rate increase, to the state Legislature for a tax increase, or to the voters for approval of a tax increase as required under Proposition 13.  It was a “California Dream come true” for politicians: “Taxation without representation and without limitation.”

Coincidentally, long-term water contracts expire in 2013, when AB 32, the California Global Warming Solutions Act of 2006 kicks in.  In other words, in 2013 California will no longer pay premiums loaded into the price of water to pay off the cost to reduce smog. But a replacement premium will instead be added to electricity rates to pay for the mandatory shift to expensive clean Green Power.

The California Energy Crisis of 2001 ended up loading the huge cost to reduce smog into premiums in water rates.  That, in turn, resulted in the necessity of an artificial drought.  Instead of building more dams, reservoirs and pipelines, the only way left to manage water supplies was by conservation. California had to protect its water-rate bubble, and thus had to squelch any new water development or competitive water markets for more than a decade.

It needed a “sustainability” ideology to legitimate its conservation policy. And it needed an “endangered fish” in the Delta to protect the “water pricing bubble” and hike water rates even higher at the onset of the managed Depression of 2008 and ongoing.

Cities all over California use Utility Users’ Taxes to overcharge for retail water. Anywhere from 5 to 10 percent of these so-called “user fees” are then siphoned into the operating budgets of cities that were imperiled by the Mortgage Meltdown and Bank Panic of 2008.  The bogus Delta Smelt case infused cities across California with taxes during the onset of the national managed Depression.

But neither a “sustainability” nor a “market” ideology has much explanatory power when it comes to understanding real world water and energy pricing in California, where “public goods” are paid for by obscure means.  Public goods such as clean air, water, energy, and artificial jobs programs for water engineers often have to be paid for by muddied-up means because everybody wants them, but nobody wants to pay for them.

California may finally put an $11 billion water bond on the election ballot in 2014, not coincidentally right after the bonds on the California Energy Crisis of 2001 are paid off and California’s Green Power mandate and Cap and Trade laws kick in.

The above interpretation of water pricing in California does not reflect a conspiracy theory.  It reflects that policy makers are often ignorant, or cast a blind eye to the unintended consequences of their actions.  Government often works by “muddling through” problems and jumbling up the price of water, energy and other public goods.

California paid $42 billion to clean the air. It will also be paying about a $5 billion or more annual premium to keep the air clean via Green Power, starting in 2013.  The $6 to $12 billion annual Cap and Trade pollution emissions trading program is mostly a tax to mitigate for lost jobs caused by Green Power.  But Cap and Trade taxes will not go to those most affected: heavy industry, public and regulated utilities, or energy-intensive businesses.  Instead, Cap and Trade will be meted out as a redistribution program to low-income communities to buy votes for political purposes.

This is to be justified on the fictional grounds that low-income communities are disproportionately affected by poor air quality.  But bad air doesn’t honor political boundaries.  By some strange logic, Oxnard is said to have more air pollution than, say, Claremont; or National City more than Carlsbad. Smoggy Visalia, Merced and Fresno would be taxed and the taxes transferred to clean-air coastal low income communities such as Oakland and Richmond. Of course, such a policy will be soundly backed by “science.”

A Water Shortage Problem or a Water Storage Problem?

California doesn’t have a water shortage problem; it has a water storage problem.  One reason is the wide dissemination of a part truth by many of the highest qualified water experts in California. They continue to assert that agriculture uses 75 to 80 percent of the state’s water.

And they are right. But they never disclose that this is only true in a dry year and when water reservoir levels are low.  The State Department of Water Resources states that agriculture uses 42 percent of all system water on average.  In a wet year, agriculture only uses about 28 percent of all system water.  And if total precipitation is considered in a wet year, agriculture only uses about 8 percent of all potential water.

And the only reason that agriculture uses 75 percent or more of all system water during consecutive dry years is that California shifted from big water infrastructure projects to water conservation, partly as a way to pay off the huge cost of cleaning up air basins for the past 10 years, as described above. U.S. Bureau of Reclamation water consultant Bob Johnson states that California only has about half a year of water storage in both the federal and state water systems, combined, even during a wet year.

California is considered a state in perpetual drought. But in 1998 — a wet year — rainfall and imports totaled 335 million acre-feet of water, or enough water for 670 million urban households or about 1.675 billion people; or 335 million acres of farming. And 64 percent of this water went to the environment, not farms, not industry not cities or suburbs.

And agriculture and industry, not urban cities, conserved 6.65 million acre-feet of water, or enough for 13.3 million urban households or 6.65 million acres of farming. In a dry year in California, such as 2001, there was “only” 145 million acre-feet of rainfall and imports, or enough for 290 million urban households or 145 million acres of farming (source: Cal State University Stanislaus). The problem is capture, storage and treatment — not drought, waste, the amount of water used by agriculture, global warming, or even population growth.

There is a lack of “abundant water” in California. But it isn’t due to a shortfall of water, but a diversion of water pricing to pay for cleaning up smoggy air basins, massive artificial jobs programs and political patronage.  Water has been “energized,” “smogified,” “fishified,” “siphonaged,” and “politicized” in California.  In California, water keeps the welfare state liquid.



Write a comment
  1. Stanley K.
    Stanley K. 25 July, 2012, 12:40

    This article is a “must read.”

    Reply this comment
  2. us citizen
    us citizen 25 July, 2012, 14:22

    Great article! After the down pour of 2010-11….I think……the rates should have gone down and didnt. Now we know why. And the consumer is being screwed once again.

    Reply this comment
  3. David Zetland
    David Zetland 26 July, 2012, 07:47

    Hey Wayne:

    1) Thanks for the plug. The book is $20, btw.

    2) Can you document how $42 billion was loaded on the SWP? Somehow I don’t think that MWDSC, which buys half the SWP water, would pay $21 billion over those dozen or so years.

    3) precip is NOT the same as runoff. As you know, California averages about 40MAF of runoff per year. In 1998, there was about 330MAF of precip but only 54MAF of runoff (, so you need to stick with apples, not oranges.

    4) We disagree on this, but storage is NOT the problem in California. It’s demand greater than supply.

    Reply this comment
  4. Tom Tanton
    Tom Tanton 26 July, 2012, 07:50

    A distinction needs to be made, for an even greater understanding, between water markets and energy/electricity. We did NOT havea an “energy crisis” in California in 2000/01, we had a “capacity crisis.” That stemmed from the fact that supply and demand for electricity has to be instantaneously and perfectly balanced even second of every day…not so much water if we’d just build some more surface storage and transfer facilities. Also, minor point, but many of the power plants along the coast that were divested, were fully amortized at the time.

    Reply this comment
  5. Kakatoa
    Kakatoa 26 July, 2012, 09:24

    Tom and Wayne,

    Thanks for providing some context to what has led to the rather high electrical costs at the large ISO’s over the years. On the water delivery front it is my understanding that about 20% of the electrical energy used in the state is to move water around the state. What I am a bit unsure of is who actually picks up the tab for the power to move the water. Are the costs spread across all the citizens of the state, i.e. does it come out of general funds, or is their an allocation to the specific water districts that actually use the water?

    I am on a well so I get to pay for the electrical power to pump my water (and maintain the system). It would be nice if I was in SMUD’s territory vs PG&E’s as they have a residential rate schedule that takes into account the need for electrical power for well owners. PG&E on the other hand does not adjust their baseline quantities for those of us that have sustainable water delivery on site. Each time PG&E drops the baseline in our territory the cost for me to keep all my fruit trees, roses, and grapes alive goes up. It’s kind of a pity the powers that be will pay some of the large private forest firms to manage their acreage- i.e. carbon credits, but they will penalize (reduced baselines) those of us take action to improve the carbon sequestration on our properties.

    Oh well, I guess the plan is to have me stop doing what I am doing and move down into a more temperature climate zone and live in a high rise. That way when my wife and I do our laundry, in the communal laundry facility, our energy usage will not show up on our personal Kwh/month/year billing metric that folks like to keep track of. Short term on the laundry front I guess we can just go back to the old fashioned way of drying clothes- hang them out in the summer. There is no way I will consider putting the infrastructure in to get propane to our laundry room, so I could stop using electrical energy, unless I can come up with some estimate of what the cap and trade program will add to the cost of a gallon of propane! I would consider it if natural gas was available where I live…….

    Reply this comment
  6. Wayne Lusvardi
    Wayne Lusvardi 26 July, 2012, 10:47

    Reply to Tom:
    You agree we did not have an energy crisis in 2001. The “capacity crisis” you mention of imbalanced electricity could be interpreted as part of the making a price bubble, whether intentionally or unintentionally.

    As to your statement that the mothballed power plants were fully amortized, when Gov. Schwarzenegger asked the DWR to float a $42 billion bond to pay off through long term water contracts that was for what? I believe it was for stranded assets.

    Reply this comment
  7. Kakatoa
    Kakatoa 26 July, 2012, 11:26


    It appears that some DWR bonds are being paid back by the three ISO’s as noted below-

    . “Overview
    This decision implements cost recovery of the revenue requirements of the California Department of Water Resources’ (DWR) relating to its power purchase program pursuant to Assembly Bill 1 of the First Extraordinary Session (Stats. 2001, Ch. 4), hereafter referred to as AB1X. On November 5, 2001 DWR submitted to the Commission a revenue requirement of $10,003,461,000, representing the total to be collected from utility customers of the three major California utilities covering the period from January 17, 2001 through December 31, 2002. On February 21, 2002, DWR sent a letter concluding that certain adjustments, totaling $958 million could be made to its pending revenue requirement. The revisions provided by DWR reflect comments from parties in this proceeding, and corrections to mathematical errors and calculations in DWR’s prior submittals.

    In this decision, we determine how DWR revenue collections are to be allocated among the customers of the three major California electric utilities: Pacific Gas and Electric Company (PG&E), Southern California Edison Company (SCE), and San Diego Gas & Electric Company (SDG&E), and we establish procedures to implement the collection process. DWR will collect its revenue requirements through charges remitted from billings to retail customers of the three major electric utilities based on designated per-kWh charges as set forth in this decision. We allocate the total DWR revenue requirement among each of the three major utilities’ service territories as follows:1

    Utility Revenue Allocation % Allocation

    $ 4,507,238 49.8%

    $ 3,553, 841 39.3 %

    $ 984,383 10.9%

    Reply this comment

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