Associated Press

SAN FRANCISCO — No stranger to sequels, California Gov.-elect Arnold Schwarzenegger hopes to sell the state on the virtues of electricity deregulation for a second time, despite the expensive legacy of the first attempt.

Schwarzenegger’s energy advisers say they will bring a fresh approach to deregulation this time, avoiding the past mistakes that led to rolling blackouts, insolvent utilities, market manipulation and a $20 billion debt customers must spend the next decade repaying.

“We have a system that is broken, with pieces laying on the ground that need to be picked up and put back together again,” said James Sweeney, a Stanford University professor and Hoover Institution fellow who helped write Schwarzenegger’s energy plan.

Deregulation critics are unnerved by Schwarzenegger’s proposal, arguing it would expose California to major risks at a time the financially strapped state can’t afford to gamble.

“It looks like he wants to put us back on the roller coaster of a very dangerous experiment,” said Public Utilities Commissioner Loretta Lynch, who dealt with lights-out turmoil that tormented California in 2001.

In his campaign, Schwarzenegger depicted electricity bills as a huge drag on the state’s economy – something he now thinks he can change by loosening energy regulations after he is sworn in as governor.

“High energy rates are an unacceptable burden for people who live and do business in California,” Schwarzenegger says in his energy policy statement on his Web site, joinarnold.com. “And the current bureaucratic rules are making the crisis worse, instead of better.”

Schwarzenegger aides say his proposed reforms are mostly the work of three men:

Stanford University‘s Sweeney, who wrote a 2002 book analyzing California’s electricity crisis; Sean Randolph, president of the San Francisco-based Bay Area Economic Forum, a group that represents business and government interests; and Lawrence Makovich, a senior director for Cambridge Energy Research Associates, a Massachusetts research firm.

The men met with Schwarzenegger for more than two hours last month and then drew up an energy policy based largely on their recent research, Sweeney and Randolph said in interviews. Makovich didn’t return a message.

Based on what Schwarzenegger has disclosed so far, “it’s an encouraging plan, one that seems to be very forward looking,” said Severin Borenstein, director of the Energy Institute at the University of California at Berkeley. Borenstein isn’t working with the Schwarzenegger administration, but is listed in the acknowledgments of Sweeney’s book.

It’s unlikely electricity deregulation will be at the top of Schwarzenegger’s agenda. He’s got an $8 billion budget deficit to deal with, and may have to defeat a legislative bill and a ballot-box initiative proposing to re-regulate the state’s electricity market.

Still, California will probably need to adopt more reforms before Schwarzenegger’s term expires in 2006 to lower the highest electricity prices in the continental United States and address an inadequate power supply, Borenstein said.

The first package of market reforms were signed into law in 1996 by then-Gov. Pete Wilson, now a key Schwarzenegger adviser. They were hailed as a way to lower prices by fostering more competition and investment in the state’s electricity market. It didn’t work out that way.

Through June, California households paid rates 44 percent above the national average and 64 percent above the average in 10 neighboring Western states, according to the most recent data from the U.S. Energy Information Administration.

The disparity is even greater for California businesses, with average rates 57 percent above the national average and 91 percent above the 10 neighboring Western states.

Unless California’s electricity price gap is narrowed, Schwarzenegger’s energy advisers say, more businesses will flee the state or curtail growth to save money.

Despite a spate of construction in recent years, California still lacks enough power plants to meet its long-term needs. And without more market incentives to expand its generating capacity, energy shortages could hit between 2006 and 2008, forcing the state to pay even higher prices to import energy.

Schwarzenegger believes a new and improved round of deregulation will avert another electricity shortage and eventually drive down the power bills for many customers, especially businesses.

Details remain to be worked out, but the Schwarzenegger plan envisions an electricity market where customers pay a little extra to provide generators with an incentive to build more plants and increase the state’s reserves.

To lower their costs, big businesses would be allowed to buy power from other sources besides California’s major utilities, probably after paying some sort of “exit fee” to help pay the bills left over from the state’s first foray into deregulation.

Major power customers also would be forced to install new metering equipment so they could be charged higher prices during periods of peak demand, like hot summer days, and lower prices in periods of low usage, like the middle of the night.

Meanwhile, most households would still get power the old-fashioned way – from the closely regulated utilities Pacific Gas and Electric, Southern California Edison and San Diego Gas and Electric.

The month-to-month prices for homes wouldn’t fluctuate much, except in unusual circumstances. Schwarzenegger’s advisers say there must be greater flexibility to raise retail rates whenever wholesale costs soar to encourage more conservation and assure the financial stability of utilities.

Because the wholesale electricity market is overseen by Federal Energy Regulatory Commission, Schwarzenegger also is promising a better relationship with that agency, which frequently clashed with the administration of recalled Gov. Gray Davis.

Schwarzenegger hasn’t taken a position on the $9 billion that California Democrats say power generators overcharged the state by manipulating the market rules created in 1996. FERC has ordered $3.3 billion in refunds; California’s suit for an additional $6 billion is before a federal appeals court.

Lynch, a Democrat appointed by Davis, is worried Schwarzenegger won’t push for the refunds, which could lower future electricity bills. She depicts Schwarzenegger’s blueprint as a rehash of the Wilson administration’s old ideas. “It’s a bunch of market ideology that ignores all the facts that we have learned in the past eight years,” Lynch said.

The architects of Schwarzenegger’s plan say it’s unfair to compare it to the 1996 reforms.

Those reforms were so flawed and mismanaged by the Davis administration that they gave deregulation a bad name, they said. Deregulation proponents say market reforms are working much more smoothly so far in states such as New Jersey, Pennsylvania, Maryland and Texas.

Lynch’s PUC term expires in January 2005, opening the door for Schwarzenegger to appoint someone more receptive to his energy policies. Carl Wood, another PUC commissioner leery of more deregulation, is scheduled to leave office shortly before her, at the end of 2004.

Schwarzenegger’s ties to a former PUC commissioner Jessie Knight, a deregulation crusader during his term, has agitated some consumer activists. Knight, a Wilson appointee who fought for more deregulation than the Legislature ultimately approved, is part of Schwarzenegger’s transition team.

Knight “was the best friend that energy producers ever had,” said Mike Florio, a staff attorney for The Utility Reform Network, a consumer group.

Knight, now chief executive for the Greater San Diego Chamber of Commerce, didn’t return phone calls seeking comment for this story.

Doug Heller of the Foundation for Taxpayer and Consumer Rights worries that Schwarzenegger has been swayed by Ken Lay, the former Enron Corp. chief executive who pushed for California’s 1996 electricity market reforms.

Schwarzenegger was among the 12 men and one woman who met with Lay at a Beverly Hills hotel in May 2001. The meeting was organized with the help of then-Los Angeles Mayor Richard Riordan, a Schwarzenegger friend who was a leading Republican candidate for governor at the time.

Heller thinks Schwarzenegger should “come clean” about the Lay meeting before he is inaugurated. Schwarzenegger has said he doesn’t recall the meeting, but appears unapologetic about his Enron connections – his transition team includes a former Enron adviser, Robert Grady, now a San Francisco venture capitalist.

Schwarzenegger’s energy advisers make deregulation sound like a no-brainer that would work under a decisive governor. Given California’s recent history, though, Florio figures it will be an even tougher sell this time around.

“It’s like we blew up the house, then got it rebuilt and now we are thinking about putting some dynamite around the foundation all over again,” he said.

On the Net: Schwarzenegger’s energy plan: http://www.joinarnold.com/en/agenda/#C1