Deregulation hit Canada with a jolt in recent months after Alberta surged ahead with its program that many considered premature and risky. With California's electricity crisis casting a long shadow to the north, Alberta became the first province to deregulate power as of January 1 this year. Canadian experts had touted deregulation as a market panacea that would create greater competition, lower power prices, encourage more suppliers and additional generation-pretty much the California mantra. Instead, deregulation is turning into a Pandora's box of errors and misjudgments, although the problems have stopped far short of California's multibillion-dollar policy disaster. A confidential industry document compares the two jurisdictions and concludes, "California is in serious trouble [while] Alberta's response is more positive and its prospects are better." Nonetheless, Alberta's problems are significant. Before deregulation it cost just C2 cents to light a 100-watt bulb for 10 hours. Now that cost has skyrocketed to C13 cents-an astonishing 650% hike. A province that once boasted having one of the lowest electricity costs in North America got zapped with the flip side of economics: quickly rising prices. The overall insecurity caused by high energy prices has burned Albertans' patience. "We want a policy that works. The rules are unclear," says Dan McNamara of the Industrial Power Consumers of Alberta. Matt Irving's family has owned and operated Foothills Steel Foundry in Calgary for more than 80 years. Power prices are critical to the foundry's success, and Irving knows the price of power every moment of the day. Now, high costs are killing his profits. "They need to put in some kind of incentive for businesses like us to run," says Irving. "We don't want a subsidy. We aren't asking for taxpayer money." Anger surged as a provincial election approached on March 12, and the oil-rich government brought in power price caps and retail customer rebates. During the campaign, which ultimately saw Premier Ralph Klein's conservatives win handily, Liberal chief Nancy MacBeth hammered away at what, in her view, remains a doomed experiment. After a french-fry plant scrapped its expansion plans because of high heating and electricity costs, MacBeth said, "This is just the tip of the iceberg. This is a made-in-Alberta problem by the Tory [Conservative] government." But Klein had already subsidized electricity rates-as well as home-heating costs-using the province's abundant oil and gas revenues. He won a huge majority, 74 of 83 legislature seats, reducing MacBeth's party to impotence. The reality is that high gas and power prices cannot be blamed on deregulation. For years, many environmentalists clamored for gas-fired generation over coal or nuclear power. While gas burns cleaner, it now costs more, thanks to insufficient supply and huge demand. That will only continue until the vast volumes of untapped gas in the Northwest Territories, Beaufort Sea and Alaska are brought on stream. Uncertainties over deregulation occurred just as gas prices increased due to a continental gas deliverability shortage. New pipeline capacity expanded the market for Canadian gas producers who now receive American prices for their product. Demand, deregulation collide During the last five years, as Alberta's economy and population have escalated, so has electricity demand, on average 2.7% per year, or 16.1% in the period. Yet supply has increased barely half that much, 8.1%. One might argue that the problem of unforeseen demand growth was caused partly by the provincial government if its policies nurtured an economic boom. But the failure to correctly forecast electricity demand wasn't an Alberta government-or even California-driven-phenomenon. "A key feature of North American power markets during the last several years has been a consistent underestimation of demand growth by the agencies that monitor and predict industry trends," says a new survey on power markets by Calgary investment banker FirstEnergy Capital Corp. Both Alberta and California experienced substantial demand growth-generation capacity simply failed to keep up. Another feature was the convergence of gas and electricity markets, due primarily to environmental regulations and technological innovations. Alberta shared some of California's traits on the demand side. E-commerce caused higher electricity usage and prices with personal computers running at home and in the office, while servers operate 24 hours a day, every day. Most of all, demand for gas took off just when supply fell flat on both sides of the Canada-U.S. border. "There's a whole series of events that nobody has ever seen before, all happening at the same time," says analyst Martin Molyneaux of FirstEnergy Capital. Looming over everything was the restructuring of the entire electric industry throughout the continent, with much of the U.S., as well as Alberta and Ontario, opting for some form of deregulation. "The majority of North American power markets are undergoing fundamental change as the industry shifts from a centrally planned model, dominated by integrated utilities, to a more decentralized model with a wider array of participants," notes the FirstEnergy report by analyst and engineer Dennis Lawrence. Today most industry players look beyond the political to the practical, explaining, as Epcor Utilities chief executive Don Lowry does: "Deregulation is not the issue. Industry restructuring is." From his vantage-point in Edmonton, Alberta's capital, Lowry sees the power industry being reshaped by the new digital economy, the emergence of gas as the preferred fuel for power, and varying government and regulatory intervention. Restructuring has become ad hoc, with "no Canadian national or U.S. federal authority setting top-down direction," he said in an industry presentation. "We are in a period where there is tremendous opportunity for creating or losing value," adds Lowry. "Abnormal prices become normal." Alberta's deregulation imbroglio started innocently enough in 1995, just like California's. Both decided independently that electricity industries deserved to be deregulated. Both adopted power pool structures, with Alberta opening its wholesale market on January 1, 1996, and the retail market exactly five years later. California's wholesale and much of its retail market started April 1, 1998. Both jurisdictions enjoyed an abundant supply of electricity when they began changing the rules. Yet prices in California were high, while those in Alberta were low, thanks to plenty of low-cost, coal-fired electricity generation. Both have since encountered substantial demand growth, which they haven't been able to meet. Nor were they able to create enough new capacity to alleviate the growth. Alberta and California also experienced relatively low wholesale prices until mid-2000 when demand exceeded supply. They have borne high pool prices since the summer of 2000, and they import from British Columbia during peak times to mitigate the scarcity. Each faces complaints of anticompetitive price fixing, even though investigations are on-going and no wrongdoing has yet been found. California imposed a four-year freeze for all consumers to April 2002, while Alberta set a residential cap to the end of 2001. Distribution utilities in both places ran up huge deficits, as the cost of wholesale power far outstripped revenues from regulated retail rates. California's utility giants, Southern California Edison and Pacific Gas & Electric , now teeter on the brink of bankruptcy because they've been forced to buy power at spot prices rather than having the market freedom to hedge their costs. Too, state law prevents them from passing their exorbitant supply costs on to consumers. Consequently, California also dropped the pool price cap, expecting to see a sharp decline in wholesale supply costs. Instead, power suppliers stayed away, pursuing higher market prices elsewhere. Freezing wholesale and retail power prices has exacerbated market uncertainty, creating a status quo of complete chaos, and preventing any major investment into new supply. "It creates little or no incentive to add additional capacity," says Peters & Co. chief executive Michael Tims. "The worst possible outcome is being where California is, in no-man's land between deregulation and a fully regulated environment." Alberta's providers were far more fortunate, first because most of the distributors hedged their prices in 2000 and 2001. (A few, like Atco Gas, didn't, and big deficits resulted.) Supply to the rescue? Already, PanCanadian Petroleum , Nexen and Calpine have each announced new gas-fired electricity plants that should be on-stream in 18 months. Alberta hopes to fast-track some of the numerous new generation proposals, although they must go through the Alberta Energy and Utilities Board first. During the next two years, the province expects another 2,000 megawatts to hit the power grid, whose current capacity is 6,100 MW-a small sum when placed next to California's 250,000 MW. (Alberta's population is just over 3 million compared with California's nearly 35 million.) Many of the short-term projects proposed are gas-fired, while the costly long-term ones will make use of the province's abundant coal. What about gas supply? This past year was the most active gas drilling time in Canadian history, and the Petroleum Services Association of Canada (PSAC) predicts 2001 drilling activity will be even more robust, with some 10,300 gas wells expected out of a total estimate of 17,500 for the year. It's still not enough. "We need more drilling and it will take time for producers to catch up to where demand is heading-a minimum of two years, and as much as five or six," notes Molyneaux. The Canadian energy industry remembers when gas was deregulated in 1985 and stresses that any major initiative takes time. As of today, the new power generating projects that have been announced will more than fill demand if even the most optimistic of Alberta's rosy economic forecasts comes true. The province has assured utilities that they will be able to collect their costs, and has committed C$4.1 billion in rebates to compensate consumers for high electricity and gas prices. (For a government that ran an astonishing C$7.3-billion surplus last year because of oil and gas royalties, the damage isn't severe.) "Under the terms of the province's newly restructured market, the spot price in the Power Pool of Alberta is set by the marginal capacity, which will be gas fired," says FirstEnergy's Dennis Lawrence. "As a result, the Alberta power market will continue to be dominated by coal and gas generating capacity." Yet even the smaller plants won't be generating electricity for 18 to 24 months, and higher costs will continue until then. "There is little doubt that we will remain on the verge of a crisis for at least a couple of years," concludes the confidential industry document. That's another reason why Premier Klein intends to introduce an energy-shielding program that will protect all kinds of consumers from the shock of rising gas and electricity costs. His shielding program is only one of several plans he says he will implement after his election victory. Klein also hopes to gather all the stakeholders-energy producers, environmentalists, consumers and business-to discuss long-term energy use. He's upset by the entire deregulation process, and blames much of it on unforeseen problems like massive growth, the high price of gas, broken generators, and the Kyoto Accord's implied effect on coal development. "I didn't want it to be that way," he says. "Who in their wildest dreams would think deregulation would come in the middle of all this?" His government could have delayed deregulation, but that would have precipitated another set of problems for companies planning to invest in new plants, he adds. "What makes me mad is the bloody hypocrisy of the [opposition] Liberals. They supported deregulation and they knew the timelines." While the politicians snipe, solutions are as scarce as new generation-for the short-term, there aren't any. It wasn't supposed to happen like this. In 1997, then-provincial energy minister Steve West boldly predicted, "You can't give people electricity too cheaply. I am very confident we can lower the cost to the consumer." The government passed its deregulation Bill 27 in 1998, and the troubles began. Today, West looks at the mess and wishes the government had deregulated earlier, in 1993. "There are things that were put off that should have been done," West told the Calgary Herald recently. "There are things in the energy industry and yes, it would have been better to get this thing started in '93 and send the right signals when we had 50-something-percent surplus power." Instead, just when the province implemented deregulation, everything shorted, and the whole plan began to fizzle. The province couldn't have forecast long-term weather patterns, or foretold the highest oil, gas and electricity prices ever. In short, the government was a victim of its own success, an economic climate second to none in the nation. The province was booming with record growth and revenue. Yet it is this very revenue that has helped soothe the painful burn of high energy prices. "People have to realize that the province is a huge net winner on this, even though customers' wallets will be thinned out," adds Molyneaux. "The net long-term is enormous over 10 years." "We're in and committed to deregulation," notes Tims. "The key point is that in Alberta they're allowing prices to generally rise to market levels, while providing short-term rebates to cushion impact." That very rise to market levels has created the incentive for new supply to be developed, and the power shortage should be corrected during the next few years. Prices will only rise until supply comes online. "Even with the projected additions, the province is likely to stay in a relatively tight supply-demand situation for the next several years," states FirstEnergy's report. It points to a number of factors that could increase Alberta Power Pool prices in the short-term: "reduced hydroelectric capacity in the Pacific Northwest, price manipulation by market participants, and political interference." The study concludes that Alberta will continue as "an attractive investment arena" for power generators and companies quick on the up-take with innovative projects. Since 93% of all new Alberta electric projects are gas-fired, some obvious winners are emerging from this restructuring muddle. There are those with existing generation and those that can quickly add capacity, like TransAlta Corp., TransCanada PipeLines , Maxim Power and Canadian Hydro Developers . Any gas-weighted E&P company will do exceptionally well too, such as Alberta Energy , Anderson Exploration , Bonavista Petroleum , Canadian Hunter Exploration , Rio Alto Exploration , Paramount Resources , Penn West Petroleum , Petromet Resources and Shell Canada . One thing remains absolutely certain in all this deregulation uncertainty. "We can't go back," explains Molyneaux. "We have to live in a deregulated economy and let the free market forces move us forward." There's no coaxing the genie back into the bottle. It's out on the transmission lines and dancing up a storm.