Briefing Report: The Electric Kool-Aid Acid Test - Energy-Intensive Manufacturing Meets CA's High-Cost Energy

Wednesday, March 3, 2010

Introduction

Wise states and nations protect and nurture their private sector manufacturing facilities. They know that a significant percentage of manufacturing jobs are high-quality, well-paying jobs that help anchor local and regional economies. Traditionally, they tend to be longer-term in nature. Job gains or losses in manufacturing are not like gains or losses in other sectors. They create intangible ripple effects - for good or bad - which are greater than the mere arithmetical summation of employment, wages and output.

Even in the best of times, manufacturers must respond rapidly to a constantly shaken cocktail mix of requirements, risks, and opportunities. These include newly promulgated regulations, soaring resource costs, and emerging technologies, markets and competitors.

Of course, these are anything but the best of times. The situation is more fluid, dynamic and intensely competitive than ever.

And for a decade, even before the current recession, California has been hemorrhaging manufacturing plants and jobs at a dizzying rate due to its disastrous business climate.

Energy: Job Builder or Job Killer?

In recent years, the Milken Institute and other researchers have compared California’s soaring cost of doing business with that of other states, including Texas - our vigorous and increasingly successful rival for high quality jobs.

Predictably, these studies identify California’s high tax burden and labor costs as huge problems for all businesses.

But manufacturing, far more than other sectors of the economy, has a unique vulnerability due to its dependence upon energy. How dependent? According to the State Energy Commission, with approximately 50,000 industrial plants and associated businesses, California ’s job-producing industrial sector consumes 15 percent of the state’s total electricity and 50 percent of its natural gas.1

Typically, the energy cost for energy-intensive industries averages nearly five percent of their total annual operating costs.2

And what is the significance of this dependence?

Only one honest conclusion can be drawn when considering that California’s energy costs are 45 percent higher than the national average and 80 percent higher than the western regional average.3

Energy is involved - a little or a lot - in nearly every phase of every manufacturing process. Therefore, any increase in the cost of energy (electricity, natural gas or oil) generates a repetitive, cumulative cost pressure. The accumulated pressure could double the price of raw materials, which must be extracted, then processed into usable form. Or it could double a fabricator’s cost of firing its production ovens.

With little margin left for maneuvering, manufacturers feel these cost pressures almost immediately and have limited options for resolving them. Consumers hold the trump cards in a devastated economy characterized by weakened demand and ever-fiercer competition for remaining customers, who expect to see the same manufactured goods available for the same prices. Indeed, in some areas of the economy, manufacturers find themselves sandwiched between inflationary energy-driven cost pressures upstream and deflationary cost pressures downstream.

The Consequences

So how do California manufacturers respond to this growing crisis?

Most have been investing in power monitoring and management technologies. These systems help minimize non-productive energy use and help fine-tune shifting production to off-peak times. They also help identify those energy-hungry components, which most need to be replaced by newer, more efficient components.

But when energy prices soar as they have in California - especially in conjunction with the other factors in the state’s poor business climate - energy efficiency and reduction alone cannot resolve the cost pressures.

Eventually we see the hits on personnel - wage freezes, benefit cuts, and finally layoffs. If the firm still cannot regain and maintain a competitive edge, corporate headquarters begins contemplating moving production to areas outside California where the power supply is cheaper. When those plants leave, they don’t return. Neither do the jobs they provide or the tax revenues lost to state and local governments.

Why So Expensive?

Global pressures are driving up energy costs in general, but why are California’s energy costs so much higher than its neighbors?

In California, we manage to turn the law of supply and demand on its head. For example, peak demand in California is an extraordinary 13 percent lower than peak demand the same time last year. Despite the plummet in demand, brought about by the economic recession, energy prices still managed to increase.4

Most of our wounds are self-inflicted due to our energy and environmental policies.

Renewable energy, especially electricity generated from solar technology, tends to be considerably more expensive than electricity derived from natural gas-fired powerplants. According to Severin Borenstein of the UC Energy Institute, if you throw out the state and federal subsidies and tax credits, solar power’s long-run average production cost is 25-30 cents per kilowatt hour (kWh) as compared to approximately 10 cents per kWh for an advanced combined cycle natural gas-fired plant.

Much of our woes come from the existing Renewables Portfolio Standard (RPS) program, which mandates that, by 2010, at least 20 percent of the electricity sold by our investor-owned utilities must come from qualifying renewable generation sources. We are behind schedule on meeting that standard.

Last year the Legislature passed SB 14 (Simitian), which would have increased the RPS standard to 33 percent by 2020. The Governor vetoed the measure, but not because he dislikes a 33 percent standard. Indeed, after the veto, he issued an executive order to the State Air Resources Board to unilaterally implement a 33 percent standard through regulatory fiat. And the Legislature will probably pass another 33 percent RPS bill in 2010.

The California Public Utilities Commission (CPUC) recently issued a report on the ramifications of implementing a 33 percent RPS goal. Their best-case scenario would result in a seven percent premium in electricity rates beyond the existing RPS mandate’s already high baseline estimate.5

This premium would soar if an expanded RPS program also includes any restrictions on importing less costly renewable energy from our neighboring states. Senate Bill 14 contained such restrictions and would have allowed the total cost of renewable-based electricity to exceed the CPUC-established market price benchmark by between $1.3 and $1.6 billion for the three large privately owned utilities.

Conclusion

About 1.3 million Californians still hold manufacturing jobs (about nine percent of total payroll employment) - even after the loss of 103,400 manufacturing jobs in 2009. As recently as 2000, manufacturing accounted for 12.8 percent of all payroll jobs in the state. California manufacturing pays an average wage of $66,200. And, according to the Milken Institute, workers in the state’s "five best-paying manufacturing industries - three of them in high-tech manufacturing - earned more than $100,000 annually on average."6

If this state is going to recover from its economic flat spin, policy makers are going to have to save those jobs and that requires making energy more affordable and reliable, not less so. The wrong decision on the next modification to the RPS program could deliver the coup de grâce to manufacturing in California.

Perhaps the wiser option would be a legislative moratorium on all renewable energy mandates until the economy recovers. History has taught us that only prosperous nations possess the discretionary income required to support aggressive environmental initiatives. A healthy environment depends upon a vibrant economy - so do the manufacturing jobs that sustain families, communities, states and nations.

 

1 2009 Integrated Energy Policy Report, California Energy Commission, December 2009, CEC-100-2009-003-CMF
2 U.S. Energy Information Administration
3 U.S. Energy Information Administration
4 "Western Price Survey," California Energy Markets, Energy NewsData Corp., February 19, 2010, Volume 1066.
5 33% Renewables Portfolio Standard Implementation Analysis, California Public Utilities Commission, June 2009, p. 1.
6 California Manufacturing and Technology Association (February 2010)

 

For more information on this report or other Energy, Utilities and Communications issues, contact Wade Teasdale, Senate Republican Office of Policy at 916/651-1501.