Mishandled Deregulation Caused California's Energy Crisis

2 February 2001

By Stentor Danielson

Pretty much everyone can agree that California's electrical system is a mess. Tuesday was the 15th day of Stage 3 alert, which means the possibility of "rolling blackouts" as utilities are unable to supply enough power to meet Californians' demand. Meanwhile, the companies and the state are running out of funds to buy more electricity from out-of-state.

On Monday, President Bush appointed Vice President Dick Cheney to head an energy task force that will examine the situation in California. At the same time, Bush indicated his thinking on the situation. First, he made the observation that only California can fix the problem. But he followed with a tenuous segue into his plan for increasing domestic fossil fuel production, as if the California crisis somehow justified his larger energy policy. The two actually have little in common.

Bush is correct in placing the solution to the energy crisis in the hands of California. Though they may disagree on whether California's energy market was underregulated or overregulated, commentators on both sides of the debate agree that the present situation stems from the 1996 deregulation legislation. A federal bailout cannot change the law; only the California State Legislature can do that.

Bush and other conservatives are also right in not giving up on California's experiment in deregulation. Consumer advocate and former Green Party presidential candidate Ralph Nader has jumped back into the spotlight, urging re-regulation. Others states, such as Nevada and Arkansas, have begun to have second thoughts about deregulating after seeing the problems in California.

The examples of Pennsylvania, New England and Australia indicate otherwise. These places deregulated properly, creating energy markets that functioned as markets should, leading to cheaper and more efficient energy production. What we see in California is pretend deregulation, deregulation laced with stipulations that prevent the market from adjusting to change as it should.

Bush has taken this opportunity to plug the centerpiece of his energy plan, increasing domestic fuel production. Most controversially, this would involve drilling in the Arctic National Wildlife Refuge. This is not the place to go into the rights and wrongs of such drilling. What is important to realize is that no amount of Alaskan oil would address the real problems with California's energy crisis.

Bush casts the problem as too little supply (the connection to the drop in oil production orchestrated by the Organization of Petroleum Exporting Countries (OPEC) is implied) for too great a demand. But the problem lies in the process it takes to get electricity from the plant to the consumer, not the amount of fuel the plants have to work with. California's crisis is a result of a lack of prophetic ability on the part of legislators, and the conditions imposed by the pretend deregulation.

Certain factors could not be anticipated when deregulation legislation was written. The foremost is the booming economy of the past few years, fueled by the rise of the electrically-powered Internet. When legislators were planning deregulation, they anticipated possible oversupply problems. But the advent of e-business cranked up electricity demand far beyond what anyone would have expected in 1996.

California's rapidly growing population only added to the mess. Neighboring states, like Arizona and Nevada, also grew. Since California imports about 20 percent of its power, greater demand in Arizona and Nevada means less power for California.

More significant problems were caused by stipulations in the deregulation legislation. The two major ones are the price cap and the Power Exchange.

In order to protect consumers, the deregulation legislation imposed a cap on prices that could be charged by utilities. This, however, defeats one of the basic principles that makes a market work. When demand rises or supply falls, prices in an unrestricted market go up. This provides an incentive for consumers to conserve, so that demand once again equals supply.

Higher prices also translate into more money for the supplier. This would encourage more companies to take the risk of investing in California's energy market. Supplies are low because too few power plants are operating. Much of the blame for the shortage of plants rests on uncertainty among investors as to how deregulation would work out.

As it stands now, rising prices for power generation cannot be passed on to the consumer. The shrinking profit margin mandated by the price cap has driven California's utilities into dire financial straits. So they have begun to abuse the California Independent System Operator (Cal-ISO).

Electricity is an unusual commodity in that it cannot be stored. Cal-ISO is an agency set up to make sure supply meets demand. It is authorized to spend far more than the market price to ensure that electricity is supplied. So some utilities would withhold power and wait for Cal-ISO to buy it at inflated prices. The lack of competition that stems from uncertainty about the effects of the deregulation-with-regulations legislation perpetuates the problem. Originally, Cal-ISO was expected to handle five percent of California's power. Lately it has been processing as much as 30 percent.

The second key structure impairing the functioning of California's energy market is the Power Exchange. Utilities in California must buy their power on a day-by-day basis, through the Power Exchange. This system is far more volatile than the alternative of long-term contracts. Utilities in Pennsylvania and other truly deregulated states are able to "lock in" lower prices with long-term, stable contracts.

It is true that the greater fuel supply Bush is peddling would drive down fuel prices somewhat. However, more fuel will not help California produce more electricity. The problem is not that power plants are running at part-capacity due to lack of fuel. The problem is that the uncertainties of deregulation put a chill on new plant construction, preventing supply with keeping pace with demand.

The ultimate solution to California's energy crisis will take months, as new power plants are essential. One new plant was recently approved, but it will not be operational before July. Until then, state legislators need to decide whether they truly want deregulation. If they do, then the unnatural restrictions imposed by the price cap and the Power Exchange need to be lifted. There will doubtless be a painful readjustment period. It may be necessary to provide some sort of aid to those least able to conserve or afford the price increases.

If Bush wants to promote his plan for increasing domestic fuel production, he is welcome to do so. But he should keep in mind that any connection to the energy crisis in California is purely coincidental.

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