California Blaming - electric utilities and deregulation - Brief Article

Chief Executive, The, April, 2001 by Sally C. Pipes

"Capitalism is falling apart," emotes the Los Angeles Times' left-wing columnist Robert Scheer, who references California's power problems as exhibit A. "The result [of deregulation] is now bordering on the catastrophic, with utility companies demanding enormous rate increases or they will declare bankruptcy."

"The experience raises questions about deregulation," warns MIT economist and New York Times columnist Paul Krugman. "And more broadly, it's a warning about the dangers of placing blind faith in markets."

Liberal columnists and economists aren't the only ones piling on. PaineWebber chairman Donald Marron recently told CNBC that California's energy market needed to be re-regulated. But there's another view. "The idea that we were deregulated is preposterous," says Stephen L. Baum, CEO of Sempra Energy, parent of San Diego Gas and Electric.

Baum's right. Deregulation didn't cause California's crisis, since the state's energy market was never deregulated. Scheer's cry that utility firms are "demanding enormous rate increases," should be evidence enough, since companies operating in a free market, such as gasoline firms, don't demand "rate increases." There's no one to demand one from.

The details of California's crisis, rooted in basic supply-demand economics, are too numerous to list. (From 1996 to 1999, power usage increased by 12 percent, while supply increased by a mere 2 percent, since not a single new power plant was built in the last decade.) But California's fiasco is hardly a cautionary tale for real deregulation and the efficacy of free markets. It is, however, a cautionary tale for executives signing on to half-baked command-and-control market hybrids flying under the flag of free markets.

Prior to 1996, the majority of Californians bought power from investor owned utilities operating under standard cost-plus regulations. For reasons ranging from bone-headed investments to forced contracts with "alternative energy" suppliers, expensive power was depressing the local economy. In 1996, the legislature passed unanimously, and Republican Governor Pete Wilson signed what was billed as a new energy law. Astute observers knew it was nothing of the sort.

In a free market, the prices of both the power bought and sold by utilities are set by the interplay of supply and demand. The 1996 bill capped consumer prices, while freeing the whole sale prices utilities paid for power. And they'd need to buy a lot of power, since the law forced the state's investor-owned utilities to sell most of their generating plants.

In a free market, companies often decide to negotiate contracts to ensure long-term supply. Under the California law, state regulators at the Public Utilities Commission (PUC) refused to allow utilities to enter into long-term contracts for power delivery. They wanted to ensure a high volume on the only spot market on which they allowed utilities to buy and sell. They also worried that the deals large utilities would negotiate would be so sweet they'd prevent other firms from entering the market.

In March 1999, Edison asked per mission to contract for 10 percent of its peak demand power. In July 1999, the regulators turned Edison down. "You just can't allow any contract," said PUC President Loretta Lynch.

Not that they're inflexible. In December 2000, regulators decided that utilities could enter into contracts for $.06 per kilowatt-hour. By that time, prices were hovering at $.25 per kilowatt-hour.

There's one other attribute critical to a free market. When resources become scarce, prices increase and consumers have an incentive to conserve, find substitutes, or, in the case of power, fight advocacy groups working to block the building of power plants. Yet with price controls in place, the wholesale price of power didn't affect anyone's final bill, and therefore they kept the lights, air conditioners, and computers on.

So after the government caused the fiasco, albeit with assistance from shortsighted utilities that welcomed the scheme, politicians promise to play an even larger role in the energy sector by actively buying and selling power. Liberals have long-dreamed of statewide public power in California as they have sought to discredit deregulation of anything. At least California's so-called deregulated market gave one group something it wanted.

Sally Pipes (spipes@pacificresearch.org) is president of the Pacific Research Institute for Public Policy, a San Francisco think tank that analyzes national economic and social problems and proposes solutions.