News Release

July 10, 2001

Cato issues comprehensive report on California energy crisis
Deregulation, environmentalists not to blame; more government control not the cure

WASHINGTON-Skyrocketing electricity prices and threats of brownouts and blackouts in California have led to a political war over who is responsible. Liberals like Gov. Gray Davis blame corporate price gouging and the state's 1996 "deregulation" of the power industry, while conservatives argue that overly restrictive regulations pushed by environmentalists coupled with the imposition of a centrally controlled power spot market are the culprits. But a new Cato Institute study reveals that both sides are wrong-and worse, both are wrong about what to do about the problem.

In "California's Energy Crisis: What's Going On, Who's to Blame, and What to Do," Cato scholars Jerry Taylor and Peter VanDoren argue that the real cause of the price spike of power in California was not state policy. Instead the cause stems from a "perfect storm" of high regional natural gas prices, a large drop in hydroelectric power from dry weather conditions, and a demand shock due to the unseasonably warm summer of 2000. These factors were then exacerbated by air pollution regulations and retail price controls.

Taylor and VanDoren find that "the 1996 restructuring law has little to do with the run-up in wholesale power prices," although its retail price caps caused the blackouts by preventing utilities from passing on fuel costs to consumers, thereby keeping demand high. "Virtually all the increase in wholesale prices can be explained by increases in production costs and overall scarcity," they write. "Although market manipulation may be present, it is not the fundamental cause of the crisis." Environmentalists aren't either, according to Taylor and VanDoren. "Environmentalists were a relative nonfactor in generator investment decisions in the early to mid-1990s, and they scarcely played any role in blocking new capacity in the months leading up to the crisis," they argue.

Taylor and VanDoren examine the gamut of proposed reforms for California's energy crisis, from price controls to public ownership, and find that "few if any accurately diagnose the problem or treat anything beyond the superficial economic symptoms of the underlying disease." The scholars call for the elimination of retail price caps to promote consumer price responsiveness and voluntary conservation. "Given the inelasticity of both the supply and the demand side of the electricity market, even moderate reductions in demand, as a result of freeing prices, would have a major effect on wholesale prices," they write. As the demand problem comes from peak use, Taylor and VanDoren also call for the institution of real-time pricing. "The simple fact is that high prices for power must be paid," and it's better to let supply and demand set those prices than short-term political considerations, they say.

"California's Energy Crisis: What's Going On, Who's to Blame, and What to Do"