Commentary

Prediction: California Power Deregulation Will be a Fiasco

This article appeared in the National Post on January 19, 2001.

While Californians were transfixed by the biennial political circus last fall, the state legislature passed with little notice but much self-congratulation an electricity restructuring law that promises to introduce competition where monopoly once ruled. Electricity regulation, however, lacks sex appeal to all but the most jaded. So, outside the trade press, few Californians realize that a revolution is in the making and big changes are on the horizon. Soon telemarketers will be pestering consumers to change electricity companies. The long-distance telephone wars will come to the power business. And the nation appears once again poised to follow a path blazed by the Golden State. “The Juice is on the loose,” indeed.

By all appearances, then, this is a victory for markets over regulation. Think again. While the advocates of California’s electricity restructuring are wearing the garb and makeup of Adam Smith, they are in truth Ira Magaziners in drag — political cross-dressers selling higher taxes and more regulation under the guise of “competition.”

The need for some kind of regulatory reform, however, is clear. Californians are paying on average 50% more for electricity than is the rest of the country. Electricity-intensive industries are reluctant to locate in California, and those already here would rather expand their operations elsewhere. The current regulatory regime, according to economist C. Wayne Crews of the Competitive Enterprise Institute, is costing California residential ratepayers US$265 a year, commercial users US$1,408 a year and industrial users US$23,486 a year.

Moreover, the electricity industry is collapsing under the weight of bad investments in co-generated power, nuclear power plants and disastrously expensive gambits in renewable energy and “demand-side management.” Ratepayers are increasingly finding ways to circumvent high power rates by getting their electricity services elsewhere. The regulatory centre, so to speak, cannot hold.

By 1994, even state utility regulators realized that something had to been done to save the system. The scheme they hatched is managed competition. The central idea is to force utilities to transmit third-party power under heavily regulated rates and conditions. The privately owned electricity transmission and distribution network (the grid of wood and wire) is to be turned into a public highway with contracts made directly between power generator and electricity consumer. To keep the utility companies from unfairly using their market position as owners of the grid to impede competition, “independent system operators” will control the wires under the direction of governmental agents. Utilities are to be prohibited for five years from selling power to any party other than a central state-managed “power exchange,” which will replace utilities as the retail seller of power to residential consumers. And as a final touch, electricity services must be marketed in an unbundled fashion while electricity companies are forced to sell most — and eventually perhaps all — of their power plants.

Consider such proposals if applied to another retail industry: merchandising. Reformers might well argue that Wal-Mart, for instance, has a de facto monopoly in many small towns; that they refuse to carry all but a few select brands of merchandise (predominantly their house brands); that, in the interest of competition, Wal-Mart should be forced to sell the merchandise of any manufacturer that requests the retail space regardless of economic considerations; that the rates Wal-Mart can charge for those services must be approved by regulators; that the store manager must be independent from Wal-Mart and answerable only to government bureaucrats; that Wal-Mart should be allowed to sell products only to a state-owned retailer; that the Wal-Mart Corporation should be forcibly broken up into several different companies; and that regulators should be empowered to force the construction of additional retail space at any store to accommodate third-party merchandisers whether Wal-Mart approves of the expansion or not.

Are regulators really the thin blue line that separates us from the electricity robber barons? Hardly. According to the California Public Utility Commission, the economic condition of Pacific Gas & Electric, Southern California Edison, and San Diego Gas & Electric is so anemic that, absent a US$28-billion bailout, those companies might well go belly up if forced to compete against the new breed of small, low-cost independent power producers and natural gas companies. So why the worry? Because a bailout is exactly what’s being proposed, and after that, the “monopolists,” we are told, must be carefully watched.

That US$28-billion bailout — to be collected from ratepayers through a new surcharge on electricity transmission — is nothing less than a naked transfer of wealth from Californians to electricity companies. And why? Because the electricity companies possess a great deal of lobbying power and few Californians understand or care enough about electricity regulation to know when their pockets are being picked. And also because of a not-too-small measure of regulatory guilt. After all, restructuring is a blatant (and uncompensated) seizure of corporate assets, and many of the industry’s economic problems stem from ill-considered regulatory orders by the state itself.

While competition is certainly better for consumers than is legally protected monopoly, the regulatory gymnastics embodied in the California restructuring law put even this rule of thumb in doubt. As industry consultant Charles Cicchetti recently said of proposals for managed competition, “Two things should be obvious. First, none of this should be called deregulation. Second, it is difficult to see how any of these myriad regulatory schemes, unless altered significantly but perhaps not fundamentally, will lower prices.”

Proponents of managed competition counter that, since the transmission and distribution grid is a natural monopoly, the only alternatives to mandatory retail wheeling are (1) the current regime, with all its known faults, or (2) unrestrained robber baronry. But the power grid is not a natural monopoly. Before the advent of public utility regulation at the turn of the century, the electricity industry was hotly competitive. Power companies established parallel private grids and delivered power at a lower price than that charged subsequently by the “regulated” monopoly franchises. Even today, several dozen communities, for unique historical reasons, can choose between various power companies — each with its own grid — and those communities find that rates are typically significantly lower than in other communities without such competition. That would not be the case if the natural monopoly diagnosis were correct.

Simply put, there are no longer significant economies of scale in the electricity business. Spot and futures markets for electricity have eroded any lingering monopoly. Advances in micro-turbine technology have made self-generation a viable alternative to the grid and threaten to render central station power generation obsolete. Extensive distribution networks and grids are almost impossible to monopolize by their very nature, and user-owned transmission and distribution facilities are a proven way for consumers to protect themselves against the exercise of monopoly power. Finally, as long as markets are theoretically contestable, monopolists invariably price as if competition were a present reality (that is the reason, incidentally, that Wal-Mart doesn’t jack up prices once its competitors are neutralized; it doesn’t want to tempt others into the market).

Managed competition not only prevents California from achieving the kind of rate reductions and service vitality that free markets in electricity would deliver, but it also threatens a second bailout of the electricity industry in a decade or so. That’s because it’s aimed at creating and protecting a new market structure — publicly controlled transmission and distribution of centrally dispatched power — that is being rendered obsolete by market forces that no regulatory body can ultimately control. As Triton Energy CEO Thomas Casten notes, “Central dispatch generation … is finished as an economically viable technology. In its place, widespread installation of smaller, more efficient generation, close to heat loads, will come to predominate and will collapse the value of much of today’s generation — and transmission — assets.” Today’s US$5-billion bailout of utility generation losses is nothing compared to the bailout that will be required of utility-owned transmission and distribution facilities if managed competition is not somehow sidetracked. The best answer to these dilemmas is for the state to simply let go of the industry. No ratepayer bailout for utility losses. No public seizure of the grid. No more expensive subsidies for economically retarded programs. Simply tear down the laws protecting utilities from competition and let businesses have at it.

Jerry Taylor is director of natural resource studies at the Cato Institute.