Bush Goes Native on Price Controls

June 30, 2001 • Commentary

With much ballyhoo and political self‐​congratulation, the Federal Energy Regulatory Commission (FERC) recently announced that it will apply its current federal wholesale electricity price controls — in force before now only during power emergencies in California — and employ them around the clock in every state on the western power grid through September 2002. As Bette Davis remarked in All About Eve, “Hold on to your seats, it’s going to be a bumpy ride.”

It’s going to be a particularly bumpy ride for California. The state remains 5,000–10,000 megawatts short of the power it demands (55,000 megawatts) during the hottest summer days. These new price controls won’t add a single megawatt to the system or, on the flip side, reduce demand by a single megawatt. On the contrary. To the extent that they’ll have any effect, they’ll reduce investment in new power plants — high prices = high profits = lots of new investment. And, if the controls are passed on to ratepayers, they’ll increase, not decrease, electricity consumption in a market already marked by scarcity.

This used to be the Bush administration’s line. So is this an about‐​face for an administration that had argued that energy price control is a road to economic hell paved by Jimmy Carter? Apparently not. “They’re not talking about firm price controls,” Bush told reporters after the FERC announced its new regulatory regime. “They’re talking about a mechanism … to mitigate any severe price spike that may occur, which is completely different from price controls.” But that’s semantics, not economics.

On the one hand, this might not be too damaging in the short term. Data published by the FERC and California regulatory officials indicate that power producers have seldom exceeded the prices deemed “just and reasonable” by the federal government. For instance, the FERC found that the “just and reasonable” rate for wholesale electricity in California during the power emergencies last January was 27 cents a kilowatt hour. The state paid all of a penny more on average. The big secret here is that power is scarce, producers are charging what the market will bear, and even the FERC has little complaint with that.

Moreover, what few “unjust and unreasonable” price violations are said to occur are found mostly during peak demand periods, and those sales periods were being regulated prior to this new order. So expanding the price controls to non‐​peak periods will probably have little short‐​term effect.

On the other hand, this brave new regime comes close to establishing a government policy of “heads I win, tails you lose” toward the power community. Economists understand that small imbalances in supply and demand in electricity markets can trigger abrupt and steep price movements in either direction. That’s because electricity demand reacts slowly to price (or not at all when retail price controls are in place) and supply adjusts slowly to demand given the long lead‐​time and sunk nature of capital investment in new generation. Suppliers in volatile markets like this are either making a ton or losing a ton with very few periods of moderately stable earnings.

A willingness to slap on price controls during spikes essentially has the government telling producers that major profit opportunities will be denied them in “good times” but that major losses are still theirs to bear during “bad times.” That might have as easily occurred in 2000–2001 had normal temperatures and normal rainfall blessed the region. The fact that this is dawning on the power community explains why a number of firms have announced either the suspension or the cancellation of new power plants in California. The business climate there is too uncertain.

The irony is that even the energy economists who have cheered the FERC price controls admit that it’s an inferior and second best answer to whatever producer mischief may exist. The first best answer, they argue, would be to remove retail price controls on the largest amount of demand politically possible, and put in their stead real‐​time pricing for the 8,000 megawatts of load already set up with such meters. Whatever “gouging” is going on, they say, is almost entirely due to the Davis‐​championed retail price controls. Under them, producers have no reason not to name the highest price possible; demand will be the same either way. Remove the retail price controls and demand will go down naturally when prices go up, disciplining producers and encouraging conservation.

Unfortunately, the president’s commitment to free markets and free prices is thin and fleeting, so we won’t hear anything like this soon from his administration or the GOP, which unfortunately takes its cue from the White House. Welcome to your energy crisis, Mr. Bush.

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