California’s Troubles Not Caused by Deregulation

January 15, 2001 • Commentary
This essay appeared in the Houston Chronicle on Jan. 15, 2001.

Skyrocketing wholesale electricity prices and the daily threat of brownouts and blackouts in California have cast a pall over the regulatory enterprise.

California Gov. Gray Davis, like most pundits and the press, blamed deregulation for the crisis in his recent “State of the State” address. He warned that the California meltdown is a harbinger of things to come, not only in national electricity markets but in industries throughout the economy if we continue our mad rush toward laissez faire.

But the California power crisis is not an example of what happens when businessmen are running important industries. It’s a story of what happens when politicians try to manage competition and impose their vision of a market.

If “deregulation” means less — not more — political control over an industry, then the California electricity industry has not been “deregulated.”

First, the state forced the electricity companies to sell their power plants to independent investors and become power distributors.

Second, the state assumed total day‐​to‐​day control of the utilities’ power grid to make sure they couldn’t abuse their market power.

Third, the state required new owners of the divested power plants to sell their juice to a state‐​managed “power pool.” The price of that power is set by a daily spot market run by — you guessed it — the state. Electricity companies that wanted to compete for your business had to buy their electricity from this pool, and the price charged them was equal to the highest price received by any electricity generator in the daily state‐​managed spot market.

Fourth, regardless of what they pay for power in the wholesale market, no company can charge a consumer more than 6.5 cents per kilowatt hour. That price can’t change until the company has paid off its share of the bailout the state gave the electricity companies in order to accept this new regulatory scheme.

Now, what kind of “deregulation” imposes rigid government dictates on how industries should organize themselves? What sort of deregulation keeps fixed prices on retail providers? What kind of “deregulation” requires retailers to buy power through a state‐​run central exchange? And what brand of “deregulation” forbids retailers from buying electricity more than one day ahead?

Real deregulation would have meant turning the old power companies loose to build what they want, charge what they want, and run the grid as they wished while simultaneously decriminalizing competition and removing barriers to market entry. State regulators, however, went in the opposite direction.

If this is the portrait of a free market, then it’s a portrait painted by Salvador Dali, not Adam Smith.

But is this new regulatory regime the cause of the fivefold increase in California electricity costs? Hardly. While it did make things worse, the primary culprit is the high price of natural gas. Since November, the spot price of natural gas in Southern California has risen 600 percent over the 1998–99 average. And because 90 percent of the marginal cost of natural gas‐​fired electricity is fuel cost, the marginal cost of electricity would have to spike from 3 cents per kilowatt hour to above 15 cents per kilowatt hour to cover costs. That is what’s happened at the wholesale level.

The bottom line: Because the state is so heavily reliant upon natural gas during periods of peak demand, Californians would be facing the same unpleasant combination of high electricity prices and blackouts even if the old regulatory rules were still in place.

The situation, however, was made worse by California’s long‐​term hostility to new power plants. Since 1996, electricity demand in California grew by 12 percent while supply grew by 1 percent. Every time you turned around over the past two decades California state regulators were discouraging new construction, arguing that renewable energy would pick up the slack, that “negawatts” — activist jargon for subsidized energy conservation — was preferable to “megawatts,” that minimizing new air emissions was more important than generating new electricity, and in general facilitating the transformation of the NIMBY (“Not‐​In‐​My‐​Back‐​Yard”) forces into a unified BANANA army (“Build‐​Absolutely‐​Nothing‐​Anywhere‐​Near‐​Anybody”).

Gov. Davis’ vow to do whatever it takes to build new generating capacity in California is a belated acknowledgment that the Naderites have held the state hostage for too long. But his threats to seize control of power plants and throw company managers in jail guarantees that few private investors will risk entering the market.

Decontrolling retail prices might save the utilities from bankruptcy. But the trajectory of wholesale electricity prices is a function of the trajectory of wholesale natural gas prices. Building new capacity will help, but only a bit. This is one “crisis” that politicians are going to have to ride out.

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