Just Say No to a California Bailout

March 1, 2001 • Commentary

Sky‐​high electricity prices in California have triggered the expected cries of rage from both residential and corporate ratepayers, but the power companies are perhaps screaming the loudest. Thanks to legislation adopted in 1996, utilities were forced to buy their power from a centralized state managed power pool at 30+ cents per kilowatt hour (kWh) but could sell that power for no more than 7 cents per kWh. Not surprisingly, utilities have lost $12 billion this way and are warning that, without a taxpayer funded bailout (either through government purchase of the power grid or utility‐​owned power plants), they will soon be forced into bankruptcy.

Fine. As the old saying goes, you reap what you sow.

It’s admittedly easy for casual observers to feel sorry for the utilities. After all, no combination of financial wizardry or business acumen could have prevented those losses given the current rules of the regulatory road. But any lingering sympathy disappears once you realize that the retail rate cap was actually dreamed up and put in place by the utilities themselves.

The story goes back to the mid‐​1990s, when politicians and regulators were drawing up plans to deregulate the California wholesale power market. The utilities worried that, were they forced to compete with independent power generators in this brave new marketplace, about $25 billion worth of their assets (largely white elephant nuclear power plants and uneconomic long‐​term contracts with nonutility power producers) would prove uncompetitive and thus immediately worthless. Those bad investments — which were made with the permission of (if not at the actual behest of) the state public utility commission — are called “stranded costs.” Utilities argued that they were promised the right to recoup those stranded costs through their captive ratebases and that denying them that right through deregulation would violate this preexisting “regulatory contract.”

Now, economists are split on the question of whether stranded cost recovery is in some existential sense “fair.” Investors surely know that the rules of the regulatory game are subject to change, and investors can and do take that into account when investing their money. You place your investment bets and you take your chances.

Moreover, if taxpayers were constantly reimbursing businessmen for investments that become less attractive once the rules of the game are changed, beneficial regulatory reforms would be held hostage. Furthermore, many of those stranded costs were enthusiastically embraced by the utilities at the time. Few were dragged kicking and screaming into those costly investments; other utility executives wisely passed them by.

Nonetheless, the scheme hatched by the California utility companies was to impose a 6.5 cent per kWh mandatory retail price for electricity as part of the “deregulatory” plan. Since wholesale spot markets were offering power at about 3 cents a kWh back then, the price cap allowed utilities to pocket about 3.5 cents per kWh as pure profit. Even nonutility providers were on the hook and forced to turn over most of this excess profit to the utilities. The price order was to be lifted only when a utility was able to recoup its state‐​approved “stranded costs” from ratepayers.

The regulations were so purposefully labyrinthine that the political class actually got away with the story that the “price cap” protected consumers from the electricity robber barons, and not a single legislator voted against the charade. The environmental lobby and even most of the consumer rights groups went along with the story: after all, they too got their sacks of money via continued subsidies for renewable energy, energy conservation, low income assistance programs and the like. The utilities could hardly believe their luck: They were able to dupe ratepayers into bailing them out under the Naderite guise of price control while still flying the flag of “deregulation.”

No one ever dreamed that the so‐​called price cap would actually be anything other than a price floor. That is, until this fall, when the fleecers became the fleecees.

The rate cap has actually proven to be a double whammy. Not only did it fleece ratepayers during the “good times,” it prevented market signals from reaching them in bad. If ratepayers aren’t given a good economic reason to cut back on the juice, then high prices will fail to reduce demand or ration available supply to those most willing to pay for it. Scarcities are the inevitable result.

A whole flock of chickens is now coming home to roost. Let the utilities declare Chapter 8 and turn the companies over to the debtors. This group doesn’t deserve our tears — or our money.

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