Revelations this summer about Enron EnergyServices' byzantine electricity-trading practices havefueled charges that merchant power producers andtraders artificially engineered the California electricitycrisis of 2000-01. A careful examination ofthe suspect trading practices, however, reveals thatthere's less to those charges than meets the eye.
The trading strategies in question all involvedthe pursuit of arbitrage opportunities, whicharise when price discrepancies exist for a commodityin different locations or time periods.Exploiting arbitrage opportunities generallyenhances economic efficiency by ensuring thatelectricity is reallocated where it is needed most.While some of the arbitrage opportunities wereartificially manufactured by the companiesthemselves (in ways that may or may not have violatedthe law), most of them arose as a naturalconsequence of the market structure imposed bythe California political system.
In any case, it's unclear whether the trading strategiesin question actually served to increase prices onbalance. Even economists who are convinced thatthey did contribute to the increase in electricity pricesattribute only about 5 percent of the alleged overchargesto the strategies at issue. Most of the pricespike of 2000-01 is explained by drought, increasednatural gas prices, the escalating cost of nitrogenoxide emissions credits, increases in consumerdemand stemming from a hot summer and then acold winter, and retail price controls that preventedmarket signals from disciplining producers or consumers.The price collapse in the summer of 2001stemmed from a reversal of those conditions, not theimposition of federal price controls or the eliminationof the trading practices in question.