In an op-ed in Thursday's New York Times, California Governor Gray Davis, with all the desperation of a politician staring electoral oblivion in the face, once again tried to hang the California power crisis on "them" — the "unconscionable" power generators, the do-nothing Federal Energy Regulatory Commission, the "irresponsible" Republican president, the incompetent former Governor, Pete Wilson, and, perhaps, if his poll numbers continue to drop, space aliens, Sasquatch, and neo-Nazi militia groups. Kick back with a bucket of popcorn; watching Gray Davis go down will be an entertaining political ride.
The California governor bemoans the "outrageous," "unconscionable" price of electricity on the wholesale market. Well, no one likes a price spike, but in this case, the market is indeed performing both "fairly and competitively" (the holy grail that the governor alleges to seek). Gov. Davis himself acknowledges the root of the problem: Wholesale natural-gas prices on the West Coast are an amazing 1,000 percent higher today than a year and a half ago. Given that about 90-95 percent of the cost of generating electricity from a gas-fired power plant is fuel cost, a 1,000-percent increase in natural-gas prices translates into a 900-percent increase in electricity prices. And given that 50 percent of the state's power — and all its emergency capacity on hot summer days — comes from these natural gas-fired electricity plants, those gas prices are driving the wholesale power market.
Gov. Davis charges that the Federal Energy Regulatory Commission (FERC) "has failed to curb these natural gas prices." Indeed they have … because there's nothing "unjust" or "unreasonable" about them. A three-year dry spell has taken around 5,000 megawatts a day of hydroelectric power off the market. The only way to pick up the slack is through increasing production from natural gas-fired electricity plants, which explains the 62-percent increase in demand for natural gas throughout the west last year. Unfortunately, the West Coast gets its natural gas primarily through four major pipelines, and those pipelines — which had more than adequate delivery capacity throughout the 1990s — were incapable of getting all the natural gas to the west that the market required to make up for the drought and for the increased demand caused by a hot summer in 2000 and a cold winter in 2001. Let's make this simple for Governor Davis and his friends: When Mr. Supply meets Ms. Demand, economic love is in the air and a price is born.
Now, if you own a gas-fired power generator and are buying your fuel stock off the wholesale spot market, you're not making any real money in the California power market: The wholesale price reflects your production costs. But if you own a gas-fired power generator and have a good deal on natural gas (perhaps because you have secure, low-cost supplies provided via some long-term contract signed before the crisis hit), you're indeed making a bundle. Nothing new, surprising, or outrageous about that; if it doesn't cost you much to produce something that's expensive and in short supply, you'd be sued by your stockholders if you didn't charge what the market would bear.
Davis's argument (as best as we can tell) is that prices shouldn't reflect relative scarcity; they should reflect production costs. Question: How many economies have thrived by telling Mr. Supply and Ms. Demand to take an economic hike? Answer: none. When governments decide that the price of, say, a Jackson Pollock painting should reflect the cost of the canvas, paint, and a "reasonable" rate of return on the ten hours worth of labor necessary to get the job done, Jackson Pollock paintings either don't get produced or they disappear in a flash. It's no different for apartments in New York City, bread in North Korea, or electricity in California.
By charging what the market will bear, producers are allocating a scarce commodity to those who need it the most. If electricity wasn't scarce, the prices could not be sustained. Counter-argument number one — that the politically imposed market structure allowed generators to game the system and increase price — is responsible for only a couple of pennies of the price of a kilowatt hour at best and is no longer an issue since those politically imposed market structures were demolished by the FERC months ago. Counter-argument number two — that producers are purposefully holding back power in a bid to raise prices — was investigated by Clinton-appointed lawyers and economists at the FERC and found to be without merit. We'll undoubtedly see several more investigations along those lines before the year is out, but like the annual investigations of price gouging by "Big Oil," nothing will likely come of it.
The unpleasant fact for those who wish to grind political axes is that no one — not Gov. Davis, not President Bush, not Enron CEO Ken Lay (the alleged pirateer-in-chief in the generating market), not the FERC, not the authors of A.B. 1890 (the so-called California "deregulation" bill), not Pete Wilson, not Adam Smith, and not Ralph Nader — is to blame for the initial price spike. The blackouts, however, are a different story.
To put the calamity of the increasingly fragile grid at Gray Davis's door we need go no further than … Gray Davis himself. "If I wanted to raise prices," Davis told the Wall Street Journal earlier this year, "I could solve this problem in 20 minutes." And he's right: That's how the other states on the western grid did it. Electricity in Washington, Oregon, Arizona, Utah, Nevada, etc., is just as scarce and just as expensive as it is in California, but while the Golden State was in the midst of its high-decibel political conniption fit, those states quietly but steadfastly went about increasing retail prices on ratepayers. Consumption fell, conservation took hold, and the meltdown was averted. Davis's recent conversion on the matter of retail prices is a day late and a dollar short.
Perhaps Davis's complicity in turning an annoying albeit costly price bubble into a full-scale economic calamity explains the ferocity of his rhetorical attacks on everyone within his political reach. But it doesn't excuse the damage that his hot-blooded rhetoric is doing to the market. If investors start taking seriously his threat to physically seize the power plants within the reach of the California National Guard — a threat he's been issuing more and more frequently as his slide in the polls accelerates — desperately needed power plants already in the pipeline will be cancelled before they produce an spark of electricity. Nor does it excuse the increasingly vicious tone of debate. California Attorney General Bill Lockyer, for instance, told the press recently, "I would love to personally escort Lay [referring to Ken Lay, CEO of Enron, Corp.] to an 8-by-10 cell that he could share with a tattooed dude who says, 'Hi my name is Spike, honey.'"
Yep… it's going to be fun watching this crew go down…