California’s Electricity Crisis: What’s Going On, Who’s to Blame, and What to Do

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The California electricity crisis threatens notonly the economic well-being of ratepayers inCalifornia but the economic well-being of theUnited States as well. Unfortunately, the politicaland economic commentary surrounding the crisisis shedding more heat than light.

California has been victimized by severalsimultaneous and severe supply and demandshocks--most notably, a run-up in wholesale naturalgas prices--that are outside the state's politicalcontrol. Those shocks were made moresevere by air pollution regulations and retailprice controls. Although California's "deregulation"of the electric utility business is beingblamed for the crisis by both the political left andthe political right, we find that the 1996 restructuringlaw has little to do with the run-up inwholesale power prices. That law is primarilyresponsible for the blackouts, however, in that itprohibits utilities from passing on increases infuel costs to consumers.

Virtually all the increase in wholesale pricescan be explained by increases in production costsand overall scarcity. While there is some evidenceof the existence of excessive generator "marketpower" (created not by the unfettered exercise offree markets but by poorly conceived regulation),it is relatively minor and responsible for only asmall fraction of the price spike, if it exists at all.

We find little evidence to support the argumentthat environmentalists are primarily toblame for the crisis. We likewise are unconvincedthat, had the state allowed utilities to enter intolong-term contracts with generators, the crisiscould have been either averted or made less severe.

None of the remedies thus far proposed--such as a state takeover of the industry, the so-farminimal increase in power rates, energy conservationsubsidies, prohibitions of "wasteful" energyuse, more vigorous wholesale price controls,or the adoption of long-term power contractswith generators--will get the state through thenext two years without frequent and widespreadblackouts and significant economic damage. Infact, all of those alleged remedies would makematters worse.

The only remedy to the crisis is the eliminationof the retail rate cap and the institution ofreal-time pricing mechanisms for the largest segmentof demand possible.