- The Washington Times - Tuesday, January 30, 2001

Most Americans look at the California energy crisis and think, "They've made their bed, now let them lie in the dark and cry about it." As much as the voices of reason would like the Golden State sent to solitary confinement for its deregulation of the energy industry, the rest of the country should pay attention and learn that deregulation is not the villain at least not when it's done right, as Pennsylvania can prove.

The rest of America is enjoying its view from the judgment seat "That's California for you," the voices of reason say, an innovator in hot tubs, group therapy and now electricity deregulation. Good thing California went first, they say, because now the rest of us know that electricity is special and should be regulated. Free markets are great for fun stuff like nose rings, but take a pass on alternating current.

The voices of reason have selectively forgotten a lot about the old system. California's reforms began in the mid-1990s with a near-universal recognition that the old system had to go. Since the 1970s, ideological bureaucrats and inefficient monopoly utilities had controlled the power supply. Their combined efforts produced prices 50 percent above the national average. They denied citizens and businesses access to cleaner and cheaper power, in the name of conservation and the protection of established utilities. In a world of potential abundance, California had thrown itself a famine.

California's Public Utilities Commission proposed direct access by consumers to producers, with utilities becoming no more than transportation providers. New entrepreneurs could help consumers to choose from competitive suppliers all over the West instead of passively paying for their utilities' mistakes. Utilities and their political allies saw that they would both lose if customers got choices, and initiated a pre-emptive counterstrategy. These long-term monopolists proposed their own version of competition, a universal and compulsory wholesale market with standardized short-term trades. Maybe it's just California, but few questioned why incumbents with a lot to lose would have any real interest in competition.

State government bought the idea, and California got a competitive facade. Behind it the utilities could maintain their retail monopolies and recover the costs of their past uneconomic investments. In the legislative bargain consumers got a rate freeze, but utilities were required to divest some power plants and purchase their power supplies in the nearly universal market they had proposed. As long as prices there were lower than frozen rates, few complained. This summer, prices quadrupled in the face of extreme supply and demand conditions, but the law compelled utilities to use this market and prohibited them from raising frozen consumer rates. Their revenue shortfall is now about $6 billion and at times increases by $1 million an hour.

Electricity is the oddest commodity. Because it cannot be stored in volume, supply must match demand instantly. Over a typical day its production cost and price can increase by as much as 300 percent and drop overnight. Any prudent buyer would seek protection against such massive and unpredictable price fluctuations, but until recently California's utilities were not allowed to hedge their costs. Five years ago they thought risk management was unimportant, and they got what they wanted.

No real-world commodity trades like California electricity, and no power markets outside the state look much like California's. In other markets, buyers make some longer-term contracts with producers and hedge their financial risk. Overnight markets like California's only supply the last increments those buyers need to balance supply and demand. California's market was initiated as a political contrivance, and its underlying design almost guaranteed that sooner or later, today's unhappy events would come. The rest of the West continues to function well electrically only California reformed itself this way, and only California is suffering so badly.

Other states and nations are doing it right. They are letting buyers and sellers sort out the transactions that benefit them, rather than deciding beforehand what is best. Like California's utilities, Pennsylvania's inherited uneconomic costs they needed to recover, and their state's plan allows them to recover these costs. But Pennsylvania had no big bang like California it just removed some restrictions and allowed consumers to enter existing markets. In little over a year, hundreds of thousands of households have found cheaper suppliers. In California, less than 2 percent of residential customers have left their utilities.

There is no single right way to provide electricity efficiently and cheaply it's just too complex an industry and there are big differences among users. We do know that the old monopolies and bureaucracies didn't do very well. In a federal system, states can experiment. Some succeed and become widely adopted. Those that fail bear most of the costs of their mistakes. (Think of welfare reform.) California took one of a thousand paths to the new electrical world it turned out to be one of the worst. Pennsylvania shows that it can be done well, but the details matter a lot.

On this winter day, I see sunshine and green grass outside my California window, but regarding electricity, W.C. Fields' tombstone was right: "All things considered, I'd rather be in Philadelphia."

Robert J. Michaels is professor of economics at California State University, Fullerton and adjunct scholar at the Cato Institute. He has provided expert testimony for independent power producers and marketers.


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