Many view California’s electricity crisis as proof that electricity deregulation and indeed deregulation in general does not work. This is wrong. California did not deregulate its electricity market, but rather “restructured” it, requiring far more state intervention in electricity transactions than existed before. In doing so, the law created a micro-managed pseudo-market where suppliers of electricity have the ability and incentive to manipulate prices to their advantage, and utilities are forbidden to shop for better prices.
Now, with the centrally planned and managed market that the restructuring architects created falling down like a house of cards, state leaders labor under the anxious eyes of state residents, and the curious eyes of the nation. They must contend with burning short-term issues as the state’s utilities approach bankruptcy and the state grid flirts with blackouts.
They also must develop a long-run vision and goals for the state’s electricity market and formulate policies to get us there. That vision ought to be a competitive electricity market and the goals ought to be addressing immediate crises and long-term structural changes to move electricity generation in the state toward competition.
Unfortunately, state leaders are working in an environment of widespread misunderstanding. Assembly Speaker Robert Hertzberg has proposed that the state pay off the utilities’ debts (over $10 billion) in return for receiving title to all of the utilities’ hydropower generating plants (worth about $5 billion). Further, his proposal would take the utilities out of the business of purchasing power altogether, with the state government purchasing all power to be passed on through the utilities to consumers.
This idea would leave us with less of an electricity market than we had before restructuring,with the state government as the hub of our electricity system. This while governments in the rest of the industrialized world are getting out of the electricity generation business. State leaders should look to deregulation success stories like Pennsylvania as a guide, not to Third World countries where the government owns the electrical system and operates it under a system of patronage.
Further, Hertzberg’s proposal would be a bailout of the utilities. They and the state government share the blame for the mess we are in, and the utilities should have to absorb a share of the losses they have incurred.
At the same time, utilities should not be allowed to pass all their new debts onto customers through higher rates. State leaders should make a deal to split the costs between the utilities and the state (they share responsibility for this mess). This will allow the utilities to buy electricity again without the high costs caused by bad credit.
To fix the system for the long term, here is what state leaders should do:
n Articulate a vision of moving toward competition. That will alleviate concern of regulatory intervention. Inflammatory, populist rhetoric by state leaders replete with threats of police action and takings only exacerbates uncertainty about California’s electricity market.
n Change the law to make the Power Exchange voluntary. A spot market is a necessary component of the overall electricity market. But centralized mandatory pools bring to the market perverse incentives and rigidities that create distortions and an inability to adapt to changing market conditions. As a voluntary spot market, the PX can become an independent competitive exchange and develop bidding rules that attract both buyers and sellers.
n Help alleviate the barriers to long-term power contracts. State leaders have acknowledged that the utilities need to add forward contracts to their portfolios to hedge against wholesale power price fluctuations, but have not developed adequate policies to help make forward contracts happen. Gov. Gray Davis’ Jan. 14 proposal to have the state enter into forward power purchase contracts is not wise. The state would be taking on futures risks with no experience or skills in evaluating those risks, and putting taxpayers at risk for their mistakes.
State leaders could achieve similar results by offering state guarantees to back utilities’ initial forward contracts. This would alleviate the credit risk that is driving up forward prices offered to utilities, but dilute the taxpayer’s risk and let the utilities negotiate the contracts.
n Create a plan for phasing out price caps and introduce real-time pricing.
In the short run, price caps only guarantee that utilities will continue to bleed red ink, suppliers will look for other markets in which to sell, and consumers will have no incentive to conserve electricity.
Gradually, but predictably, raise the price caps. Convene a working group to create an initial schedule, and revise the schedule periodically as market conditions change. Tie rate cap increases to milestones in accomplishing other policy changes that increase competition and customer choice in the market and reduce utilities’ market power.
Meanwhile, implement a system to guard against exercise of market power in utilities’ customer charges. Until consumers have options in the face of high prices or bad service from utilities, regulatory oversight is necessary.
And encourage utilities to implement real-time pricing and metering so that consumers can adjust their use of electricity as prices change.
n Accelerate completion of new power plants with a constructive approach to licensing and enforcing environmental rules. Restructuring spurred a level of investment in new power plants not seen in decades in California, but the permitting and construction process takes years longer than in other Western states.
n Integrate municipal utilities into the market. California’s electricity market will not be truly competitive if customers in many of its largest cities are not allowed to choose their electricity provider. As restructuring moves forward, municipal utilities should be integrated into the competitive market. Over the long run, state leaders should challenge the federal government to end the inequities and wealth transfers that federal subsidies for municipal utilities and preference distribution of federal hydropower inflict on California residents.
n Do not dictate utility industry structure. Requiring the utilities to sell their power plants turned out to be a mistake when market conditions changed in ways policy makers did not predict. Forbidding utilities to sell power plants repeats the same error. Policy makers do not know the future of the electricity market and should not lock the utilities into any arbitrary structure based on the exigencies of the moment.
Moore is an economist and executive director of the Reason Public Policy Institute in Los Angeles (www.rppi.org).
