Don’t Blame the Power Crisis on Deregulation

That there are no free lunches is an eternal truth clear even to many of our public officials, who nonetheless must pretend otherwise lest they be forced to acknowledge the hash they have made out of our “deregulated” California electricity market. That is why we now hear endlessly silly accusations of greed and market manipulation serving as substitutes for the hard decisions that must be made without delay.

We are confronted with an amusing spectacle: Sacramento is shocked (no pun intended) to discover that the electric utilities, forced into the role of mere middlemen by the deregulation law, find themselves unable permanently to purchase electricity at a price 100 times higher than they are allowed to sell it. Let us be clear: Only the wholesale price of electricity has been deregulated. At retail, electricity still is subject to the shortages and other inefficiencies of price controls.

The deregulation law forced the utilities--most prominently, Southern California Edison and Pacific Gas & Electric--to sell most of their electric-generating assets, thus depriving the market of the efficiencies created by vertical integration in industries with large and highly specialized capital investments. Long-term contracting and the efficient allocation of risk that it allows was forbidden. And transmission and distribution remain regulated and operated for the most part by a state-sanctioned Independent System Operator whose incentives for efficient operations and investments are ambiguous at best.

Investment in electricity-generating capacity is heavily politicized, influenced by expectations of regulatory (that is, political) pressures on prices and by not-in-my-backyard concerns and other obstructionism masquerading as environmentalism. Everyone agrees that California is in need of many thousands of megawatts of additional generating capacity. PG&E; last summer attempted to put in San Francisco Bay a barge with a generator offering a grand total of 95 megawatts of capacity in order to smooth voltage problems and avoid some of the then-threatening blackout risks. For the “environmental” and “consumer” groups--unelected, unappointed and unaccountable--even that was too much, and the project was abandoned. No major generating plant has come on line in California since the early 1990s.

So let us dispense with the canard that “deregulation”--allowing market forces to work--is the source of the current mess. The real problem is that market forces have not been allowed to work because of the past hubris of our public decision makers.

Thus do we find ourselves in the current mess. That utilities cannot continue to sell $3,400 worth of power for $35 is not rocket science, but the “consumer” groups still shout that the utilities have deep pockets, that they are not close to bankruptcy and that lenders forever will have faith in the ability of Edison and PG&E; to repay the loans needed to bridge the gap. They complain loudly about past “uneconomic” investments, even though those for the most part are contracts for grossly inefficient “renewable” power, forced upon the utilities by those very same consumer groups.

And now they argue that the state should take over the business. Put aside the inexorable politicization of electricity rates and investment decisions. Put aside the large and growing tax subsidies that would ensue. Ask only the simpler question of whether we really want an electric power system run by bureaucrats from other government agencies who were passed over for promotion.

Some public officials, recognizing privately but not admitting publicly that the price control regime is a disaster, advocate an extension of price controls over the entire West, so that for a while (their terms in office) California could compete more effectively for available supplies. That would mean that consumers in other states would have to pay more so that Californians could pay less, an outcome unlikely to prove popular in, say, Colorado. Such a scheme would yield highly perverse effects on future incentives to invest in additional generating capacity, which is why the Federal Energy Regulatory Commission wisely has refused.

So what is to be done? In the short run, prices must rise so that California can compete for available supplies in the wholesale market and so that consumers will face incentives to conserve. Small generating units can be deployed throughout the state to provide additional production capacity; it is relatively expensive, but not nearly as much so as the constant threat of blackouts.

In the long run, more large-generating capacity is needed, along with substantial investments in modernization of the transmission and distribution system so that additional power can be imported efficiently from outside the state. Higher prices, painful though they will be for consumers, will serve this end both by improving the basic economic viability of such investment and by changing the politics of the regulatory approval process for new generating plants. Higher prices will engender a huge consumer interest group favoring supply expansion and thus willing to oppose the obstructionism of the “consumer” and “environmental” lobbies.

More fundamentally, it is necessary to get the government substantially out of this market and to recognize that the “consumer” and “environmental” lobbies are interested less in consumer welfare and environmental protection than in the expansion of their political power.