Keeping Rates Below Cost Sinks the Electric System

Among the government, media and private-sector energy industry people from outside of California, there is a common contempt toward the state’s electricity crisis. The view from east of the Colorado River is that the “left coast” deserves this man-made disaster because its legislators and former governor made a mistake in crafting the 1996 deregulation.

There’s no sympathy out there for the argument that the state’s problems are the fault of bureaucrats in Washington who are failing to help, or free-market zealots who are out just for profits.

Like it or not, there’s a lot of truth to this view.

While Gov. Gray Davis has never let any of us forget that this mess was not created by his administration, the governor’s slow response in the past six months has made what was destined to be a major economic and infrastructure problem into a full-blown crisis that threatens the state’s economy.

To start, there was no reason to allow the state’s two major investor-owned utilities to teeter on the edge of bankruptcy, worsening an already untenable supply shortage and undermining the state’s energy infrastructure. State regulators, under Davis’ direction, shirked part of their constitutional responsibility, which is to assure that the utilities are financially viable. This responsibility is every bit as important as providing consumers with “just and reasonable” prices for their energy.

The traditional balancing act between protecting consumers and protecting the utilities--never politically popular--was accepted, albeit reluctantly, by past members of the California Public Utilities Commission. There was a similar case in the early 1980s, just after the wellhead prices of natural gas were deregulated by the federal 1978 Natural Gas Policy Act. Southern California Gas Co., for which I worked at the time, faced skyrocketing wholesale prices resulting in an unthinkable $1-billion shortfall, the equivalent of the $12-billion in undercollections faced collectively by Edison and Pacific Gas & Electric today.

Back then, state regulators bit the bullet and granted the rate increase needed to cover the shortfall. Fingers were pointed from California to Washington, particularly to “greedy” out-of-state pipeline companies at whose mercy the state had temporarily fallen. But the state’s two principal natural gas utilities survived, and throughout the 1990s there were abundant supplies and lower prices.

California’s power crisis today is due to flaws in deregulation, such as the over-reliance on the spot market and the creation of a state-mandated wholesale auction, which were exacerbated by a looming supply shortage that most everyone ignored for far too long. The combination of these factors, along with frozen retail rates, created the current mess. It wasn’t caused by deregulation in and of itself, or the companies that generate the power, or the marketers who the state encouraged to come to California in order to make money.

State policymakers at the outset of deregulation took great pains to coddle California’s investor-owned utilities, assuring them that they could recover their past investments in energy plants and sell generation assets at handsome profits. These are the same policymakers who today are letting two of the three major electric utilities--and more important, their thousands of shareholders and loyal employees--circle the financial drain pipe.

By not allowing the utilities to raise rates to cover their costs, the state has made the supply situation much worse. Davis’ vow to solve this is more power plants, increased conservation and long-term contracts (an option his PUC and the Legislature ignored early in the summer’s price spikes in San Diego), all of which would be more doable with financially sound utilities. It’s no surprise that this high-stakes political gamble by the governor is leaving the state with marketers who are refusing to ensure additional supplies this winter. Why should they when they have no viable prospect of getting paid any time soon?

Deregulation did not cause this situation; it was caused by a state policy decision not to raise utility rates, no matter what, even though the governor, the PUC and the Legislature know very well that taxpayers and utility shareholders are already footing the bill, and that bigger ones loom in the future.