Davis Ducks Reality on Electricity ‘Overcharges’

As temperatures rise and the lights go out, let us recall the blessed memory of Marx. Not Karl. Groucho. Well, not Groucho exactly, but instead the other star of “You Bet Your Life,” his duck, which would descend from the heavens with a cigar and a crisp $100 bill upon hearing a contestant utter the secret word of the day.

For Gov. Gray Davis, the magic word is “votes,” and he wants to offer $100 bills to everyone, courtesy of the electric power sector. Davis will discover during the long, hot summer that it won’t work. While he and the Legislature and the Public Utilities Commission and the Electricity Oversight Board have had a grand time chasing each other around a room with whipped cream pies and seltzer bottles, the economic and political risks faced by producers have grown, the state budget reserve largely has gone poof! and efforts both rhetorical and political to force other Western states to bail California out predictably have come a cropper.

And so the buck-passing season is in full bloom. Accordingly, we now have studies from the Independent System Operator--the board of which was appointed by Davis--purporting to show that recent prices charged by power producers have exceeded costs, and thus have been unreasonable to the tune of $6.3 billion, concluding that the current mess is all their fault, and that everyone should get big refunds.

Well. It all depends on what your definition of “cost” is. The ISO analysis ignores the risks of nonpayment, now very real in the California market, to the tune of $14 billion owed by the utilities, largely to power producers and traders. The interest costs on late payment are ignored. The ISO shunts aside the risks of unplanned outages of generating equipment, necessitating the purchase of power in volatile spot markets. It ignores the market value of investment in reliability, the political risks of after-the-fact changes in the rules of the game, the risks posed by the lawsuit industry, the risks of transmission breakdowns, the risks of rising prices for natural gas and on and on. That a number of important costs faced by power producers do not show up on the books does not mean that they are not real.

More fundamentally, the mere fact that prices are high does not demonstrate that the market is noncompetitive. It is not costs that determine prices in competitive markets, it is the relationship between cost and demand conditions. Suppose sudden bad weather destroys a substantial part of the wheat crop. The price of wheat will rise, despite the fact that costs as measured by the accountants--the price of fuel and other inputs--will not have increased at all.

The ISO and others attempt to circumvent this simple reality by offering exotic theories of market manipulation, in which producers withhold electricity to drive prices up. This old argument fails to answer the crucial question of which producer will withhold production. Each producer prefers that his competitors withhold so that he can receive the benefits of higher prices. An assumption that producers will take turns is not very helpful, because their respective interests and expectations of future market conditions are likely to differ. And anyway, where is the evidence?

And so we are left with a call for regional price controls. Do bureaucrats never learn? Price controls raise true prices, they exacerbate demand/supply imbalances, and yet are beloved of politicians whose time horizons extend only to the next election. The rest of us, unfortunately, must live with the longer-term effects. Can anyone believe that confiscating billions of dollars from the private sector will increase long-term investment in electric generating capacity?

The reality is that for nine months Davis has dallied, dithered and engaged in demagoguery. Scapegoating now is the order of the day, as it sinks in that no amount of talk will pull an electric rabbit out of a hat. It was obvious last year that this problem largely would have been solved with a moderate increase in electricity rates, combined with some straightforward changes in regulatory policies.

It is true that Davis did not create this problem, although his attempts to blame prior Republican officials conveniently ignore the fact that the Democrats held the Legislature when the current system was enacted. Oops. In any event, it matters not one whit: We elect public leaders to lead when unexpected problems arise.

It would be nice if Davis were simply to level with Californians: There is no painless route out of this mess, attempts to make scapegoats of the producers are dishonest and destructive, and our regulatory system is dysfunctional. Actually, that would be more than merely nice; it would be uplifting.