∫ Deregulation & The California Energy Crisis

Back in the good old days – before we realized climate change was an enormous threat to civilization and Dennis Eckersley still played for the A’s – utilities owned power plants.

Utilities are “regulated monopolies.” The government frees utilities from competition by only allowing one utility per geographic region, but in exchange for this freedom the utility must abide by minimum reliability standards and price caps set by our government.

The idea is that competition lowers prices and increases quality, but in the case of infrastructure, competition would lead to significant redundant costs; it is cheaper to build one transmission system than five, even if that one transmission system is built by a relatively inefficient monopoly. Thus, the government authorizes monopolies and regulates the quality and prices those monopolies can get away with. This system has a number of problems, but the status quo is surprisingly good: it costs less than 10 cents to power your laptop for 15 hours, and the average utility customer loses power for less than an hour a year.

In the late 1990s, however, the State of California decided to make this pretty good system even better. Regulators realized that although we only need one electric grid, we actually need hundreds of power plants. So why not let competitive markets build those power plants? Competition, it was believed, would lead to decreased costs in electric generation.

This was a good theory, but flaws in execution (predicted at least as early as 1996 by a fantastic group called The Regulatory Assistance Project [1] among others) led to a drastically different reality. In 1999 California’s regulators required utilities to sell off all of their generation assets. The problem? Not enough companies purchased the power plants to lead to competition. Individual companies were able to independently manipulate prices. By shutting down 20% of its recently acquired power plants, a company could increase the price of power in the entire state by, say, 50%, and make boatloads of money at California’s expense.

Companies like Enron did exactly this, so even though there were just as many if not more power plants in 2000 as there were in early 1999, power was 800% more expensive than a year earlier and suddenly in great shortage. [2] So voila. The California energy crisis.

This process – requiring regulated utilities to sell off their power plants to a competitive private sector – is called deregulation. Many States learned from California’s mistakes and deregulated successfully. New York and the entire Northeast have all undergone successful deregulation, as has Florida. The huge gains in efficiency hoped for by economists have not been wholly realized, but disasters like California’s have been avoided.

Of all the States to deregulate, Texas has seen by far the best results. The leading theory for why deregulation was so successful in Texas is that Texas’ electric grid is actually not connected to the rest of the country or Mexico. (Technically, this is no longer true; Texas has some really cool High Voltage DC lines now interconnecting it to the Southern power pool, but this is relatively small.) When Texas deregulated they were able to enforce market rules and prevent market manipulation since almost all the generators were inside of Texas State boundaries. When adjusted for the price of fuel, Texas’ energy prices have remained almost completely flat since they deregulated, even though concrete, steel, and everything else required to build a power plant has gone up substantially.

California’s utilities all ended up in “bilateral contracts,” long-term (20-year) power purchasing contracts approved by the State’s regulators. Thus, there is not a substantial wholesale market in California so California is now called a “Reregulated” State.

Want to learn more? Then discover “How Electric Markets Actually Work.”

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[1] Austin et. al, “Perspectives in Electric Utility Restructuring: A compilation of papers prepared by The Regulatory Assistance Project,” 1996, http://raponline.org/Feature.asp?select=49

[2] Weare, Christopher, “The California Electricity Crisis: Causes and Policy Options,” Public Policy Institute of San Francisco, 2003, http://www.ppic.org/content/pubs/report/R_103CWR.pdf

[3] M. Swartz and S. Watkins, “Power Failure, The Inside Story of the Collapse of Enron,” Doubleday, 2003.

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