Deregulation and California’s Power Industry

Published 03 Aug 2016

In 1996, the California Assembly undisputedly agreed to deregulate the electric industry of the state of California. The main reason for this was so that the state could take apart what was deemed as an industry monopoly that was controlled by the government.

To help with the privatization of California’s energy distribution services, the state offered attractive incentives to encourage utilities to sell their power plants to private companies that are unregulated. The state required them to shift the control of transmission lines and power grids to a private nonprofit organization. In spite of the transfer of authority over operations, the service providers still maintained control and ownership of the energy supply system.

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The effects of the deregulation are as follows. First, the prices of the services were formerly regulated by the state. After the deregulation, the prices are set through auction by the California Power Exchange, which is a private, non-profit organization. Next, the transmission lines and power grids were turned over to the Independent System Operator, which is a private nonprofit organization that manages operations. Third, similar to the previous system, utilities own and control the wires that supply homes and businesses with power.

The overall aim of the deregulation of California’s electric utilities was to attempt to lower the prices of the electric bills of the consumers.

Consequences of the Deregulation

Following the deregulation of California’s electric utilities, the state of California started to experience serious power shortages in the summer of 2000. Power outages continued to sweep through parts of California in the months that followed. Then-Energy Secretary Spencer Abraham advised that the United States was face to face with the most serious power shortage since the 1970s.

The power crisis came to a point such that the Federal Energy Regulatory Commission is asking for refunds whenever prices rose above $273 per megawatt hour such as in January of 2001 and then later at $430 per megawatt hour in February of the same year.

The escalation of the prices of utility rates in California had been causing much argument. Much speculation and blame storming was generated by the reason behind this rise in utility prices. Much of the blame was put on the deregulation of the utility system.

Different reasons behind California’s power crisis

Then California Governor Gray Davis told CNN that those who had pushed for the deregulation of energy distribution in 1996 “made a huge miscalculation”.

Although the deregulation remains a big factor, the reason behind California’s power crisis cannot be blamed solely on the deregulation. This can also be attributed to the fact that the state of California extends more electricity than it produces. During the deregulation in 1996, California’s two largest utility companies Pacific Gas and Electric (PG&E) and Southern California Edison were persuaded to sell their power plants. The two energy giants were to shift their focus on the distribution of gas and electricity to their customers. The plan was for them to buy power from the market and resell it to consumers. To address this crisis, the state of California had created a special committee that is tasked to investigate the cause of the power shortage.

Thomas Sowell said in his January 11, 2001, article in the Capitalism Magazine that “When prices are free to rise, that causes consumers to buy less and producers to produce more, eliminating the shortage. But when the price is artificially prevented from rising, the shortage is prevented from ending.”

The case of the California energy crisis is similar. The slight difference is that no limit was set with regard to how much the suppliers can charge utility companies. However, the utility companies cannot pass on the additional expenses to the consumer as there is a limit as up to how much they can charge for their services. This leaves the utility companies no choice but to limit the supply of power. To add fuel to the fire, so to speak, a restriction in supply causes demand to swell. When that happens, prices continue to rise. If left unresolved, this will become a vicious cycle.

Sowell further points out that this situation should have been solved by an employing a seemingly simple solution has been blown out of proportion by extreme politicking. To emphasize his point, Sowell mentions in his article that “the idea that the government can run businesses at lower costs flies in the face of worldwide evidence that whatever enterprise politicians and bureaucrats run has higher costs.”

In his article published in the New York Times, Paul Krugman states that the deregulation of the power industry is supposed to “deliver cheaper, cleaner power”. What had happened instead was that the state was plunged into a severe energy crisis that is said to be the result of market manipulation.

Krugman further states that although it is true that an unexpected surge in electricity demand is easily a cause of the energy crisis, it is also possible that the crisis would have happened even without deregulation. Conversely, in this case, the power companies were hesitant to build new plants to meet the demand for more power. This led to an unexpectedly high level of demand for power that snowballed into power shortages and higher prices.

With the economy on the rise, there is so much demand for energy. The electric power system has been running to the point of overloading the capacity for providing power. George Reisman Ph.D. argued that the short-term cause of the power shortage is price controls and the long-term cause for the supply shortage is government regulations. He responded to Krugman’s article that the combination of restricting the supply of electricity and government price controls on electric power has led to the foreseeable consequence of deficiencies in electrical power and not market manipulation.

How it all began

The quest for cleaner, environment-friendly power supply, and California’s venture into the construction of nuclear power plants proved to raise the prices of utility rates. This turned off businesses that are constantly in the search for cheaper alternatives for sources of energy. The utility’s strong consumers like steel and cement manufacturers were clamoring for a change. As the answer to this dilemma, the state of California turned to deregulation in an attempt to lower the rates of electricity bills.

In 1996, California became the first state to deregulate its electric power industry. This law promised to bring about lower prices to consumers by ending the monopoly of the power industry and bringing in new industry players. The deregulation law called for the utilities to turn over their production facilities and freeze their rates until all their assets have been sold and for them to buy power from an open market.

Problems of the Deregulation

After the deregulation, the purchase of power was done through auctions. Naturally, the highest bidders are in control of setting the prices. As a result, the market prices went up. The utilities were forbidden to pass on the additional costs to the consumers because their rates were frozen. This left them no choice but to put up with the additional expenses on their own. This forced the utilities to limit the distribution of power.

The Union of Concerned Scientists came up with a list of causes that contributed to the power shortages in California. This list included three things: cutbacks in conservation, cutbacks to renewable energy, and power plant outages. During the deregulation, utilities cut their energy conservation budgets by more than half, creating a need for additional power plant capacity. In 1995, utility companies convinced the Federal Energy Regulatory Commission to eradicate a state program that would have provided an additional 1,400 MW of renewable energy — wind, solar, geothermal and biomass. Had that state program been in place, California would have averted the power crisis. When the rolling blackouts were kicked off, it was discovered that power plants were not operating at their full capacity. Up to one-third of the capacity of the power plants were not accessible, a level that was far above the normal levels. Much blame was put on those in charge of power plants in “creating “ artificial deficiencies so prices would rise. It was further proved by independent studies that market abuses have caused utility prices to shoot up.

Recommended solutions to the Energy Crisis

The Union of Concerned scientists also made recommendations on what to include and what to exclude in resolving the California energy crisis. According to them, the solution must include: “increasing funding for improved energy efficiency and tougher energy efficiency standards, Further diversifying the power supply with renewable energy sources, Extensive market reforms to preclude market abuses” (Union of Concerned Scientists, 2007). Funds to improve energy efficiency should be enough to allow for cost-effective energy efficiency improvements. Policies that encourage the adoption and use of alternative and renewable energy sources must be in place and strengthened. Programs that would grant incentives to consumers who would cut back on consumption during peak hours or by using clean distributed generation should be launched.

Legislators should take care to exclude the following: “Gutting power plant citing rules, weakening air quality regulations, and oil drilling in the Arctic National Wildlife Refuge”. In the haste to solve the problem, legislators should still pay attention not to overlook these items. For the first item, legislators must carefully evaluate proposals for new power plants. They must check on the advantages and disadvantages before making approvals. For the next item, legislators should not sacrifice air quality for profits. Lastly, the state should not even think of including oil drilling as a solution as it has been proven in the past that it is not necessary to resort to this step to prevent power shortages or lower prices.

Policy makers should always consider the consequences that federal policy changes have on the possibility of plunging into crises. The Union of Concerned Scientists suggests that Congress should endorse sufficient funds for state efficiency and renewable energy programs, develop renewable energy production tax credits, and ratify a renewable energy standard of 20 percent by 2020.

Furthermore, the union suggests that the Public Utility Holding Company Act (PUHCA) and the Public Utilities Regulatory Policies Act (PURPA) remain in place as these two pieces of legislation can help prevent future problems with energy similar to what happened to California.

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