SYNOPSIS: California messed up. But it has options in cleaning out its power box.
How did California get into its electricity mess? Now what?
Start with the less interesting question. The biggest single cause of the California power crisis is simply that nobody expected demand for electricity to grow so rapidly. When the political momentum for deregulation was building, in the mid-1990's, California's economy was still suffering the aftereffects of a nasty recession; most experts thought that there would be excess generating capacity well into the next decade. Then California began growing faster than anyone had thought possible. The result was surging demand for power.
To cope with an increase in demand, you either need to persuade consumers to consume less or make it possible to produce more. But California's deregulation did neither.
First, while the wholesale market in which local utilities buy power from generators has been set free, the prices charged by local utilities to final users have stayed under state control — at the request, let us add, of the utilities, which wanted protection from a price slump. So consumers have had no incentive to economize on electricity use.
Meanwhile, no new power plants have been built. This is partly the result of the regulatory hurdles that would-be builders of plants must surmount; it is probably also the result of the fact that companies that already own substantial shares of California's generating capacity, and which therefore stand to benefit from a tight market, have little incentive to add capacity. (Some analysts believe that these power companies have actually withheld power from the market for the same reason, though this is not the core of the crisis.) Eventually new plants constructed by new players will ease the strain — but this will take time.
So for the time being California finds itself with a demand for electricity that it cannot meet. One result has been rationing of power, mainly hurting businesses rather than families. But the physical shortages of electricity have actually been more or less manageable; what is really pushing the state to the brink is the financial fallout. California's utilities find themselves in a bidding war, both with one another and with their counterparts in neighboring states, for the limited supply of wholesale power available. This bidding war has sent wholesale electricity prices to 40 or 50 times their normal level, bringing huge windfall profits to the companies that generate power, but also bringing the utilities that deliver power to the edge of bankruptcy.
It's a miserable story — botched deregulation meets Murphy's Law. But the main question is, Now what?
Bear in mind that while the huge profits now being earned on electricity sales will lead, over time, to construction of more plants, it could be years before the situation returns to normal. So what are the options?
The simplest option would be for California to deregulate all the way — and let the prices to final consumers go as high as necessary to persuade them to limit their demand to the available supply. This would work; it would be efficient; and it would also transfer tens of billions of dollars from California consumers to eight lucky power companies.
An alternative would be a temporary and partial reregulation: placing price caps on wholesale power, while also raising prices to consumers, and engaging in some power rationing while fixing the pricing system and hastening the arrival of new generating capacity. This would be messy, somewhat inefficient and a lot fairer. It would also, however, require federal help. California has already found that it cannot unilaterally impose price caps on wholesale power because other states are also short of power, and the electricity simply goes elsewhere. So this solution would require higher-level intervention.
If the "power summit" now scheduled for this week had happened a year ago, one could reasonably have expected a compromise along the lines of the latter alternative — that is, a compromise that, without trying to wish the shortage away, tries to limit the damage to consumers and the windfall profits to producers. But George W. Bush doesn't just have an ideological attachment to free markets; he has close personal ties to some of the companies that are making such huge profits in California right now.
Mr. Bush has been conspicuously silent on the California crisis. But in the end it's his decision. Will he help California find an answer that does not involve paying a huge ransom to his friends?
Originally published in The New York Times, 1.7.01