SYNOPSIS: Electricity deregulation, California style, is subject to market manipulation.
Welcome to the Cartel California. Last week a report by the Independent System Operator, which runs California's power grid, made it more or less official: the electricity crisis in the Golden State is partly the result of market manipulation by power generators. The report alleges that generators overcharged the state's utilities, which distribute power to consumers, by more than $6 billion over a 10-month period.
The report is almost certain to be ignored by federal authorities. But I'll come back to that in a minute. First, there are a couple of things I need to make clear about the report's claims.
The I.S.O. is not alleging that power generators were part of some vast conspiracy. Actually, I shouldn't have used the word "cartel" in the opening sentence. The generators didn't have to conspire: the logic of the situation made it easy, almost irresistible, for each individual company to manipulate the market. In fact, to believe that the generators didn't engage in market manipulation, you have to believe that they are either saints or very bad businessmen, because they would have been passing up an obvious opportunity to increase their profits.
Imagine the situation: it's a hot summer, and the California electricity market is very tight. You are one of only a handful of major players selling wholesale electricity. Surely the thought has to occur to you: what would happen to prices if one of my plants just happened to go off line? And when companies act on that thought . . . well, you get the picture.
It's also important to realize that accusations that power companies were withholding electricity to drive up prices didn't emerge out of nowhere when the crisis erupted; this isn't a case of politicians suddenly looking for scapegoats. On the contrary, economists were raising red flags about the possibility of market manipulation long before California's woes hit the headlines. Indeed, some economists warned about the issue before California even deregulated: there was clear evidence that "market power" was a problem in Britain, which began experimenting with deregulation and privatization years before the movement came to America.
And the research evidence continues to pile up. Just before the I.S.O. issued its report, the economists Paul Joskow and Edward Kahn circulated a study that found strong evidence that "exercise of market power" played a large role in raising electricity prices last summer. The authors aren't leftists, or even opponents of deregulation. They were merely trying to look objectively at the evidence, which points more or less unmistakably to the conclusion that deliberate withholding of electricity to drive up prices has been an important factor in the California crisis.
Still, there is every reason to believe that Washington will turn a deaf ear to this evidence. As an article in this newspaper explained on Friday, the Federal Energy Regulatory Commission, which is supposed to act as the nation's watchdog over the energy industry, lately seems more like a lapdog. I was particularly struck with the report that FERC's staff found that California's power companies "had the potential to exercise market power," but could not conclude that they had actually used that power. As I said, those power generators must be saints, bad businessmen, or both.
What should the regulators be doing? I'm skeptical about proposals to make the generators pay big fines; it's not clear that you could figure out which company was responsible for which part of the problem, or for that matter that the companies were doing anything illegal. What FERC could do is impose a temporary cap on wholesale prices. This would limit the financial damage to California — the state government is currently spending more than a billion dollars a month to subsidize electricity purchases. And in a market where "exercise of market power" is a major factor, a wholesale price cap might actually increase supplies, because power companies would no longer have an incentive to withhold electricity to drive up its price.
But it's not going to happen. Blame knee-jerk free-market ideology, or the political influence of the power companies (many of which are based in, yes, Texas). Whatever the reason, it is hard to imagine an administration less likely to be sympathetic to California's plight than the one currently in power.
And if this indifference makes Californians angry, it should.
Originally published in The New York Times, 3.24.01