June / 2001
The Future of Electricity

How to make a mess

If you've followed the news at all the past several months you've heard at least something about California's energy woes.
The crisis, brought on by the state's 1996 law that restructured the state's electric utility industry, fascinates us like a horror movie. But it also offers lessons for anyone concerned about reliable and affordable electricity.
Finding those lessons requires returning to the reasons for the disaster, which is made up of an unlikely combination of bad policy, bad planning, and bad luck.
Here are the major causes of California's electricity supply and price problems.
No major power plants have been built in California for 10 years. Making fun of California's environmentalism is one of America's favorite sports, and in this case it seems deserved. The state hoped to establish a thriving alternative energy industry, but that dream never came true. Local resistance to building new power plants and transmission lines further increased California's dependence on outside sources of electricity.
Electricity supply did not keep up with economic growth. California began the 1990s in an economic slump, but the high-technology boom boosted a kind of growth that used up the available electricity in the state and much of the region. While California's demand for electricity increased by 3,000 megawatts in the past four years, it built only 500 megawatts of new capacity.
Hydroelectric plants faced low water supplies. Hydropower helps bless the Pacific Northwest with some of the lowest electric rates in the nation and provides a reserve when California's supplies get short. But hot and dry weather led to unusually low levels of water to flow over the dams and turn power turbines. Water runoff in the Northwest in the first part of last year was at the lowest level in five years.
Utilities sold their power plants. The restructuring rules encouraged the state's three major investor-owned utilities to sell their power plants. That might not have been so bad except the plan also discouraged long-term power purchases.
Restructuring discouraged long-term power contracts. A part of the restructuring plan, intended to increase competition, instead ended up deterring utilities from signing long-term contracts for their wholesale electricity. That meant that each day they had to go to the spot market, where prices can soar to hundreds of times normal on very hot or cold days when electricity use is highest.
Wholesale electricity markets have grown more competitive. The utility industry is more competitive than it used to be. Since 1992 when the federal government deregulated the price of electricity that utilities sell to each other in times of need, those transactions have changed from polite agreements to highly competitive bidding and dealing. Hundreds of companies have sprung up in the past few years, just to buy and sell electricity. When those companies saw California utilities start to go to the market every day, they raised prices according to how desperately the state needed electricity. You can call that immoral profiteering or you can call it the American free enterprise system-in either case it's how the wholesale electricity market works these days.
Price caps were put on consumer rates. A limit on rate increases for many of California's consumers pushed the major investor-owned utilities in the state toward, or into, bankruptcy as they sold power for much less than they paid for it. The state has recently moved to increase rates for consumers-a hugely controversial move. On the one hand, utilities claim consumers have no incentive to conserve electricity unless they pay what it costs. On the other side, consumers say they shouldn't have to pay for the huge profits being earned by the electricity brokers. One observation is that the price caps kept a competitive electricity market from developing in California because consumers had no incentive to try to get better rates from other power suppliers.
A little over a year ago Kentucky's Special Task Force studying electricity restructuring recommended watching to see how deregulation works in other states rather than trying it in the Commonwealth. California's experience makes that look like a very good decision.

-Paul Wesslund