Freeman

ARTICLE

The California Power Mess

The Golden State's Energy Crisis Is a Political One Caused by an Appalling Ignorance of Basic Economics

APRIL 01, 2001 by LAWRENCE W. REED

Years ago, California state senator Bill Richardson (not the former energy secretary) wrote an instructive little book about politicians with a charming title: What Makes You Think We Read the Bills? The electricity debacle in the Golden State makes me think there’s a need for an updated version. The title could be What Makes You Think We Read Anything at All?

It’s customary in public-policy discussion to treat the views of others with a certain dignity, as though they represent legitimate differences of opinion. But what happened in California was utter, certifiable, and inexcusable “lunacy,” as Treasury Secretary Paul O’Neill put it. Saying so is also completely bipartisan: Every single legislator of both parties voted for the 1996 bill that bore its fruit in recent months in the form of random blackouts and soaring prices.

The geographic boundaries of the crisis ought to tell us something right up front. Drive one mile across the California border in any direction and there’s no power problem. This is not a crisis of the free market. It is a political crisis confined to the jurisdiction of which so-called public servants are in charge. It is a crisis made in Sacramento by consenting adults whose appalling ignorance of the most basic principles of economics will get them all fired if there’s any justice in this world. Moreover, anybody who has the gall to call what they did “deregulation” is no better informed than the culprits themselves.

It is not “deregulation” when government fixes retail prices, forces companies to sell their power plants and bans them from buying power through long-term contracts, creates a state-run power broker, and stifles additional supply while demand soars. All this California did in the name of “deregulation”—and it did it in the form of a law the size of a city phone book. True deregulation would have actually freed markets to operate according to supply and demand. It would have removed rules and barriers instead of creating a mass of new ones. It would have granted government less control, not more.

We cannot overestimate the extent to which the assumptions built into California’s botched “deregulation” attempt flouted long-settled and elementary principles of economics. This is the frustrating aspect of the whole mess, the reason it’s hard for any market economist to write about it without grinding teeth. Didn’t anybody in the California legislature ever read any economics?

Consider this: Prices are the signals of the marketplace. They tell us infinitely more than the most deluded, narcissistic central planner could ever dream of knowing—things like what people want, how badly they want it, where and when they want it, and what they’re willing to pay for it. Prices also direct production—they tell suppliers to create more of something or create less and switch instead to other, more valued lines of work in concert with conditions of supply and demand. We know that when prices are fixed by government decree, they can’t do any of these miraculous things effectively. If mankind has learned anything from hundreds of years of research, study, and exposition in economics, surely that’s it.

Retail Prices Fixed

But not California legislators. They fixed retail prices of electrical power, perhaps because they thought they were immune to the laws of the marketplace or because they just didn’t think at all. In any event, a funny thing happened on the way to electrical Nirvana in La-La Land. Electricity demand rose twice as fast in California as in the nation as a whole. Stripped of the power plants the law required them to sell, Golden State utilities had to buy power in a government-managed wholesale market where prices were rising—rising in part because of a harsh winter, a strong economy, and a regulatory environment that prevented any new power plants from being built in over a decade.

In the last six months of 2000, the two largest utilities alone spent $11 billion more to purchase electricity from power producers than the state’s price controls allowed them to recoup through sales to customers. In late January the state’s two largest utility companies were hemorrhaging cash and facing bankruptcy.

The 1996 law created something called the “Power Exchange,” which Adrian Moore of the Reason Public Policy Institute describes as “a mandatory bidding pool where all sellers of electricity are paid the price of the last bidder needed to meet total demand, which is the highest bidder.” A new state agency called the “Independent System Operator” took over operational control of California’s electricity transmission grid. Only in bureaucratese could this painstaking, centralized micromanagement be termed “deregulation.”

One effect of this Rube Goldberg contraption was to prevent utilities from making long-term contracts for power. All the electricity they purchased had to be bought in the spot market, where prices are agreed to according to conditions at the current moment and delivery is immediate. Long-term contracts historically allowed utilities to lock in their power costs and thereby give them some protection against high and erratic spot-market prices. Moreover, the “deregulation” scheme mandated that utilities cannot look outside the government’s power exchange for cheaper sources of power.

With deregulation in other states looking much more like the real thing, new power plants are being constructed to meet growing demands. But not in California. Texas power companies have added 5,700 megawatts of generating capacity over the past five years—nine times what California has added. It’s nearly impossible to build a new power plant anywhere in the Golden State because of the most cumbersome, time-consuming, and costly regulations in the country. No new plants in California have been built in 15 years. Indeed, according to Investor’s Business Daily, California “produces less power per resident than any other state and imports one-quarter of its energy from places as far away as Quebec.”

So add it up: Don’t let anyone build a power plant. Slap on retail price controls that guarantee that utilities’ costs will far exceed what they can get for the power they sell. Forbid companies from getting the best deals in an open marketplace. Force utilities to get rid of their power plants and buy power through a government bureaucracy. This is not rocket science. It is a surefire prescription for disaster that can’t honestly be labeled deregulation.

The California power meltdown has one source and one source only: politicians. It has nothing to do with the free marketplace. The people who thought they knew more than the market and could “plan” the state’s electrical future need to step up to the plate, take responsibility, apologize profusely, rid the books of their nightmarish schemes, and promptly find honest work.

ASSOCIATED ISSUE

April 2001

ABOUT

LAWRENCE W. REED

Lawrence W. (“Larry”) Reed became president of FEE in 2008 after serving as chairman of its board of trustees in the 1990s and both writing and speaking for FEE since the late 1970s. Prior to becoming FEE’s president, he served for 20 years as president of the Mackinac Center for Public Policy in Midland, Michigan. He also taught economics full-time from 1977 to 1984 at Northwood University in Michigan and chaired its department of economics from 1982 to 1984.

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