On Electricity Deregulation And The California Power Crisis

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Justin Riley and Gilbert Michaud
October 27, 2019

Over the past few decades, many states have attempted to restructure, or deregulate, their electricity markets, typically under the auspice of state legislatures trying to enhance competition and drive down prices. While many states’ deregulation efforts have been successful and sustained, others have realized the complexities around competing interests, grid reliability and other complications. Thus, they have attempted to re-regulate their electricity markets.

While some states (e.g., Arkansas) have completely re-regulated their electricity market, others have implemented freezes one way or another for further study. The general freeze in efforts by new states to deregulate electricity markets across the United States has often been attributed to the California Power Crisis of 2000–2001, yet how much were the crisis’s blackouts, soaring electricity prices and financial calamity (including the bankruptcy of one of the state’s major utilities) a result of deregulation itself? At the time, energy prices were slated to increase, as natural gas prices increased by 500% between 1999 and 2000. An untimely drought caused a shortage of low-cost hydropower in the state. However, many studies have placed significant blame for the crisis on the way California implemented deregulation itself. They argue that several elements of the state’s deregulation plan exacerbated the issue. Much of this cannot be reduced to any particular aspects unique to the state’s implementation.

Logistically, deregulation removes the entities responsible for managing demand. Typically, regulated utilities are obligated to predict and meet electricity demand with supply, but under California’s deregulated environment, they were to simply buy the necessary electricity on the wholesale market. However, the crisis really emerged when the deregulated generation market failed to prepare enough generation for the future. Moreover, energy efficiency programs received half their previous support under this new regulatory structure, as utilities rushed to eliminate any costs that decreased their competitiveness. Thus, between 1990 and 1999, the state’s generating capacity declined while demand increased by 11%.

Deregulation intentionally shifted energy suppliers’ priorities from public gain to private. The state’s new non-utility electricity suppliers, such as Enron, knowingly threatened the reliability of the state’s electricity grid to maximize profits. Some have claimed that California would have still had sufficient electricity capacity had these suppliers not manipulated the market. Enron itself has even admitted in internal memos that their exploitative practices—which they gave names like, “Death Star,” and, “Fat Boy,”—were not only creating market inefficiencies and higher prices, but even leading to a state of emergency.

This aspect of the California Power Crisis demonstrates the disconnect or disregard for public benefit held by many private institutions. While public and private gain can often be brought into quasi-alignment by the free market, the electricity market is one area where this does not necessarily occur without additional intervention. Given our inelastic electricity demand, and the monumental barriers to generation market entry, large power producers have significant market power which may be abused without a threat of competition or punishment.

Aspects of California’s deregulation plan itself also stifled competition. As late as 2000, incumbent utilities claimed all but 12–13% of the state’s retail electricity sales—at a time when deregulation was expected to be in full bloom. Rules, such as the assignment of stranded cost recovery to all customers, prevented power marketers from offering customers a better rate than the incumbent utilities, making entry into the retail market unappealing. Given this situation, coupled with the fact that California chose to freeze retail prices, the power crisis was solidified as wholesale suppliers continued to manipulate the market.

The California Public Utilities Commission (CPUC) created a similar problem by restricting utilities’ purchase of power supply contracts to no more than one day ahead. This was meant to force utilities into purchasing power competitively. However, purchasing power in long-term supply contracts can stabilize prices and serve as a source of long-term planning in the deregulated market. This would have alleviated the drastic price increases.

In essence, California’s deregulation and subsequent power crisis serves as an exemplary case study of what occurs when politicians remove governmental authority over such a complex area as electricity. Electricity markets require extensive planning, and the failure to set up alternative mechanisms for meeting consumer demand, at least in the California case, proved to heighten deregulation’s ineffectiveness. Typically, or, at least in theory, the free market would force electricity suppliers to compete with each other. However, it has proven difficult to achieve this alignment in deregulated energy markets due to the immense market power each supplier can achieve. This problem has historically been dealt with by the very regulation which deregulation necessitates removing, and it may be difficult to ensure such an alignment without some degree of governmental regulation. It should not be taken for granted that any electricity market regulation is unnecessary red tape, or that the free market will magically solve complex issues. States should proceed with caution when considering alternative electricity market regulatory structures moving toward the future, especially given new demands for renewables, electric vehicles and growingly complex questions concerning distributed vs. centralized generation.  

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Authors: Justin Riley is a Research Scholar at the Voinovich School of Leadership and Public Affairs at Ohio University. He conducts research on energy policy issues and can be reached at [email protected]. Dr. Gilbert Michaud is an Assistant Professor of Practice at the Voinovich School of Leadership and Public Affairs at Ohio University. Michaud can be reached at [email protected].

 

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