Power politics
Should California deregulate or reregulate the electricity industry?

By Diane Ainsworth, Public Affairs

29 NOV 2000 | Electricity deregulation in California promised to benefit consumers, not double their rates, as happened to San Diegans this summer. Demand for electricity in the newly restructured market has been growing and the supply of energy has been failing to keep pace. The result is price spiking, but what's causing the problem?

Chalk up a major part of the rate hike to a supply-side deficiency and over-reliance on spot markets, in which prices fluctuate wildly, say some of Berkeley's policy and regulatory experts.

The supply/demand imbalance in California - the first state in the nation to deregulate electricity - has led to markedly higher prices because the public utilities are not allowed to sign long-term contracts that could stabilize prices over time. Instead, the publicly owned utilities are forced to buy electricity at a daily rate, then turn around and sell it at a regulated rate that is often far less than they paid.

Even though California is off to a tumultuous start in electricity deregulation, it's too late to turn back, said Lee Friedman - a professor of public policy at the Goldman School of Public Policy - who opened the debate at a recent daylong conference on campus, "The Energy Summit: Deregulation or Reregulation?" Still, a $20 billion savings to consumers by 2010 and new, more environmentally clean power plants may be in store.

"One of the problems that has frustrated deregulation is that we haven't had any new generating sources coming on line," Friedman said. "That's because the utilities have not been allowed to enter into long-term contracts with the power suppliers.

"They have to buy exactly how much they need each day in spot markets, no matter what its price," he said. "If they were allowed to offer generating companies long-term contracts for power, this would give the generating companies the financial assurance to build modern plants that could replace some of the aged, polluting and inefficient ones that struggle to keep up with demand now."

When the electric market was deregulated in 1996, then-Gov. Pete Wilson and the state legislature promised lower rates. The complex state law sought to boost competition in California's $20 billion electrical power industry, which was expected to produce savings for customers, Friedman said. At the time, it seemed a reasonable expectation because California was paying some of the highest rates in the country. But as deregulation took hold, it began to generate even higher rates.

San Diego was the first city to undergo deregulation. Once electricity rates were unlocked on the open market and no longer priced by the state Public Utilities Commission, consumers watched their monthly bills skyrocket from an average of about $68 per month to $120.

Part of the cause was a scarcity of supply, which was predicted by private power companies, such as Calpine Corp., a San Jose company that has built or acquired 50 power plants in 15 states in the past eight years and plans to acquire or develop 46 more by 2004. Its goal was to jump into the newly deregulated, starved energy markets with lots of supply and let the power-mad computer age catapult it into position as the largest power company in the nation, said Joseph Ronan, vice president of government and regulatory affairs at Calpine.

"This was the perfect storm," he said. "We determined a number of years ago, before most other people, that there was going to be a shortage of electricity in California. We felt demand was growing so fast that the old set of power plants built by utilities years ago would not be able to keep up."

The shortage gave suppliers the market power to drive up costs, which were passed along to consumers in San Diego and to utilities in the rest of the state.

Consumers in all but San Diego are still protected by a public utilities rate freeze, introduced by Assembly Bill 1890, which was part of the deregulation act, said Severin Borenstein, director of the UC Energy Institute and E.T. Grether Professor of Business Administration and Public Policy in the Haas School of Business.But the rate freeze will be phased out over the next two years, and officials fear the rate crisis could hit all areas of the state as they are deregulated.

Northern California, which gets most of its power from Pacific Gas & Electric Company, is scheduled to lose its rate-freeze protection on March 31, 2002.

"When the policymakers designed this restructuring law, they envisioned it as a way to create new competitors, called energy service providers," Friedman said. "But 98 percent of California has stayed with the utilities companies and we've only seen a few energy service providers enter the market."

Federal regulators, namely the Federal Energy Regulatory Commission, as well as the state Public Utilities Commission, have assured Gov. Gray Davis that they are ready to impose legislation to fix California's deregulating electricity markets before PG&E and Southern California Edison end their freezes statewide.

"Everyone is concerned that we have an energy crisis on our hands," Borenstein said. "We don't have an energy crisis. We are in a situation of short supply that has caused a scarcity in the market and allowed generating firms to exercise market power. What we have to do is figure out a way to get through the next few summers and deal with those issues until we can move into a more competitive market."