Nobel Laureate Dan McFadden, professor of economics, is among 19 authors of a 'manifesto' on California's current energy crisis. Noah Berger photo.

31 January 2001 | California can avert its energy crisis by lifting the cap on retail costs for electricity and allowing competitive pricing to bring wholesale and retail rates into sync with free market trade.

That's the main message in an energy "manifesto," issued Jan. 26, by 19 leading energy experts and economists from Berkeley and other academic institutions, the public utilities and industry.

The group is urging California's stakeholders - generators, industrial, commercial, residential users and state government - to "share the pain" of higher retail prices, (between 30 and 40 percent higher), before the deepening energy crisis sends the economy into a tailspin.

"California is battling a twin-headed crisis," said David Teece, director of the Berkeley Institute of Management, Innovation and Organization. "We have a financial crisis in electricity that must be dealt with quickly. It's critical that we keep our utilities solvent, which is going to require that California's various shareholders share the pain of higher retail rates.

"This, in and of itself, will help bring wholesale prices down," Teece said. "But unfortunately, there is no escape from the reality of higher retail rates. Either retail rates go up or the frequency of rolling blackouts will increase."

The other half of the problem - a scarcity of supply - can be remedied by bringing new plants online to meet the state's rising demand for power, he said.

Electricity prices are high now because the state's public utilities are considered credit risks by out-of-state suppliers, who have been reluctant to supply them with more power, he said. To compound matters, natural gas prices have risen dramatically, generation and transmission capacity shortages have occurred throughout western markets, and customer electricity demands have climbed.

"We should be in a situation in which the distribution company is charging customers rates which reflect the rates it has to pay for electricity and, effectively, earn its fair rate of return," said Daniel McFadden, a Berkeley economist and Nobel laureate. "It is, after all, a regulating utility and, in principle, should be buying power and selling it back to users at a normal rate of return. We have to have some flexibility on the demand side to respond to wholesale prices, so that when the costs of power go up, the demand can be moderated (through higher prices)."

Signs of an imbalance in fixed retail prices on the demand side and free market rates on the supply side surfaced last year, when wholesale market prices began to soar, the new report states. The "perfect storm" was precipitated, in part, by rising demand and higher prices for natural gas, which powers about half of California's generating plants. The wholesale price jumped from less than 5 cents per kilowatt hour in January 2000 to nearly 40 cents last December.

But electricity deregulation had capped the price that utilities could charge consumers for electricity. According to the manifesto, by insulating customers from free market rates and allowing them to pay only a small fraction of its power costs, California's two largest investor-owned utilities - Southern California Edison and Pacific Gas & Electric - were forced to absorb rising costs themselves.

New government ownership of generation and distribution facilities won't solve the immediate crisis or deliver below-market power prices, the economists noted. "State ownership is not a solution at all - merely a guarantee that the taxpayers will be saddled with additional obligations for decades to come."

Rather than making state government the new energy broker, "a 30 - to - 40 percent increase in retail prices would work right now," said Pablo Spiller of the Haas business school's public policy group. "But these prices need to be flexible, so as wholesale costs start to fall, the retail prices will fall as well."

Manifesto Online: Read the manifesto written by professors from Berkeley, and other leading energy experts and economists.