ocregister.com
The state's electricity crisis may be forgotten, but it's not gone
October 28, 2001
By Alan Bock
The Orange County Register
According to Stanford economist James Sweeney, California's government managed to make almost every misstep possible in dealing with our energy problems this year and last. A series of challenges that could have been overcome with common-sense leadership were allowed to become a crisis, Sweeney told an audience of journalists and academics at the opening session of a conference Oct. 18 and 19, and is likely to evolve into a long-term blight over the next several years.
Held at the Hoover Institution at Stanford and co-sponsored by Hoover and the Stanford Institute for Economic Policy Research, the Conference on the California Electricity Problem brought a wide array of academics, analysts, policymakers and participants to discuss the continuing crisis.
Given a mild summer with no blackouts and the terrorist attacks on Sept. 11, few Californians want to think about electricity just now. But most of the speakers at the conference agreed that the real problems haven't been addressed yet and further energy problems will surface in the next few years.
Almost all the speakers agreed that what happened in California in 1996 was not "deregulation" but a restructuring of the electricity marketplace that involved stricter regulation in some areas and less regulation in others. As Sweeney put it, setting the stage, the legislation created a new wholesale market from scratch, the PX or power exchange, required utilities to buy power only through the PX and banned long-term contracts.
It loosened price controls at the wholesale level and tightened them at the retail level. The result was to isolate the consumer from power producers, which prevented the two-way feedback that balances supply and demand and registers changing preferences in a properly functioning market.
As Vernon Smith, an experimental economist at the Mercatus Center at Virginia's George Mason University, who has designed and tested experimental power market systems for Australia and New Zealand, put it, we faced not so much an energy crisis as a market design crisis. Professor Sweeney noted that the basic electricity crisis - the Pacific Northwest drought that dried up hydropower supplies, spikes in natural gas prices, all leading to inadequate supplies and high wholesale prices - affected all the Western states.
But only California had a financial crisis that led to draining the financial assets of the utilities, the bankruptcy of Northern California's PG&E, the crisis and settlement for Southern California Edison and the decimation of the state budget. The financial crisis will be with us for years. Whether the $10 billion the state government spent to buy electricity is financed by a bond issue, a tax increase or a reduced state budget, we'll all pay eventually.
The long-term contracts Gov. Davis negotiated last spring will probably have the state paying higher-than-market prices for years to come. Sweeney figures it will cost $4 billion a year for the next 10 years to pay for our leaders' refusal to make sensible decisions. Severin Borenstein, director of the University of California Energy Institute at UC Berkeley, puts the total costs, both the avoidable and those due to circumstances beyond any official's controls, at up to $100 billion over the next 10 years.
Edward Leamer, director of the Anderson forecasting project at UCLA, suggested consumers will feel those costs most painfully in two or three years. A California economy moving into recession will be hit hard by the terrorist attacks, he suggested, especially tourism. Based on his analysis of the aftermath of natural disasters like hurricanes and x earthquakes, however, he expects the impact to be painful but relatively brief, with "normal" growth returning next spring or so.
Unfortunately, a recession - which Leamer defines as reductions in capacity utilization in manufacturing along with increases in unemployment rather than the GDP figure many economists focus on - had already begun. And unless we see more business investment - which Leamer thinks is more important to growth than the consumer spending many see as the "driver" of the economy - it will last a while.
And if we start to come out of recession in a year, higher energy prices could stymie recovery or even prevent it. All in all, it's not a rosy picture. What might make matters a bit better? Almost all the speakers agreed that the more reliance on the private marketplace and the less reliance on government provision and even regulation of the power market the better off California would be over the long run.
Leamer even argued that while deregulating retail electricity prices would lead to higher prices in the short run it would mean lower prices and less uncertainty (which would encourage business investment) over the long run.
Several speakers, including Borenstein, Leamer, Stanford's Frank Wolak and Vernon Smith, argued for some variant of "real-time pricing," in which the retail price of electricity hour to hour (or even minute-to-minute) would track the wholesale price.
That would let consumers know how much electricity really cost at peak hours and give them strong incentives (much stronger than feel-good "public service ads) to adjust their use accordingly. That would lead to more consumer choice, more conservation, more efficient production and less environmental damage.
I suspect they're right, but as Nobel economist Milton Friedman noted the next day, most of the sensible solutions are viewed as politically impossible these days. It seems unlikely to me that Gov. Davis and the PUC will even allow deregulation of retail prices, let alone the more conceptually drastic step of real-time pricing.
So the crisis is likely to become a long-term blight.
As Edison Chairman John Bryson and Calpine President Peter Cartwright, speaking on a panel along with former Gov. Pete Wilson, made clear, politics will inevitably play a huge role, even (or especially?) in the deliberations of ostensibly independent regulatory agencies like the California Public Utilities Commission.
That hardly bodes well for a sensible future. Most of the speakers agreed that while most of California's problems arose from regulatory failure rather than market failure, the upshot of the debacle had been to discredit the whole idea of deregulation and privatization, at least for some time to come.
Sweeney's advice, to develop a system in which the private sector is dominant rather than the public sector, is unlikely to gain much traction soon, I suspect. But a more modest suggestion from Friedman - that the money the state has already shelled out for energy and will shell out for the long-term contracts in the future should be paid for by Californians in their role as taxpayers rather than in their role as ratepayers because that will distort the market less and for a shorter period of time - just might get a hearing.
Former Secretary of State George Shultz had the last word, and he harked back to President Eisenhower, on whose Council of Economic Advisers Shultz served. The council was doing a "practice alert" to do role-playing on how it might respond to a theoretical economic crisis, and President Eisenhower gave them their pep talk.
He noted that plans and planning are important, "but in my experience plans are worthless. The unexpected will always happen and you have to be ready to deviate from the plan." Shultz suggested that it's a mistake to let any government entity operate with a surplus, because the surplus becomes a honeypot that will inevitably be squandered.
Unfortunately, that kind of common sense doesn't seem likely to carry much weight in a California electricity crisis that will almost certainly afflict us for years to come.
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