Calif.'s Davis talks electric in Mexico
By Ian Campbell
UPI Economics Correspondent
Published 12/14/2001 7:41 PM
QUERETARO, Mexico, Dec. 14 (UPI) -- Gov. Gray Davis of California came to Mexico last week and spoke bitterly. "Don't do it," he said, "Don't hand over your electricity infrastructure to private interests, unless you have 15 percent more energy than you need. In private meetings, (Mexican) President (Vicente) Fox and I agreed on this," Davis said.
What had provoked this loathing of "private interests" on the part of the governor of California, administrator, after all, of one of the world's greatest and wealthiest free-market economies? He spelled it out. "They tried to charge us for electricity seven times more than they charged us in 1999. I had to fight a great battle with them in which we did not have great negotiating power, since we had much less energy than we needed."
The California electricity crisis of this year risked bringing to a halt that state's economy, which, if stripped off from the United States, would be about the sixth-biggest in the world. The message Davis brought to Mexico was that he waged war with exploitative private companies in order to prevent that happening.
In Mexico, Davis would find no fault with the current arrangements for electricity. Mexico's monopoly producer is the state-run Comision Federal de Electricidad. But within Mexico there is dissatisfaction with the CFE's performance. There are supply problems. And with the CFE responsible for generation and distribution there is no incentive to produce cost savings, according to Juan Rosellón, a researcher in energy at the Colegio de México in Mexico City. Electricity tariffs are not excessively high, Rosellón says, but that is largely because the government subsidizes these tariffs. He estimates that these subsidies cost the government about $5 billion in 2000, almost 1 percent of GDP. In addition, it will be expensive for the government to invest in the increased capacity the economy will need as it grows; that, too, would be a strain on the government budget. "Private sector involvement is needed," Rosellón says.
Electricity, it must be admitted, is a difficult product. Electricity cannot be stored, is difficult to transport and when we need it, such as on a sweltering day in the Californian summer, we all tend to need it at once. Thus capacity, which is expensive to install, is required to meet peak demand but for most of the time, indeed most of the year, that capacity is not fully utilized. Another problem is that the consumer is not aware of price changes when demand is at peak levels. The price for the consumer generally remains the same, giving him no incentive to consume less and help moderate demand for electricity.
If electricity utilities do not manage their supplies well, even a small generator of electricity can enjoy, and exploit, considerable market power at these moments of peak demand. The genearator will charge as much as it can. Companies outside Calfifornia did profit from the state's crisis this year.
To prevent the danger of exploitation is it best then to keep electricity in the public sector? This is Davis's conclusion after his "great battle" with the private sector. But every battle has two sides, and many observers have a quite different view.
Professor Jim Sweeney of Stanford University is writing a book on California's electricity crisis. He points out that throughout the 11 Western states of the United States wholesale prices for electricity rose abruptly, and by more in the Pacific Northwest than in California. But "the only economic disaster" took place in California. The reason, Sweeney says, is that "the state government had regulated them (the electricity utilities) to force them to buy everything on the spot market and prevented them from entering into long-term contracts before the crisis occurred."
If a utility is obliged to buy from the generator on the so-called "spot" market rather than being able to rely on guaranteed supplies, it is vulnerable. Sweeney argues that Davis forced California's utilities into this position.
Davis, in Sweeney's view, might have alleviated the crisis by allowing the utilities to raise their prices in order to cover their input costs. "He (Davis) said himself," Sweeney says, "that he could solve the crisis in 20 minutes if he let prices go up."
California's problem was not deregulation of electricity, which was effected five years ago but only for the wholesale market for electricity, but "greater regulation than there had been before," according to Sweeney, because the state imposed a price cap on electricity at the retail level.
How has California's crisis played out? Rather than allowing the utilities to raise retail prices in order to cover their costs, Davis put the state's money to work and signed long-term supply contracts at an average price of around $70 per megawatt. According to Sweeney the current expectation is that the wholesale price will average $30 per megawatt over coming years. In other words, Davis committed California to pay more than twice the expected market price. California's budget, and California's consumers, are going to have to bear that cost. Sweeney characterizes Davis' management of the electricity crisis as "the worst failure of political leadership" he has seen in his lifetime.
What is needed to produce a healthy electricity market? It is clear that a state-run monopoly is unlikely to be efficient. There is no incentive for it to cut costs. Meanwhile the government needs to pay for necessary investments if capacity is to be increased. What is required is private competition in the supply of electricity; long-term contracts for that supply; and ideally, a way of making consumers respond to variations in the price at times of high demand. That is the model toward which California and Mexico should be working.
But in Mexico, Davis's words may redound. Mexico is still a country that is wary of the private sector and especially of foreign capital. But to raise its oil and electricity supply and its growth prospects, Mexico needs to let private investment, some of it foreign, into its energy sector.
Davis, governor of one of the biggest states in the Goliath to the north, has advised them against it. That is a pity. Mexico's policy debate on what to do with energy is active but there has been as yet little progress towards implementing change. Oil is so central to the Mexican economy, providing one-tenth of exports and one-third of budget revenues, that the country can ill afford to stall much longer.
Having done great harm in California, Davis has done a little more in Mexico. Mexico, with its vast sea of poverty, can afford it less well than the state across the border where the private sector that Gray decries has created so much wealth.
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