What do California electricity rates and the state's unemployment rate have in common? Both are significantly higher than the national average. That's why the California Public Utilities Commission embarked more than a year ago on an ambitious effort to deregulate the state's electricity industry.
Unfortunately, as the PUC completes its restructuring plan, two things are clear: The big utilities and a few large electricity users will make out like bandits, and neither the broader California economy nor the average electricity user will be better off.
At present, California utilities generate electricity at a cost 50% higher than the national average and more than 70% higher than some independent power producers. Under deregulation, these independent power producers will significantly underbid the utilities and turn billions of dollars worth of utility assets into economic dinosaurs.
Utility lobbyists want the PUC to grant them 100% recovery of the so-called "stranded" power plants by allowing them to tack the cost on to everybody's electricity rates. They argue that since these power plants were built under an implicit "regulatory contract" with the PUC, such full recovery is only fair.
The reality, however, is that much of the utilities' stranded costs may be traced directly back to the bad management decisions of the individual companies. This is particularly true for the utilities' nuclear power plants.
To grant full recovery would perversely reward bad management. It would also grossly overcompensate these utilities. The PUC has allowed them to earn rates of return well above average for the past decade--precisely so as to compensate them for their risky financial investments.
Nonetheless, rather than force the utilities to absorb all of their stranded costs, or even push for a more equitable 50-50 sharing, the PUC has agreed to a 100% recovery. The practical result will be to institutionalize current high electricity rates for at least another decade. This means high electricity rates will continue to be a drag on the California economy and high wage, electricity-intensive businesses will continue to flee the state for the cheaper electricity pastures of New Mexico and Arizona.
The second problem with the PUC's proposal is that it fails to ensure that a deregulated electricity generation market will also be competitive. At present, the state's three biggest utilities--Pacific Gas & Electric, San Diego Gas & Electric and Southern California Edison--control well over half of the state's generating assets. The clear danger from such a high market concentration is that the Big Three utilities will collude in a deregulated generation market to fix prices and gouge ratepayers. This is almost exactly what happened in Great Britain when its industry was deregulated and prices rose by almost 20%.
The best solution to this market concentration problem is to break up the utilities' generating assets into smaller, more competitive pieces. This could be accomplished either through a divestiture sale of assets or through spinning off these assets into numerous independent subsidiaries. But rather than recommend this bold step, the PUC has opted to do nothing. It wants to wait and see if this inevitable problem will emerge--a strategy not unlike a sky-diver waiting to see if he will hit the ground before pulling his chute open.
The third problem with the PUC's plan is that it unfairly discriminates against small captive business and residential customers. Big industrial customers can threaten to generate their own electricity or even leave the state--and thereby negotiate for the best bargains; small businesses and residential customers are held captive.
What's needed? A bold electricity restructuring that rejects full recovery of stranded costs, breaks up the big utilities into smaller competitive pieces and groups small consumers into effective bargaining units. This would dramatically lower electricity rates and lay the foundation for the state's strong economic recovery well into the next decade.
The PUC's proposed alternative will accomplish the opposite. It will re-regulate under the guise of deregulation, institutionalize high electricity rates for at least another decade and grant a handful of powerful special interests the license to rip off the rest of us.