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The Answer: Turn Up the Thermostat

Blaming price-fixing conspiracies won't end the problem. New investment in power sources will take time.

August 09, 2000|GEOFFREY ROTHWELL | Geoffrey Rothwell is the senior lecturer in the economics department at Stanford University

When California electricity deregulation was contemplated in the early 1990s, economic growth was low and electricity reserve margins were high. When the Legislature adopted deregulation in 1996, concerns about new investment in electricity generating capacity were low and optimism about an electricity market that would generate the proper investment incentives was high.

Today, after a summer threatened by rolling blackouts, reliability is low and prices are higher than anyone could have imagined in the mid-1990s.

What happened to the vision of competition reducing California's high electricity rates? An economics cliche: Too much demand and too little supply. As more people move to California to work in the high-technology sectors, more electricity is required.

But with this shift in the economy, there has been little investment in new electricity generating capacity in California. While markets were being defined between August 1996 and March 1998, investors were too unsure about the profitability of new capacity. After March 1998, many out-of-state investors purchased existing facilities with the hope of upgrading or building new capacity at older sites.

Although new electricity technologies (primarily fueled by natural gas) are much cleaner than old technologies, Californians do not want power plants in their backyards. Also, environmentalists prefer investment in renewable resources, such as wind and solar, rather than building fossil-fueled power plants, nuclear or environmentally harmful hydro. Therefore, some environmentalists usually oppose all nonrenewable projects, even those that would replace polluting plants. As a result, little new capacity has been approved and still less has come into production.

As a result, prices have risen in recent months in areas served by San Diego Gas & Electric and will soon rise elsewhere. These price increases should signal customers to consume less electricity and should signal investors that new capacity would be profitable in California. Unfortunately, consumption changes slowly, leaving ratepayers with huge bills. New generation cannot be built overnight, leaving reserve margins at less than 3%. Also unfortunate is a political response that attempts to find price-fixing conspiracies.

What would be different if California had avoided deregulation? The Public Utilities Commission would have continued to grant annual rate changes. Electricity prices would have decreased in the late 1990s with declines in the price of fuels. Recent increases in these prices would have been passed on to customers. It is unlikely that new capacity would have been built because of delays in the approval of power plant projects. We would have had rolling blackouts and the public would have demanded that state politicians look into mismanagement in the electricity sector.

Can California re-regulate electricity generation? The PUC continues to regulate transmission and distribution services. To re-regulate the wholesale electricity market would require either the sale of generation assets to the traditional electric utilities at prices determined through regulatory proceedings (a regulatory nightmare) or the resuscitation of rate-of-return regulation and its application to dozens of electricity generators (an even bigger regulatory nightmare). Either option would take several years. And during those years, no new capacity would be built and prices would rise with scarcity and uncertainty.

The solution? We must be willing to live with less electricity and live next to electricity generators. Politicians should investigate why so little supply has come into production. They must be willing to make politically difficult decisions to encourage less consumption and more production. Trying to fix rates in an emerging electricity market could be counterproductive in the long run, although it will be an opportunistic issue for those running for office this November.

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