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The State Will Pay for Davis' Panic

July 31, 2001|KATHLEEN CONNELL and PETER NAVARRO | Kathleen Connell is California state controller. Peter Navarro is an associate professor of economics and public policy at UC Irvine

The five-to-20-year power contracts signed in a panic by the Davis administration have saddled California with billions of dollars of "stranded costs" that will burden our economy and state budget for years to come.

Now, Gov. Gray Davis' spin doctors want us to believe that these $43-billion long-term contracts were both necessary and the impetus for a moderating energy market. Here's the real story:

Last summer, under a flawed deregulation, a handful of large out-of-state generators effectively cornered California's wholesale electricity market. This "sellers cartel" first drained our electric utilities dry. In November, it became the taxpayers' turn to be victimized, when the Davis administration gave carte blanche authority to the Department of Water Resources for energy purchases. Between November and July, the department burned through $8 billion in short-term energy purchases, devouring almost the entire state budget surplus. This required the state Public Utilities Commission to pass the largest rate hike in California history and will require the state to issue $12.4 billion in bonds this fall to service this debt.

In February, with spot market prices at all-time highs and rolling blackouts rippling through the state, the governor's representatives began to negotiate long-term contracts with the sellers cartel. This was an ill-advised long-term strategy to fight a short-run crisis. To understand why, look at the negotiating chessboard from the electricity cartel's perspective. The cartel's negotiators knew that within 18 to 24 months, there would be a huge glut of power on the market as many power plants were already under construction in California and throughout the West. Once the new energy resources were available, the cartel would no longer be able to manipulate the market. This supply glut would drive prices back to the 1999 range of three to five cents per kilowatt-hour, far lower than the prices now set in the long-term energy contracts.

To the cartel members, this looming power glut was a recipe for heavy losses. Locking the state into long-term contracts at lucrative rates was their redemption. The Davis administration walked into this market inferno, bargaining from extreme weakness at the top of the market, signing contracts that were too expensive. The administration also capitulated on two highly objectionable clauses. The first requires the state to absorb all costs of environmental protection for many of the generators. The second holds the generators "harmless" for any increase in taxes imposed on the generators by the state. This provision essentially freezes taxes on the generators over the next several years, requiring taxpayers to pick up the tab.

Notwithstanding the administration's spin, the current improvement in our energy situation may be traced to at least four other factors: This summer has been unusually cool, Californians have increased their conservation, recessionary forces have reduced demand and, most important, the Federal Energy Regulatory Commission finally imposed price caps on the sellers cartel, dampening market manipulation.

The bottom line is this: Long after the rolling blackouts stop, California still will be saddled with billions of dollars of unnecessary electricity costs and high bond debt. These higher costs will hurt consumers and businesses, put heavy pressure on the state budget for years and inhibit the state's economic growth.

There are two lessons from this multibillion-dollar mistake. The first is to have full public review of major energy decisions. Equally important, the Public Utilities Commission must be allowed to retain its rate-making authority so that problems are not hidden in a state bureaucracy.

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