[BETA] Fortnightly

 

The problems stem from a lack of incentives for long-term, fixed-price contracts.

The end of summer found energy regulators working overtime in California to appease an angry public that had seen electric bills double and triple in some parts of the state.

Gov. Gray Davis had asked for federal support for poor families. President Clinton obliged with funds in late August, and asked Congress to focus on federal restructuring legislation. The California Republicans had asked for a special session of the state Legislature, but Gov. Davis was not giving in. The California PUC had introduced rate caps for some users, but the interest groups were not yet satisfied. Then, on Sept. 12, the commissioners from the Federal Energy Regulatory Commission traveled to San Diego to investigate whether the rules of the California Independent System Operator (ISO) actually facilitate price manipulation.

With so much political heat, chances are that any quick fix to the California power market—one that attempts to ease the pain without diagnosing or treating the illness—will only make matters worse. Indeed, at the core of this mess is the politically motivated interference with markets that was embedded in California's electric restructuring program before the state's 1998 launch of retail choice.

Californians are well advised not to repeat those mistakes. Instead, regulators must forge ahead with further market liberalization if they ever hope to achieve the lower prices and attractive options sought from the beginning for California consumers.

To its credit, California's restructuring plan was premised on a more equitable distribution of risks between stockholders and "ratepayers" (a euphemism for "consumers"). Previously, consumers enjoyed stable prices, but shouldered the risk of bad investment decisions—whether made by the utilities or regulators.

To reallocate risk, California deregulated the generating sector to attract new players and stimulate efficient investment. In the long run that was expected to push prices lower, but the promise has yet to be fulfilled. Yes, investors have responded to the incentives created by competitive markets. And since deregulation, after nearly 10 years of virtually no new generation, projects totaling almost 20,000 megawatts of capacity are on the drawing boards. The size of that investment can be appreciated more fully when considered against the backdrop of California's total generation capacity of 45,000 MW. Unfortunately, however, because of the state's lengthy and cumbersome approval process, only a small percentage of these projects have come online to date.

In fact, the high prices being experienced in San Diego and elsewhere—in California and the West in general—stem not from a lack of regulation, but rather from steps taken by regulators at the opening of the market. Regulators imposed two key restrictions on the operation of wholesale markets. In California, these restrictions create two key shortcomings, embedded from the start in the restructuring plan:

• No incentive for distribution utilities to lock in long-term purchased power contracts at lower prices.
• No incentive (during the transition period) for competitive energy retailers to offer service contracts with stable prices for consumers. And now regulators would propose to mitigate the damage from these mistakes by committing a third