Let the Free Market Rule

Electricity restructuring caused micromanagement and market distortions

People who proclaim that “deregulation is dead” have the right diagnosis on the wrong cadaver. California did not deregulate the electricity market. It restructured, creating centralized market institutions and greater micromanagement of utilities, telling buyers and sellers what, when and how they would trade, what prices consumers would pay, how assets would be maintained, and so on.

The past year of wholesale price spikes, utilities bleeding red ink and rolling blackouts are not the result of “unfettered free markets,” but of the political micromanagement and market distortions that restructuring wrought.

Meanwhile, in states that have truly deregulated, people are shaking their heads at California. In Pennsylvania, for example, true deregulation has lowered prices 30 percent, customers can choose from among 130 electricity companies besides the old utilities, “green power” has won 20 percent of the customers and surveys show consumers are far more pleased with their electricity service than the national average.In Pennsylvania, power generators don’t set the prices; customer choice does.

California is at a crossroads where state leaders must choose the direction of electricity policy that will determine how you and I buy our electricity for the next decade.

Down one road – the re-regulation road – lies a gentle slope, a quickfix where electricity rates remain at 30 percent above the national average, locked in by state contract for years to come. Also down that road are no choices for consumers, increasing dependence on natural gas to fuel electricity plants, a green-power industry barely clinging to life, and no flexibility to change if market conditions fluctuate again.

Down the other road – the true deregulation road – lies a competitive electricity market, where a short but steep climb (higher electricity rates this year) will soon bring us to electricity rates 20 percent below where they were last year. Down this road, consumers are no longer captive to the big utilities but get to choose from whom to buy electricity; new companies with new generation technologies set up shop in California; green power wins a substantial share of customers; and the market adapts as the world changes.

If you are thinking that this second road is mere fancy, or at best, theory, remember how it has worked out for Pennsylvania.

Taking the road to a competitive electricity market won’t be easy. Abroad range of factors contributes to the crisis, factors affecting supply, demand, underlying electricity costs and the institutions of the market. Addressing these factors in an integrated fashion, rather than in isolation, requires California’s leaders to combine several immediate steps with some longer-term efforts.

In the short run, we have to allow electricity rates to rise – slowly and on a preset schedule – to reach market prices, while taking quick action to improve electricity supply so that rates will not have to rise too much.

No one wants even temporarily higher rates, but that’s what gets people and businesses to reduce their use of electricity. And the state may want to use some of the budget surplus to rebate taxes to consumers to offset the higher electricity costs.

At the same time, utilities should not be allowed to pass all their new debts on to customers through higher rates. State leaders should make adeal to split the costs between the utilities and the state (they share responsibility for this mess). This will allow the utilities to buy electricity again without the high costs caused by bad credit.

Finally, state leaders need to change their attack-dog attitude toward electricity generators and encourage them to sell in California.

Generators can get good prices in other Western states without the political hassle California is giving them. If we want their electricity and investment, we have to be an attractive market.

These measures will help us get through winter and spring, but by summer, the state must implement longer-term measures if we want to avoid blackouts on a whole new level. In the longer run, state leaders must begin by bringing more power plants online. New plants are being built, but they take twice as long in California as in other Westernstates. The problem is that state regulators don’t care if power plants get built, only that siting and environmental rules are followed.

The energy czar Gov. Gray Davis has proposed ought to have the mission of changing regulators’ attitudes so that they see their goal as facilitating new power plants while still enforcing appropriate rules.

The distinction is subtle, but crucial: Will regulators just put up the legal hurdles in a power plant’s path, or will they also coach companies on jumping over them as quickly as possible?

Also in the longer term, state leaders have to adopt a new market structure that does not mandate where, when and how electricity purchases will take place, but that takes an approach similar toPennsylvania’s, where the Power Exchange competes with long-term contracts and other means of trading electricity.

None of these policies is overly difficult to implement – other states have done it. But they do require political will, something in short supply in Sacramento these days. If we want to enjoy the same consumer sovereignty and positive business climate that competitive electricity markets are bringing to other states, we must eschew the easy, quick-fixre-regulation road, and instead climb that first hill on the competitive market road. It will be worth it.

Adrian Moore is Vice President of Reason Foundation.