California's power debacle and the free market
Ross, Benjamin
THE CALIFORNIA power crisis has made it clear to all but the most theory-besotted ideologues that "trusting the market" does not automatically solve economic problems. This comes as news to few...
...By the 1990s, the electric power industry had been coasting for years on the slack created by the overbuilding of the seventies...
...DISSENT / Spring 2001 n 47...
...But if deregulation won't make power cheaper, what purpose can it have...
...As growing scarcity raises prices, developers increase spending on political influence and become more willing to add expensive "amenities" to new construction to pacify neighbors...
...In addition, use the crisis as an excuse to advance long-sought, but only marginally relevant, goals of the lobbyists such as oil drilling in Alaska and relaxation of clean air standards...
...In a deregulated market where the costs of rejected proposals are not reimbursed, the risks that this process entails are worth taking only for handsome profits...
...The market can't match planning for reliability of supply...
...In a competitive market, however, there is no reason to build peaking plants, and thus no way to ensure a continuous supply, unless the price of power rises to astronomical levels when demand peaks...
...But predictions of future power requirements are unavoidably prone to error, and the number of hours that peaking plants will operate cannot be accurately foreseen...
...This gives the rest of the producers, who have much lower costs, gigantic profits when the peaking plants run...
...To get this scheme past state legislatures, a deal had to be cut between the new entrepreneurs and the existing utilities...
...So competition can't improve the quality of the product...
...As the siting battles of the seventies showed, power plants do not spring out of the ground whenever the price of electricity exceeds its cost of production...
...Electricity cannot, without great difficulty, be stored, and demand fluctuates from moment to moment...
...Market electricity prices skyrocketed, sending utilities that had agreed to cap retail prices hurtling toward bankruptcy...
...Projecting rapidly growing electricity use into the indefinite future, and facing skyrocketing costs for the oil that fueled many older generators, the utilities embarked on a vast program of investment in nuclear and coal-burning power plants...
...Power plants and transmission lines take years to build, so planners had to look far into the future...
...Electricity demand fell far short of predictions, while the price of oil dropped from its peaks...
...it is all the same, and the consumer doesn't care whether it comes from the Napa Valley or the Finger Lakes...
...The utilities accepted this freeze in the belief that excess generating capacity left over from the regulated system would hold prices down for a while anyway, and in the expectation of greater profits later...
...They were so large that the needed land, water, and transportation could only be brought together in a few places...
...and it will do its best to ignore environmental and social costs...
...Here is where California has come to grief...
...The only possible reason to deregulate power is to save money...
...Electricity has characteristics that will make it hard for market forces to attain the overpriced stability of suburban real estate...
...Where these constraints were most severe, the problem of power plant siting was turned over to new government commissions...
...As licensed monopolies, the utility companies were held responsible for generating enough electricity to meet all demand...
...The offer was premised on the low price of natural gas, which made it possible for new gas turbines to generate electricity at lower cost than existing nuclear and coal plants...
...The cost of a kilowatt-hour generated by these plants was enormous, but it was spread over all the other electricity and remained invisible to the consumer...
...Profits will be huge, and they will come only after the political wheels have been well greased...
...ALTHOUGH THE public had forgotten the electricity crisis, it was still paying for expensive nuclear power plants built in the seventies...
...Thus the Bush administration's initial response to California's power problems: Refuse to control the price of electricity generated out of state and let California find its own balance between supply and demand...
...But in many parts of the country, these plants were hard to build...
...no one wanted to make vast investments to duplicate existing power lines...
...WHETHER THIS approach can restore order to the power market is doubtful, even in the long run...
...Rapidly growing California was a special case...
...But the utilities' generating activities would shift into new subsidiaries whose profits would escape government controls...
...Politics, to be sure, intervened when this general formula was applied, and utilities deployed their considerable political influence in a quest for higher earnings...
...At times, the state could not get enough power at any price...
...At best, the long-term functioning of a deregulated electricity market will resemble real estate development in fancy suburbs...
...Before deregulation, electricity was produced and sold by local utility monopolies...
...To stop the utilities from gouging the consumer, prices were set by government agencies at levels that allowed them to recover their costs and earn a profit on invested capital...
...Defenders of deregulation admit this when they argue that the California experiment failed because it only went half-way and kept retail prices controlled...
...Electricity distribution would remain a regulated monopoly...
...Nuclear power came under attack, new air pollution rules made coal harder to burn, and NIMBY (not-in-my-backyard) opposition sprang up in many localities...
...This was easy to do...
...Getting permission to build is a laborious and expensive process that requires open-handed spending on engineers, lawyers, and politicians...
...Demand exceeded forecasts, and peaking plants were called into steady service...
...In sunbelt states, where demand had grown fastest, business had free rein, and it was still pos sible to build coal-fired power plants...
...California's ostensibly free-market system therefore centralizes the moment-to-moment management of the grid in an entity called the Independent System Operator...
...The promise that deregulation would lower prices in the long run was always a hoax...
...When rents on existing buildings yield only moderate profits, NIMBY opposition to development prevents new supply from entering the market...
...it relied on electricity imported from neighboring states where power plants were easier to build...
...To the extent government oversaw the planning process at all, the regulators' task was more to prevent overspending on unneeded equipment than to ensure adequate supply...
...Deregulatory fervor, driven by ideology and the fat fees paid to lobbyists and investment bankers, is increasingly clashing with the need of the real economy for a dependable supply of essential services...
...However things finally get sorted out, the promise of savings for consumers will surely be broken...
...The value of new buildings rises far above the cost of land and construction, settling down only when the political clout engendered by excess profits reaches equilibrium with the votes and influence of the NIMBYs...
...Fate intervened before the new siting agencies had to make hard decisions about whether to approve controversial plants in the face of local opposition...
...Driven by technological imperatives, this body orders generating plants on and off, creating ever-changing opportunities for plant owners to manipulate the highly artificial auction mechanism that sets the prices...
...How this conflict plays out in a business-dominated political environment will be fascinating to watch...
...If prices are high for only a few moments, little harm is done...
...Some utilities faced financial crisis when revenues fell short and new nuclear plants cost far more than projected...
...The market sets prices that match supply with demand, but the balancing point bears no relation to the equilibrium described in economics textbooks...
...Elsewhere, it was possible to get by with inexpensive and inoffensive natural gas turbines that operated only at times of greatest demand...
...Here entered the promoters of privatization, and they were able to make a seemingly irresistible offer: open up the electricity business to competition, and we will save you money...
...BENJAMIN Ross is a consultant on ground water and soil pollution and writes on the economic and social aspects of environmental problems...
...How something works is often easier to see when it breaks down than when it's running smoothly...
...This comes as news to few readers of Dissent, but what went wrong is worth a closer look...
...The companies were happy to take on this job, because more investment meant greater profits...
...The shortages in California are endemic to the deregulated power market...
...The entire system is connected into a single network that will crash unless generators are carefully synchronized...
...The utilities would split into two entities...
...To make the promise of savings credible, retail prices were frozen for the first few years after deregulation laws went into effect...
...Every instinct of the business lobbyists, who are the core of George W. Bush's constitu46 n DISSENT / Spring 2001 PLAN B ency, favors the extension of this economic model to the power industry...
...Electricity is not like fine wine...
...DISSENT / Spring 2001 n 45 PLAN B This system ran into problems in the 1970s...
...Electricity has now joined airlines, telephones, and freight railroads in showing how deregulation of natural monopolies undercuts reliability...
...As more natural gas was burned in peaking plants, gas prices shot upward...
...Regulated utilities, responsible for ensuring uninterrupted supply, maintained "peaking" plants that operated only during the few hours of greatest demand each year...
Vol. 48 • April 2001 • No. 2
