Power Tripped.

• Author: Lynch, Michael W.
• Position: Energy crisis, California

Faulty re-regulation turns out the lights in the Golden State

Dominic Ciolino has had many headaches in the 13 years that he's owned Dominic's, an intimate restaurant specializing in Sicilian cuisine. But his electricity bill--which hovered around $700 a month--wasn't one of them. That changed last summer, when Ciolino first heard about San Diego's electricity problem on the evening news. "I thought, 'That's cool, whatever,"' says 52-year-old Ciolino, whose restaurant sits in Escondido, California, a blue-collar community about 30 miles north of San Diego. "Then I looked at my bill and said, 'Holy shit.'"

At the peak of the crisis last summer, Ciolino's monthly bill from San Diego Gas & Electric nearly tripled to $2,000, as electricity rates in San Diego jumped from under 4 cents per kilowatt-hour in May to roughly 13 cents in July. Although his electricity bill has shrunken back to about $1,200 a month, last summer's increase devoured his savings and the current cost is gobbling up what used to be his profits. "I had to go to my kitty," recalls Ciolino. "The thing is outrageous. How the hell do you run a small business like mine? You try to put a little money away and you can't."

At least he's still in business. Seeing no relief from his own $2,000-a-month electricity bill, fellow San Diego County restaurateur Steve Gramzay shuttered his 4-year-old Le Peep Grill, a popular breakfast spot in the beach town of Encinitas. "There's no sense in banging your head against the wall," Gramzay told the North County Times.

But bang their heads against the wall--and shake their fists at power companies, politicians, and regulators--is exactly what thousands of San Diegans did last summer, when their electricity bills spiked like the Nasdaq used to. Businesses dimmed their lights, turned up the thermostat, and shut down appliances in order to save power. Individuals turned off air conditioners and sweated it out. And they protested. "The more people talk about it, the more you will get politicians listening," 40-year-old Pam Ashby told The San Diego Union-Tribune last August while protesting outside the Sempra Energy building, headquarters of San Diego Gas & Electric's parent company.

San Diegans were the first, and in some ways only, Californians to experience the full effect of the state's now-notorious electricity crisis. Electricity was in short supply throughout California last summer--reflected in wholesale price spikes of 700 percent--and it remains so at press time. Indeed, rolling blackouts have even dimmed the lights in places as unused to scarcity as Beverly Hills. But SDG&E was in the unique position of being allowed to charge its customers the full cost of power.

Elsewhere, government-mandated retail price caps were still in effect, which kept consumers' bills steady. It was the utilities--PG&E in the North, Southern California Edison in the South--that were looking at their bills and exclaiming, "Holy shit." Buying power for as much as 75 cents a kilowatt-hour and selling it for a measly average of 12.5 cents a kilowatt-hour, the utilities ran up billions of dollars in bills to power suppliers that they couldn't pay.

Of course, it wasn't only utilities and San Diegans that were affected. Energy-hungry businesses found themselves without power, either because they had signed "interruptible" contracts (in exchange for a lower rate, they agreed to go without electricity in times of extreme scarcity) or because they simply couldn't get power. Miller Brewing Co., which lost power 24 times between June 2000 and January 2001, shifted production from its Irwindale plant to Dallas, idling 750 workers. Steel plants shut down, leaving thousands of workers at home, and the production of such essentials as potato chips, pork rinds, and cottage cheese fell victim to the power shortage. As of press time, the lights have gone out five times in California, including twice in March, when demand was roughly half of what it's expected to be in the summer period. Expect to read more tales of people stranded in elevators and staring at darkened movie screens.

The Blackout Bandwagon

Why is cutting-edge California experiencing a power crisis worthy of Cuba or North Korea? "Capitalism is falling apart," vented Los Angeles Times columnist Robert Scheer in late December. "The result [of deregulation] is now bordering on catastrophic with utility companies demanding enormous rate increases or they will declare bankruptcy." Likewise, MIT economist and New York Times columnist Paul Krugman blames "placing blind faith in markets." "California's deregulation is a colossal and dangerous failure," declared Gov. Gray Davis in his January State of the State speech.

Only Scheer totally misses the mark, as capitalism isn't falling apart and has little to do with California's energy crisis. But it's true that a sort of blind faith in markets--academic blind faith in the spot market, to be more precise--helped turn the lights out in California. And the state's deregulation is a disaster, a la Davis. The governor's only problem--and not an insignificant one when it comes to diagnosis and solutions--is his choice of words. It isn't deregulation that is a disaster in California, but re-regulation. Contrary to all the hand-wringing and accusations, the state never deregulated its electricity industry in the first place.

Roughly half a decade ago, energy deregulation became big buzz in Sacramento, when it dawned on politicians and business leaders that the state's relatively high energy prices were hurting its economy. Other countries had lowered energy costs by opening services traditionally delivered by public utilities to something like market competition, so why shouldn't California? In June 1994, on the day after Nicole Brown Simpson was found dead, the California Public Utility Commission opened hearings on deregulating the state's electricity market. By late 1995, it had completed a plan, and in 1996, state Sen. Steve Peace (D--El Cajon) decided to step to the front of the parade. He gathered the relevant players--big industrial customers, utilities, environmental groups, consumer groups, and the state's utility regulators--and put together an electricity-restructuring bill that passed the legislature unanimously and was eagerly signed by Republican Gov. Pete Wilson.

Such legislative unanimity was the first sign of trouble; whenever that much consensus is reached, especially on a topic that traditionally causes a lot of friction, you can safely bet something screwy is going on. But the restructuring plan was so popular--and so hurried--that there was little time for anyone outside of Peace's working group to really peruse the 67-page law, much less debate its wisdom. Instead, everyone was left to trust that the involved parties had gotten it right.

Some observers did sound alarms at the time. "Two things should be obvious," said former chairman of the Wisconsin Public Service Commission, Charles Ciccehetti. "First, none of this should be called deregulation. Second, it is difficult to see how any of these myriad regulatory schemes, unless altered significantly...will lower prices." The New York Mercantile Exchange, experts in the creation and function of commodity markets, sent the California Public Utilities Commission a memo predicting that the new rules would result in less competition, less product and service information, higher prices, lower consumer value, and higher costs.

But none of that mattered. Everyone involved--the pols, the environmental groups, the power providers--wanted it to work, since, like any successful political coalition, it contained something to placate all the different players.

Politicians, claiming the plan would provide consumers with more choice and lower prices, funded an $87 million propaganda campaign to spread the good news throughout the state. Big businesses figured their purchasing power would mean lower prices. Consumer groups didn't kick up a fuss because they had secured plenty of restrictions on how the utilities could operate; they also got an immediate 10 percent rate cut and price caps. Environmental groups were able to maintain the status quo on environmental rules, including where power plants could be placed; they were additionally titillated by the prospect of environmentally friendly power competing against dirty juice. Utilities got billions in subsidies to retire old debt. And the regulators got to keep their jobs.

How It Doesn't Work

Here's the basic outline of how the restructuring was designed to operate: Seeking a closely managed system, the state's politicians passed over a more freewheeling "direct access" model, in which businesses and residential customers would enter into agreements with utilities, generators, or whomever they wanted for power. Instead, the wise legislators created an actual centralized marketplace called the Power Exchange (PX) in a building in Pasadena. They prohibited utilities from contracting for power in advance, mandating instead that all electricity must be bought and sold there in day-ahead...