The crisis resulted at least in part from a botched hybrid deregulation plan in which wholesale prices from electricity suppliers to distributors (utilities) were freed, but retail prices utilities could charge consumers remained capped. Not surprisingly, utilities were driven to the brink of bankruptcy when suppliers raised their prices.
Many blamed Governor Gray Davis and other state politicians, unwilling to be identified with any measure increasing consumer costs, for failing to act in time to head off the crisis. Consumer advocates alleged collusion among the suppliers, especially those who took plants off-line in the midst of the shortage for what they claimed was routine maintenance. Others blamed recent spikes in the cost of natural gas, which is used to generate electricity.
Californians have also been conspicuously unwilling to build new power plants and other infrastructure despite rapid economic growth. In addition to stressing conservation, state planners have favored small "co-generation" plants over large and supposedly obsolete centralized ones, based on the idea (referred to as "soft path") that power generation would become more distributed and local over time, eventually resulting in a world where people would supply their own electricity through backyard fuel cells, windmills, and solar panels. However, consumer electricity rates skyrocketed because the policy required utilities to pay inflated prices to suppliers who plugged into the grid, often displacing their own lower-cost generating sources. In the midst of the early-'90s recession, with industry in flight and unemployment steady at 10 percent, electricity cost twice as much in California as it did in neighboring states, leading to strong calls for deregulation.
Enacted in 1996, one of the deregulation plan's provisions required
utilities to sell off their own generators, under the theory that more
players in the new market was necessarily better. In practice, this
meant the utilities had even less leverage with suppliers once
shortages hit. (Eager to be able to sell off plants at twice their
book value under the plan, utilities apparently didn't note the
presence of many willing buyers, a sign that the market was predicting
future scarcity.) The Los Angeles Department of Water and Power,
which was exempted from the sell-off requirement, kept generating
electricity surpluses throughout the crisis, sparing that region, but
was unable to wire the electricity north due to a transmission grid
that hadn't been updated under small-is-beautiful policies and also
due to irrational claims over the health risks of electromagnetic
fields.
Another provision of the legislation banned utilities from signing long-term "forward power" contracts with suppliers that would allow them to hedge future price fluctuations, but under terms usually undisclosed to the public. Instead, California utilities bought watts strictly by the hour in two newly created public spot markets, called the California Power Exchange and the Independent System Operator. As MIT economist Paul Joskow observed, "If a generator has a long-term contract, then the financial incentive is to generate steady power in order to maximize sales. If you have no contractual promises and there's a new price every day on a spot market, then your incentive is to withhold production to maximize price. Banning forward power was just an incredible blunder."
Using its emergency powers to respond to the crisis, the Department of Energy ordered suppliers in nearby states such as Oregon and Washington, which rely heavily on hydroelectric power, to sell electricity to California. But sharply increased economic growth in those states, coupled with unusually low water tables, resulted in a regional shortage there as well, with prices increasing more steeply than was allowed by law for relatively affluent California consumers, a point not lost on Northwesterners. Since their prices remained capped, Californians' incentive to conserve power was also considerably blunted, leading to further resentment amidst perceptions that they were leaving their air conditioners on.
The Northwest's energy-intensive industries such as aluminum manufacturing were particularly hard hit. Vanalco had to lay off 600 workers because it could not find a stable supply of cheap electricity. Kaiser laid off many of its workers as well, but under far more favorable (albeit absurd) circumstances. Since Kaiser held a long-term low-priced power contract, it became more profitable to sell the power back to the regional utility at a windfall rate, rather than use it to manufacture aluminum. (Kaiser eventually filed for bankruptcy, primarily due to asbestos litigation.)
Many worried that the federal government, which ordered Northwestern suppliers to sell power to California utilities, would be liable in the likelihood that those utilities defaulted on their contracts, passing the cost on to taxpayers nation-wide. Warning that the crisis might roll across the entire nation, some regional governors even called on the federal government to institute "temporary" energy price controls across the board, which most economists believe generates long-term shortages. Other proposals included a windfall profits tax on energy suppliers and a complete state takeover of the power industry. Facing pressure from the incoming Bush administration and complaining of "out-of-state profiteers," Governor Davis reluctantly dipped into the state's impressive surpluses and allowed rates to rise somewhat to meet the shortfall, but not before one of the major utilities, PG&E, went out of business.
[Ed.: There's no end to the absurdities in this matter. The state's stringent air-quality standards have been temporarily jettisoned now that many factories and retail stores have installed their own local diesel generators to keep their lights on. Cisco Systems opposed construction of a new power plant in San Jose that even the Sierra Club supported. Activists killed a proposal to float a barge in San Francisco Bay that would generate electricity. There has also been talk of allowing a nuclear submarine to park in the bay for a while, but I think Berkeley is a nuclear-free zone. Also, Attorney General Bill Lockyer, with no evidence of price-fixing or any other wrongdoing whatsoever, said of (out-of-state supplier) Enron chairman Kenneth Lay, "I would love to personally escort Lay to an 8-by-10 cell that he could share with a tattooed dude who says, 'Hi, my name is Spike, honey.' " (In an unrelated matter, a year later the entire nation wanted Mr. Lay to be made into someone's bitch.) And after recommending the federal government institute price controls on electricity, which the Bush administration granted, state officials conceded that "the newly imposed limits have had the unintended consequence of increasing [the] threat of blackouts," as the San Francisco Chronicle reported, with generators withholding power from the California market rather than abiding by rate caps. And finally, largely as a result of an unexpectedly mild summer and pricey long-term contracts prompted by past shortages, energy authorities later predicted that California would soon face a wasteful power surplus, the only solution for which would be to resell power at a loss, or else encourage more energy use—that is, discourage conservation. The state lost $46 million in July alone by selling surplus power for less than it paid.]
