California Energy Crisis of 2000 and Deregulation of Energy in California
In the spring of 2000, a series of blackouts hit California, cutting off power to 100,000 customers and plunging the city into darkness. During the crises the wholesale price of electricity suddenly rose five-fold. This jump in the price and the swell in demand following the power failure quadrupled the profits of the companies that generated electricity. Electricity trader Enron Corp was one of the biggest profiteers from the crises. A similar scenario occurred in 2000 and early 2001, when rolling blackouts affected more than a million Californians and spiked up prices.
In the aftermath of the crises it was discovered that it was a result of market manipulation by electricity companies who used existing loopholes in a partially deregulated industry to make profit at the cost of its customers. Was the California debacle a lesson strong enough to deter all consequent attempts to decentralize electricity or was it a singular instance of a poorly designed deregulation structure which should be avoided in all future implementations of deregulating electricity. The answer to this can be found by analyzing how the partial de-regulation contributed to the California Energy Crises as follows
Californias deregulation experience began in 1996, when the states three dominant utilities Pacific Gas Electric, San Diego Gas Electric and Southern California Edison joined forces to campaign for a deregulated market. (Sweeney 2002) They proposed a strategy which involved partial deregulation.
Under this proposal the distribution and generation function would be separated by each company and construed as separate independent functions. Thus the industry would be divided into two distinct classifications electricity producers and electricity distributors. The Distribution function would continue to be regulated and subject to a price cap. However the producing function would be deregulated and not be subject to any kind of restrictions. The presumption was that partial deregulation would encourage competition among companies, increase energy options available to customers and lower prices.
However partial deregulation did not achieve the objective it was designed for as it did not completely free the market from all controls. This put the company engaged in distributing electricity in a tough situation. On one hand government regulations capped the price that energy distributors could charge. On the other hand deregulation of the market the freedom to increase the cost of energy. The retail price cap which protected the end user from any price fluctuation created an inelastic demand curve in which demand was not responsive to price. Thus any hike in the cost of producing electricity did not affect the retail price paid by the end user. The artificial market structure did not allow the distributor to pass the higher prices on to consumers without approval from the public utilities commission.
Structure
This partial de-regulation procedure created a very different structure for the electricity industry. A fully deregulated environment would have attracted companies which competed against each other and help lower prices. But already lowered or capped prices discouraged companies from entering the industry and also did not support the development of competition in the industry at both the distributor level and the producer level. As a result the anticipated entry of new firms did not happen. Since new entrants did not enter the de-regulated industry and reduce the cost of producing electricity the prices charged to distributors by producers did not reduce. Instead, with increasing demand for electricity, the producers of energy charged distributors more for electricity. The distributor could not pass this cost on to the consumer and this is what created the unique market structure that developed into one of the causes of the California crises
Conduct
Partial deregulation created an industrial structure which allowed electricity producers to manipulate markets to create price increases which would increase their profits. A lot of manipulative misconduct governed the electricity whole sale market as a result of the greed exhibited by electricity generating companies. In the existing market scenario electricity wholesale prices exceeded retail prices, end user demand remained unaffected, and utility distribution companies were forced to purchase electricity at a loss. This situation allowed independent producers acting out of greed to manipulate a price rise in the electricity market by withholding electricity generation. (Beder, 2003) When producers stopped generating electricity there was no supply in the market and this caused wholesale prices to rise steadily. Producers then capitalized on these prices by making huge profits. This in fact is what happened in the first series of blackouts which rocked California in the spring of 2000. At the time no regulatory body stepped forward to monitor and regulate this practice by electricity producers. As result this exercise happened two more times before the authorities noticed that the huge price increases in whole sale electricity were being caused artificially by the electricity producers themselves. In this particular industry collusion rather than competition characterized the conduct of electricity producers. Rather than working against each other to lower prices, they worked together to increase prices and capitalize on revenue. There were no established antitrust policies to regulate these activities and they went undetected for a long time.
Performance
Though one of the objectives of partial deregulation was to protect consumer welfare and enhance overall efficiency it failed to do so in the long run. Government had to pay from taxpayers funds to sustain the crisis caused as a result of the electricity shortage. Though the consumer was protected in the short run from incurring a hike in retail prices they still had to pay greedy energy companies tax payer dollars to secure electricity. Thus the retail price cap did not really work in the interests of the consumer. The partial de-regulation structure did not contribute to overall market efficiency because it still constrained the free functioning of supply and demand forces and did not encourage competition in the market. Instead r it fostered corrupt and manipulative practices and encouraged them to flourish
I feel that the major flaw of the deregulation scheme was that it implemented an incomplete eregulation system. If the government had deregulated both the production and distribution function in the electricity industry I personally feel that it would have achieved its goal of increasing competition and lowering prices more effectively. I also feel that the government should have raised retail prices and abolished the cap after the initial crises in the spring of 2000 instead of justifying it as a freak occurrence. If the government had launched investigations after the initial power failure and taken more decisive actions perhaps the crises would not have repeated it later on. While setting up the partial deregulation system the Government also neglected the need to set up a preventive or watchdog body to monitor and deter market manipulations from occurring.
By creating a system in which utility distributors were forced to charge fixed prices, while electricity providers were free to raise prices the Government set up an industrial structure which was not well aligned to the market forces of supply and demand. Other state governments such as Pennsylvania have fared better in their deregulation venture because they have opted to deregulate both utilities and providers.
Conclusion
The California Energy Crises plays a significant role in defining deregulation practices in the American Energy markets. It offers several invaluable lessons to future proponents and State government who wish to adopt deregulation in their energy sectors. One clear lesson which can be drawn from the California Experience is that partial deregulation will not achieve the objectives of deregulation and therefore should be avoided. The second lesson is that governments should conduct extensive investigations as well as constantly monitor unfair or manipulative market practices that may develop as a result of the deregulation. Proponents of deregulation have emerged stronger and many States have developed successful deregulated energy sectors in aftermath of the California Crises