A California Crisis

Jason Pront
January 16, 2001

On the day of Thomas Edisons death, a prominent figure suggested that a fitting tribute to the great inventor would be for all the power to the entire country be disconnected for a length of one minute. While certainly fitting, this tribute was never carried out  the world, it seemed, was incapable of functioning without power even for a mere sixty seconds.

Today, roughly one century after the death of the father of modern electrical engineering, it appears the lights will go off after all. However, this time it is not in tribute to a great mind. Rather, it is a monument to the enormous mental blunders made by many Californian politicians and businessmen. Financial errors made in the name of free market economics have caused what potentially could be the biggest financial crisis since the Savings and Loan failures of the early 1980s. Despite efforts by many to the contrary, this situation could potentially leave thousands of Americans without electric power for their homes and businesses.

Before I begin, I feel it necessary to clarify a few points. I personally am a believer in the free market. It is my opinion that markets are, for the most part, efficient and, given the proper government intervention when necessary, markets will tend to behave properly on their own without harming the consumer or producer. Furthermore, I applaud the government for attempting to privatize many industries that have unnecessarily remained in the public sector well after the Great Depressions conclusion. It is my opinion that the troubles in California reside not in the fact that privatization has occurred, but rather in the method in which privatization has commenced.

Two years ago the United States Congress voted to allow utility companies to compete with each other on the open market. Monopolies that were once held by local utilities were broken, and prices to the consumer generally remained stable thanks to government restrictions on price increases. Competition, in theory, would eventually cause rates to naturally fall, and the consumer would benefit.

In order to maintain a fair marketplace, some states enacted certain additional restrictions on utility companies. California, in order to level the playing field, did just that. So as to give new entrants into the states utility business a fair chance to compete, California mandated that the existing utilities were not permitted to own power generating plants. The two aspects of the business were separated, with the utilities becoming essentially middle-men  buying power from the power plants and selling it to their customers.

Theoretically, this system should work perfectly well. The utility companies were happy not to have to worry about the upkeep and costs of running power plants, and the plants were happy, as they now had a handful of captive customers rather than an entire state full of homes and businesses. The system worked well and all parties prospered.

There was, however, one flaw with this plan. In order to protect the consumer, electricity rates that the utility companies could charge were capped. However, the price that the power plants could charge the utilities was not. While this appeared to be a recipe for disaster, few were concerned. Fuel costs were at their lowest levels in years, and eventually the utility companies would be permitted to raise their rates. It would only be a matter of time, and the risk appeared minimal.

By late 1999, however, disaster raised its ugly head. Spurred by a colder than expected winter at the same time as supply problems, the price of natural gas began to rise. Languishing at $1.50 per million BTU when deregulation was initiated, the cost of natural gas was now pushing $7.00 and rising rapidly. Furthermore, many plants around the state were closed due to routine maintenance. The cost of electricity was soaring, and the utilities were unable to raise their rates.

Desperately, the utilities hoped for a reprieve. There was none. Eating through their cash reserves, the utilities faced higher and higher costs with no end in sight. Some of their customers who had entered into long term contracts, notably several aluminum processing plants, had found it more profitable to merely shut down operations and resell their electricity to the utility companies at a hefty markup. The inevitable cash crunch set in. Without a reduction in costs, the utility companies would be bankrupt by February.

At this time the situation remains unresolved. The utilities have used every possible source of capital to prevent bankruptcy, and seen their once flawless credit ratings plunge to that of junk-bond status. Further, it is uncertain that business will be able to commence. If the situation is not fixed, the money will run out and the lights will go off.

Deregulation is a good thing as long as it is handled properly. In many cases this has been an easy task. For California, it has been a nightmare. Unless some resolution is reached, it will be a long, dark winter for much of the West Coast.