F.Y.I.


Business World: How California Turned Out the Lights
By Holman W. Jenkins Jr.

08/30/2000
The Wall Street Journal
A27
(Copyright (c) 2000, Dow Jones & Company, Inc.)

Back in the 1970s, National Lampoon proposed a solution for inflation: pay 
people less in salaries and wages, and
charge less for things in stores. 

Now the state of California has seized upon the identical solution for its 
electricity woes. By fiat, it has lowered the
price that utilities are legally allowed to pay for bulk electricity, and 
also lowered the price they are allowed to
charge for the same electricity to their end users.

Wow, we wish someone had hit upon this approach before. Rents too expensive? 
Make apartment owners put us
up for free. Medical bills a nuisance? Require doctors and hospitals to work 
for nothing. 

Almost any inconvenience can, in theory, be solved by passing a law 
compelling others to do what we want. If any
state is well situated to make this its comprehensive approach to governing, 
it's California -- being a state in close
geographical proximity to North Korea. 

Because each year the graduate schools release another class of educated 
professionals into the readership, we
probably need to emphasize why the National Lampoon solution wouldn't work: 
Lowering the price of electricity
creates an incentive for consumers to consume more. At the same time, 
lowering the price creates an incentive for
producers to produce less. 

Now, for extra credit: Whose idea of a solution is this? 

California's politicians, most notably State Sen. Steve Peace, have 
calculated, undoubtedly to a pointillistic degree,
that any blame for blackouts will naturally accrue first to the utilities -- 
because a blackout is an urgent problem
demanding an urgent solution. Meanwhile, higher prices are something 
consumers can resent at their leisure, even
unto November, and thus would be more likely to take out on elected 
officials. 

Electricity makes an interesting challenge for deregulators, one we've been 
fumbling heroically. Electricity cannot be
stored, except at ridiculous expense. Ever try to run your house on 
batteries? 

A second quality is that demand is highly variable, fluctuating by 100% in a 
day, and often nearly as much
seasonally (as measured peak to peak). To meet the highest demand, a utility 
might easily find itself having to keep
an entire generating facility on hand that it would only fire up a couple 
times a year. A peak plant -- the one that
stands between customers and a blackout -- runs only about 200 hours 
annually. That's a large capital good that
sits idle 357 days out of 365. 

A third quality is that electricity doesn't travel well over long distances, 
though technologists are working on this.
But thanks to the efforts of the New Yorker and other publications scaring 
people about the unproven health risks of
power lines, try building a new set of lines across anybody's neighborhood 
anyway. 

These are all reasons why, in the past, it was deemed efficient to produce 
and distribute power within one company
over a large geographic area. 

"Monopoly" is a bad word when used by a newspaper but not when used by an 
economist. It wasn't monopoly that
led utilities to build expensive nuclear plants in the 1970s and 1980s. It 
was "cost-plus" rate regulation. In other
words, any utility, as long as it could get a regulator's approval, was 
guaranteed to collect its construction costs
and an operating profit on any plant it built. 

Is this a good way to encourage the building of expensive power plants, 
enough so that there would always be
sufficient power to go around even on peak days? Yes. 

Result: To this day we have a system that in no way induces consumers to be 
rational in their usage. Looking
around, your columnist right now is running a fan, two computers and umpty 
lights, most of which he could turn off
with no impact on his comfort and productivity. In fact, the stereo has been 
switched on but turned down to zero
since last Friday. But why get off the couch to shut it off? 

The sensitive, new age solution: Reward utilities not for how much they 
invest in construction but how efficiently
they meet demand -- which, in the first instance, would mean incentives for 
consumers to rationalize their usage. 

The rough-and-ready solution: Free utilities to sock their customers with 
whatever prices they want, and let
customers fight back by turning off lights or seeking out alternatives (which 
exist aplenty if you look hard enough). 

But California and other states have opted for a bonehead-with-a-drawing 
board solution: They call it deregulation but
the scheme seems to have been designed with the idea that consumers still 
shouldn't know how much electricity
costs from one moment to the next. 

Utilities were more or less forcibly stripped of their generation role: Now 
they would be middlemen, buying power on
the open market. The problems with this approach range from a shortage of 
transmission capacity to the greatly
magnified difficulty of preventing grid overloads and other nasty physical 
effects when the generating plants and the
grid aren't under the same control. 

Even under deregulation, of course, utilities still have an obligation to 
meet peak demand. But, effectively, it's farmed
out to the market, and if the power isn't there, it isn't there. And 
California has made sure it won't be there in the
future by slamming down price controls. 

Maybe it's time we retired the word "market" altogether from the policy 
debate, since it's become one of those
conjuring words that justifies everything and has ceased to mean anything. A 
modern economy creates or negates
markets as it needs to: The real underpinning is property rights and freedom 
of contract. Would we tell GM to stop
making engines and buy them on the open market? No, because we assume that GM 
has every incentive to make
the most efficient decision itself. Yet government planners have decided, 
based on no evidence, that the age-old
vertical efficiencies in the electricity business simply don't exist. 

By whatever route, California's solution is to allow utilities with the skill 
and experience to run integrated power
distribution networks to get on with the job -- without either the old 
guarantees or the old heavy-handed restrictions
on their freedom to price. Utilities can judge for themselves how much of 
their demand to contract out to
independent suppliers. 

Undoubtedly there would be a need for residual regulation to protect the most 
vulnerable consumers and make sure
universal service is available to all. But that would be far less intrusive 
than the "deregulation" they've been
practicing in California -- and that's now unraveling in California, 
discrediting the idea of a more market-based
electrical system.




Copyright , 2000 Dow Jones & Company, Inc. All Rights Reserved.