Ignoring California's Energy Crisis Imperils the Economy

By Laura D'Andrea Tyson

Rolling blackouts in California over the next several months endanger an already faltering U.S. economy. California accounts for about 14% of the nation's output, more than the smallest 22 states combined. In the past two years, it has generated about one-quarter of the nation's job growth. Like it or not, California's electricity crisis has national ramifications. Yet, after weeks of secret meetings, the Bush Administration's recently unveiled energy plan does nothing to ameliorate this crisis. Instead, the White House has used the crisis to justify a long-term "drill-and-burn" strategy that benefits its friends in the energy industry and poses unnecessary risks to the environment.

According to the Bush team's logic, soaring electricity prices in California, like soaring U.S. gasoline prices, reflect years of inadequate investment in energy production. And why have investors been unwilling to develop the necessary supplies? Primarily, say Administration officials, because of government regulation, especially environmental rules. This analysis is consistent with traditional Republican ideology but inconsistent with the facts. Private companies shelved investment plans and closed operations in the oil, gas, and electricity industries in the 1990s not because of environmental restrictions but because of sagging energy prices, excess capacity, and poor profitability.

When natural gas prices were low, Alaska's North Slope producers had no incentive to build a multibillion-dollar pipeline to supply the rest of the country. Last year, when prices jumped, the same companies announced plans to do so. Today, without any relaxation of environmental regulations, they are spending $75 million on feasibility and design studies. Nationwide, the number of rigs drilling for natural gas is up 57% in the past year. Similarly, when the price of electricity was low, suppliers in California and elsewhere had little incentive to build new transmission and generating facilities.

Now, in response to higher prices, private power companies are finishing work on plants that will add 92,000 megawatts to the nation's capacity by next year. This is a larger increase in capacity than any in the previous decade and nearly a quarter of what the Energy Dept. deems necessary to meet demand growth through 2020. This investment surge has not required weaker federal regulatory standards.

Flaws in California's deregulation plan have aggravated its electricity woes. By the time the wholesale price for electricity rose to levels encouraging the development of new capacity, it was too late for the state to avoid a short-term crisis. To make matters worse, because the deregulation plan precluded long-term contracts between utilities and generators, there was no way for either buyers or sellers to hedge against the volatility of prices in unregulated electricity markets.

Such contracts have been a feature of successful deregulation plans elsewhere, preventing large fluctuations in electric bills while encouraging suppliers to maintain excess or stand-by capacity.

SAVVY SELLERS. The Bush Administration is not responsible for California's self-inflicted wounds, but it is responsible for failing to impose a temporary cap on wholesale electricity prices in order to control their manipulation by a handful of generators and natural gas suppliers, many headquartered in Texas. Economists have long recognized that tight conditions in electricity markets put sellers in a very strong position to exercise market power by withholding supply to drive prices upward. There is compelling evidence that savvy sellers are doing just that in California; indeed, there is no other explanation for the tenfold increase in wholesale prices in less than one year.

The White House sneers at such evidence, arguing that a price cap would discourage needed investment in new capacity. But not if such a cap were set at a level high enough to provide suppliers with a reasonable profit and relaxed once the short-term crisis was over. The price-cap bill proposed by Senators Dianne Feinstein (D-Calif.) and Gordon H. Smith (R-Ore.) satisfies these conditions but has been steadfastly opposed by the Bush team and its supplier friends.

Although a temporary price cap would ease supply conditions in California and the Western grid, existing capacity constraints exacerbated by drought-induced shortages in the state's hydroelectric dams make substantial shortages inevitable over the next several months. According to Vice-President Dick Cheney, conservation may be a sign of personal virtue, but it is not a sufficient basis for a sound energy policy. But over the next several months, conservation is the only way to handle electricity shortages in California. The question is whether conservation will be voluntary, encouraged by real rate increases for residential users and more aggressive cutbacks in air conditioning, or involuntary--caused by blackouts that threaten the nation's economic well-being. Either way, California gets no help from the Bush Administration's energy strategy.

Laura D'Andrea Tyson is dean of the Haas School of Business at the University of California at Berkeley.

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