Energy Price Caps: Will They Work?

Generating capacity may grow, but not by this summer

After receiving numerous demands from California politicians to cap gyrating electricity prices, the Federal Energy Regulatory Commission has finally given in. At a June 18 meeting, its five members imposed limited price controls throughout the West. Part of the hope is that caps will limit the state's electricity bill, already projected to run from $35 billion to $60 billion this year. That's well above the record $27.1 billion spent last year. But will the changes offer Californians and other Westerners a real solution to blackouts and wildly fluctuating prices? Here's a guide to the new regulations--and their likelihood of having a lasting effect.

How do the controls work?

FERC's order limits the price that generators of electricity can charge on spot markets throughout the West at all hours of the day. Effective through September 2002, FERC will now calculate a monthly benchmark wholesale price based on the operating costs of California's least efficient power plant. The thinking is that if generators can't make a profit on their least efficient plants, they wouldn't run them, which would create more shortages.

So if electricity prices are now limited, why would generators want to operate in or sell to California at all?

They can still profit, and rather handsomely if they're smart. The caps give generators an incentive to build more efficient plants, thus capturing fatter profit margins. "It will allow the more efficient plants to get billions more in profits," says Peter Navarro, a professor at the graduate school of management at the University of California, Irvine. And to offset the risks of selling to California's financially strapped utilities, producers can charge buyers there 10% more than other Western states.

How does limiting prices elsewhere in the West help things in California?

Until now, generators in the Golden State could get higher prices selling electricity to wholesalers in other states during its power emergencies. But much of that power ended up being sold back to California at much higher prices, since prices of interstate power sales weren't regulated during emergencies. By applying its rules to the entire 11-state Western power grid, FERC is attempting to limit such "megawatt laundering."

Will the plan help boost California's electricity supply?

Not much, at least not in the short term. It doesn't add any more power to the grid, meaning blackouts are still likely during periods of high demand.

How are power generators reacting?

That depends. Companies such as San Jose (Calif.)-based Calpine Corp. (CPN ) that sell most of their power using long-term contracts, still plan to invest in the state; they figure that efficient producers will still profit handsomely. However, other generators such as Mirant Corp. (MIR ), which sells on the daily spot market, are waiting to increase investments there. They fear that price controls will curtail returns on their investments.

By Laura Cohn in Washington

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