Free Markets Are Great--but Not for Electricity

Despite the California fiasco, Washington is pushing to further deregulate state utilities, no matter what havoc that might wreak

By Robert Kuttner

The Enron affair forced Congress and the Securities & Exchange Commission to stiffen regulation of accounting standards and corporate governance. But a second dimension of that scandal is being ignored: the Enron-related $30 billion electric power debacle in California. Congress and the Federal Energy Regulatory Commission (FERC) are barreling ahead toward fuller deregulation of the electricity markets as if the California and Enron messes had never happened. Worse, they are proceeding over the strenuous objection of dozens of Republican and Democratic governors as well as state regulators. Most state officials have concluded from the California meltdown that they prefer to retain integrated and regulated power utilities. But Washington isn't listening.

The architects of deregulation broke up traditional regulated utilities in order to create trading markets. Deregulation promised lower costs, more consumer choice, more reliability, and fewer government bailouts. So far, it has produced higher prices, more manipulation of consumers, volatility, brownouts, and bailouts running into the tens of billions.

Under California's plan, utilities sold their power plants but were still responsible for getting power to consumers. Others took over transmission and generation. In theory, this created an efficient market. It practice, it created a system so complex that energy traders like Enron Corp. could manipulate supply and price, evade scrutiny, and fleece consumers. Enron cooked its books, but even relatively honest traders amassed market power and gamed the system.

Electricity is unlike other commodities. Short-run demand is not very sensitive to price; demand fluctuates wildly, sometimes by 200% according to time of day and season. But large-scale power cannot be efficiently stored. So the system needs spare capacity, lest prices spike or brownouts occur. In a deregulated system, nobody profits from holding spare capacity, so utilities and consumers are prey for traders.

Traditional integrated utilities and public power agencies deliver electricity to customers based on real costs plus modest profits. Even a well-designed market system boosts prices because it's riskier and more complex. It also creates opportunities for market manipulation.

Other states that partly deregulated have avoided catastrophe because none has yet given free rein to market forces. Sometimes cited as the state that did deregulation right, Pennsylvania keeps postponing the date when the market sets the price. Most consumers in Pennsylvania are still protected. Prices also settled down in California when FERC reluctantly imposed a rate cap. All in all, the states that have rejected deregulation enjoy lower prices, less volatility, and fewer supply disruptions. Not surprisingly, these states are resisting having their integrated utilities broken up.

Yet FERC is close to finalizing a rule that could force states with integrated utilities to "unbundle" their generation, transmission, and retail sales. From an Administration that supposedly honors states' rights, this is a federal power grab. It will also benefit industries friendly to the Bush Administration. The move is opposed by an unusually broad bipartisan coalition of Southern and Western governors, state regulators, unions, consumer groups, and many political conservatives. This coalition is at once pro-regulation and pro-states rights. In Congress, it stretches from Trent Lott (R-Miss.) and Jesse A. Helms (R-N.C.) to Dianne Feinstein (D-Calif.) and Maria Cantwell (D-Wash.). These strange bedfellows hail from states with either good experiences with traditional regulation and cheap power--or horrendous experiences with deregulation.

Why is FERC continuing down this road? One reason is the familiar story of ideology trumping experience. A second is interest-group politics. Despite the Enron lessons, energy traders, non-utility power producers, and Wall Street underwriters think lots of money can be made in a deregulated system. But since cost-based generation by regulated utilities is already efficient, any windfalls will be at consumers' expense.

Even more bizarre is the fact that key congressional leaders want to go further and repeal the 1935 Public Utility Holding Company Act. That act was passed after scandals in the 1920s that read like a playbook for Enron. The abuses included watered stock, off-the-books transactions, and phony billing designed to evade state regulation. The electricity provisions of the proposed 2002 energy act, now in House-Senate conference, would gut the 1935 act's ban on megamergers that evade state regulation and would invite other Enrons. This idea is promoted in the name of greater efficiency and competition, but it would produce greater concentration and monopoly power at a time when FERC is weakening state regulators.

Much of the U.S. economy can be efficiently run as a free market--but not electricity. How many more Enrons and failed experiments like California's will it take before they get it?

Robert Kuttner is co-editor of The American Prospect and author of Everything for Sale

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