For Immediate Release, May 28, 2002

New Study Shows How Public Policies Caused California’s Electricity Crisis and How Legislators Should Respond

San Francisco, CA — Despite recent Enron revelations, California’s electricity crisis of 2000-2001 was a product of misguided government policies, not corporate misconduct or market forces. This is revealed in Power to the People: An Economic Analysis of California’s Electricity Crisis and Its Lessons for Legislators, a new study by economist Benjamin Zycher, released today by the Pacific Research Institute.

“For those willing to let economic realities speak for themselves, and to recognize the link between policies and consequences, the answers are readily apparent,” said Zycher.

“California’s electricity crisis was entirely due to poorly designed public policies. Unfortunately, the issue has been surrounded with misperceptions and clouded by demagoguery,” he said.

Power to the People provides a background of how other energy fields, such as natural gas, have provided lower prices and better service through deregulation and competition. The author also outlines national electricity trends such as greater long-term contracting, spot markets for bulk wholesale power, cogeneration, joint ventures in distribution, and multiple ownership of facilities.

By contrast, California’s “half-measures” resulted in a “political design of market institutions.” Zycher provides a thorough analysis of AB 1890, the 1996 California law that deregulated wholesale power prices but left retail rates subject to state controls.

The author tackles the issue of the utilities’ “stranded costs” and shows how the imbalance between supply and demand, combined with regulatory rigidities and transmission constraints, yielded numerous stage-two and stage-three alerts in the summer of 2000 and winter of 2001.

“The retail rate freeze provided poor incentives for consumers to reduce their demand for power and the price ceiling imposed by California’s Independent System Operator worsened supply difficulties,” Zycher said.

Power to the People does not shrink from the complicated issues and tackles head-on the argument that the crisis was caused by market manipulation. The study devotes a special section to the Enron debacle. The author shows how the current system preserves disincentives to investment on the part of utilities and makes the case that consumers should be able to choose their electricity supplier through “direct access.”

The effects of the crisis will linger for years if current policies continue, the author warns, but he provides legislators with a better way.

“An uninterrupted flow of power at competitive prices is vital for California’s future, and can best be accomplished through the original idea behind the restructuring of the electricity industry—lower consumer prices through competition—and is best achieved through measures such as direct access,” said Zycher.

“Public policy on energy needs to serve all Californians, who deserve better than the poorly designed polices that manufactured the crisis of 2001,” he said. “The wise decisionmaker can guarantee power to the people by deferring to the decentralized competitive process.”

Power to the People includes:

• Analysis of natural gas deregulation as a precedent for electricity.
• How the Public Utilities Regulatory Policy Act of 1978 (PURPA), mandated explicit and implicit subsidies for inefficiently small generation facilities
• Analysis of technological interdependency.
• How economies of scale affect electricity generation.
• How politicians use regulation as a means to transfer wealth.
• The pitfalls of partial deregulation.
• The market price for reliability.
• The value of preserving long-term investment incentives.
• Why direct access is crucial for California’s future.

Read PDF Study

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Benjamin Zycher is a senior fellow in economic studies at the Pacific Research Institute. He holds a Ph.D. in economics from UCLA and a Master’s degree in public policy from UC Berkeley. Zycher served as senior staff economist with the President’s Council of Economic Advisers during the first two years of the Reagan Administration. His articles on energy issues appear regularly in the Los Angeles Times.

The Pacific Research Institute is a non-profit, non-partisan 501(c) 3 organization that advances parental choice in education, high academic standards and accountability, charter schools, teacher quality, and school finance reform.