For Immediate Release: June 6, 2001

San Francisco, CA – Mismanagement by Gov. Gray Davis has contributed to the energy crisis and helped to create the power shortages now facing California, according to a report released today by the California-based Pacific Research Institute (PRI). Lights Out: California's Electricity Debacle, Causes and Cures by Lance T. Izumi, examines the causes of the disaster, Governor Davis's responses, the political ramifications of the crisis, and practical solutions. The report also evaluates the causes of increased wholesale energy prices, and warns against wholesale price caps.

"With rolling blackouts guaranteed as summer heat increases electricity demand over available supply, Californians are right to wonder how the state got into this mess aSnd what will be the fallout of this government-created debacle," said Izumi, a PRI senior fellow in California studies.

Lights Out explains that while California deregulated wholesale electricity rates in 1996, the state capped the retail prices that utilities could charge consumers, prevented utilities from entering long-term purchase contracts, and forced utilities to purchase power on the daily spot market.

When wholesale prices soared, utilities still had to sell electricity to consumers at the government-dictated price well below the wholesale cost. This plunged utilities into debt, delayed conservation efforts by insulating consumers from the true market rate for electricity, and contributed to skyrocketing wholesale electricity prices.

Gov. Davis's Reaction

In February, Governor Davis acknowledged that "if I wanted to raise rates I could have solved this problem in 20 minutes." Instead, Davis has opted for an ill-conceived strategy of government intervention. Izumi charts how economists, lawmakers, journalists, and industry officials have all noted defects in Davis's leadership. Over the last year, Davis emphasized polls rather than prudent policy, failed to meet with industry leaders, failed to allow utilities to sign long-term contracts and raise retail rates, and did not recognize the severity of utility losses.

According to Izumi, Davis's latest proposals to cap wholesale energy prices will drive many power generators out of the market, further constricting supply. They also ignore legitimate causes of skyrocketing wholesale prices in California, including:

• A fourfold spike in natural gas prices in 2000: California receives 34 percent of its electricity from natural gas, nearly double the national average. Natural gas prices have increased from about 3 cents per kilowatt hour in Spring 2000 to 43 cents per kilowatt hour in February, 2001. The price increase was caused by a number of factors, including reduced exploration and production activity due to falling gas prices in 1998 and 1999, a pipeline explosion in August that reduced gas supply, and a significant increase in demand as a result of record low temperatures in Winter 2000.

• Drought in the Pacific Northwest, which resulted in a decrease in hydroelectric production.

• Failure to build any new major power plants over the last 10 years. Over the last five years, California's booming economy increased electricity consumption by 24 percent, but in-state energy production remained static. An estimated 55 percent of California's plants are 30 or more years old, and must go off line for maintenance often, sharply reducing supply. In recent years, 25 new power plants were proposed, which would have increased California's in-state power generation by more than one-third, more electricity than California imports.

• The state's refusal to allow the utilities to enter into stable, lower-price, long-term purchase contracts.

• The state's refusal to eliminate retail price caps over a reasonable amount of time. If there is market manipulation, the state's retail price caps allow such manipulation. Because the retail caps insulate consumers from the increased wholesale rate, consumers have little incentive to decrease consumption, virtually ensuring power generators the same demand regardless of what they charge.

Policy Recommendations

For California to avoid disaster, Lights Out recommends that lawmakers consider several courses of action:

• Eliminate government controls on the retail price of electricity over a reasonable period of time.

• Enact a surcharge on consumers to recoup some part of the utilities' losses under government price controls.

• Implement real-time pricing so that rates increase during peak demand periods.

• Allot some transitional/temporary aid for the poor to assist them during the changeover to market-determined prices.

• Give utilities full flexibility to enter into short, medium, and long-term contracts.

• Gov. Davis should use his emergency powers to suspend government regulations that delay power plant construction.

"More government intervention will increase, not resolve, our electricity problems," said Izumi. "The only way out for Californians is to do what we should have been doing all along: emphasize market-oriented solutions rather than government intervention and focus on increasing energy supplies."

###

The Pacific Research Institute for Public Policy is a non-profit organization dedicated to the promotion of the principles of individual freedom and personal responsibility. The Institute believes these principles are best encouraged through policies that emphasize a free economy, private initiative, and limited government. By focusing on public policy issues such as health care, welfare, education, and the environment, the Institute strives to foster a better understanding of the principles of a free society among leaders in government, academia, the media, and the business community.