SACRAMENTO, CA - Memos showing that Enron used manipulative strategies during last year’s California energy crisis have caused a furor. The incentives and opportunities for Enron to use such strategies, however, were created by California’s government-regulated electricity market.

Enron’s strategies included buying electricity in California at the state-capped retail price of $250 per megawatt-hour and then selling that power in states which had no cap and where the price was higher, thereby garnering tidy profits. Also, because California’s utilities would often understate the amount of electricity they needed to supply customers, Enron would overstate the amount of electricity it claimed its customers needed. When the utilities then informed the state that they needed more energy supplies, the state would pay a premium to Enron not to use energy that the company didn’t plan to use anyway, thereby allowing that power to be redirected to the utilities.

Further, because of its inadequate transmission system, electricity in California often gets clogged at certain transmission points. The state would pay companies fees to reduce or redirect the power they were transmitting to avoid these clogs. Enron filed power transmission schedules to create phantom congestion, knowing that the state would then offer the company premiums to avoid congestion. Enron would also route power to send in the opposite direction of a clog in order to collect premiums.

These strategies sound bad and some may have broken government rules, although that’s still to be determined. Economists, however, are not surprised. Because of California’s below-market retail price caps for electricity, Enron adopted strategies that made the most of retail price disparities between California and other states. Stanford economist Frank Wolak, who advises the state on energy, observes that “If the price in one area is higher than another, you buy in one area and sell in the other.” Wolak says that most of Enron’s schemes were common strategies used in other types of markets.

Lynne Kiesling, a Northwestern University economist and energy expert at the Reason Public Policy Institute, notes that the utilities would knowingly underestimate their next-day power needs in the government’s Power Exchange (PX) to lower prices. Kiesling says that “Reductions in the PX day-ahead price induced suppliers to, surprise, surprise, supply less to the day-ahead market.” If more power was needed on a particular day than was estimated by the PX, then higher prices on the same-day market operated by the California Independent System Operator would occur. Kiesling points out that Enron may have anticipated such events, but it didn’t go beyond taking advantage of poorly designed rules and regulations. She also says the price caps exacerbated the dysfunctional incentives.

The big question, say experts, is not whether Enron’s practices were unethical or even illegal. Questionable trading strategies may have cost California half a billion dollars over 2000 and 2001. More important is whether energy providers colluded and cost the state tens of billions. Kiesling says collusion was unlikely. Even if one competitor asked another to collude, the latter “would profit from saying they’d go along, but nonetheless supplying into the market.” Kiesling concludes that “It’s the behavior that determines collusion, not what the memos say about who said what.”

Whatever federal and state investigations turn up, one thing is certain. Private misdeeds would not have been possible without flawed government regulation.

Lance Izumi is a Senior Fellow in California Studies at the California-based Pacific Research Institute for Public Policy. He can be reached via email at lizumi@pacificresearch.org.