How Not To Deregulate
September 12, 2002
In April 1998, California initiated an ambitious program to bring retail and wholesale competition to its electricity sector. Those pressing for sweeping changes believed the program would lead to lower consumer prices, a host of innovative retail services, improved performance from existing generating plants and massive investment in clean new ones. But rather than becoming an example of how to transform the industry, the experiment has become a model for how not to deregulate.
Some suggestions for avoiding problems like those caused by the California experiment include:
- Deregulate retail prices (rather than freeze them, as California did) or allow utilities to use forward contracts to hedge their regulated retail service obligations -- since failure to do so not only drove the utilities into insolvency, but also left consumers without incentives to reduce consumption.
- Create a retail market framework to ensure that a large fraction of consumer demand is covered by longer-term fixed-price contracts -- thus avoiding problems that emerged in California and better matching most consumers' taste for bearing risk.
- Let utilities to enter into programs that will allow industrial customers to respond to wholesale price spikes and reduce consumption.
- Focus less on short-run gains from low-priced power suppliers, and instead create institutions that support investment in generation and transmission facilities.
The future of California's electricity sector remains murky. Wholesale power markets largely disintegrated, the California Power Exchange stopped operating at the end of January 2001 and subsequently went bankrupt. The state's electricity sector is in much worse shape than it was in when the discussion of restructuring began in 1994.
Source: Paul L. Joskow, "California's Electricity Crisis: A Postmortem," Milken Institute Review, Second Quarter 2002.
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