Electric Power Reforms in California
May 30, 2002
California's electric industry restructuring and competition program encountered numerous setbacks and difficulties. The problems were not inherent with deregulation, but rather with the way California implemented its reforms, plus "a good deal of bad luck and ineffective government responses."
The state seriously underestimated the challenges associated with creating well functioning competitive electricity markets. And both state and federal regulators failed to respond quickly or effectively to market problems when they emerged. There are a number of lessons to be learned from this experience:
- Competitive electricity markets cannot work properly if consumers are completely insulated through regulation from variations in wholesale market prices.
- The failure of retail prices to respond to changes in wholesale market conditions led to the credit problems and insolvencies and destroyed incentives for customer conservation.
- Spot electricity markets also perform poorly when supplies are very tight; therefore, it is important to remove unnecessary administrative barriers to speedy completion of new generating plants and transmission networks.
- Finally, when market problems do emerge, government officials should act quickly and decisively to fix the problems.
If California and federal regulators had done so in September 2000 when the current problems became crystal clear, they would have reduced significantly the ultimate magnitude of the crisis.
By Fall 2001, many concluded that the crisis was over. But the state's largest utilities remained insolvent, the state is on the hook for tens of billions of dollars of contract costs, the new wholesale and retail market institutions are in shambles, and the future institutional arrangements that will govern California's electric power industry remained uncertain, threatening future investment.
Source: Marie Bussing-Burks, "California's Failed Electric Power Industry Reforms," NBER Digest, December 2001; Paul Joskow, "California's Electricity Crisis," NBER Working Paper No. 8442, August 2001, National Bureau of Economic Research.
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