NCPA - National Center for Policy Analysis

Does California Lack Watts Or Money?

June 11, 2001

To the naked eye, California's electricity crisis seems simple: there are not enough watts. However, a closer look shows the government's intervention in the state's energy market is the problem. According to Nobel Prize-winning economist Daniel McFadden, the electricity crisis is a result of "rigid regulation of retail prices in the face of rapid increases in wholesale prices." The difference between the retail price and the wholesale price (the price utilities pay for electricity) caused the utility companies to accumulate a $14 billion debt.

One reason wholesale prices increased is the peculiar mix of fuels used in California:

  • The state receives 34 percent of its electricity from natural gas-fired plants, and as natural gas prices increased fourfold last year, the cost of gas-produced electricity rose as well.
  • A drought in the Pacific Northwest lowered hydroelectric production and reduced electricity exports to California.
  • While 61 percent of electricity in the rest of the United States comes from coal and nuclear power, and 29 percent from natural gas and hydroelectric, California's fuel is 75 percent natural gas and hydro, 15 percent nuclear and 0 percent coal.

Another factor: California's electricity demand increased 24 percent over five years; but the state has not built any new power plants in 10 years. Old power plants have to be taken off line and repaired constantly, reducing supply.

Also, state regulators failed to write guidelines to allow the utilities to enter into stable long-term purchase contracts.

Analysts say the crisis could have been avoided by raising the retail price cap. At higher retail prices, consumers would use less electricity. This reduction in demand would have prevented producers from raising prices above market rates for fear of losing customers, putting supply and demand back in balance.

Source: Lance T. Izumi, "California's Electricity Debacle," Insider, May 2001, The Heritage Foundation, 214 Massachusetts Avenue, N.E., Washington, D.C. 20002, (202) 546-4400.


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