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F.Y.I.
Business World: How California Turned Out the Lights By Holman W. Jenkins Jr. 08/30/2000 The Wall Street Journal A27 (Copyright © 2000, Dow Jones & Company, Inc.) Back in the 1970s, National Lampoon proposed a solution for inflation: pay people less in salaries and wages, and charge less for things in stores. Now the state of California has seized upon the identical solution for its electricity woes. By fiat, it has lowered the price that utilities are legally allowed to pay for bulk electricity, and also lowered the price they are allowed to charge for the same electricity to their end users. Wow, we wish someone had hit upon this approach before. Rents too expensive? Make apartment owners put us up for free. Medical bills a nuisance? Require doctors and hospitals to work for nothing. Almost any inconvenience can, in theory, be solved by passing a law compelling others to do what we want. If any state is well situated to make this its comprehensive approach to governing, it's California -- being a state in close geographical proximity to North Korea. Because each year the graduate schools release another class of educated professionals into the readership, we probably need to emphasize why the National Lampoon solution wouldn't work: Lowering the price of electricity creates an incentive for consumers to consume more. At the same time, lowering the price creates an incentive for producers to produce less. Now, for extra credit: Whose idea of a solution is this? California's politicians, most notably State Sen. Steve Peace, have calculated, undoubtedly to a pointillistic degree, that any blame for blackouts will naturally accrue first to the utilities -- because a blackout is an urgent problem demanding an urgent solution. Meanwhile, higher prices are something consumers can resent at their leisure, even unto November, and thus would be more likely to take out on elected officials. Electricity makes an interesting challenge for deregulators, one we've been fumbling heroically. Electricity cannot be stored, except at ridiculous expense. Ever try to run your house on batteries? A second quality is that demand is highly variable, fluctuating by 100% in a day, and often nearly as much seasonally (as measured peak to peak). To meet the highest demand, a utility might easily find itself having to keep an entire generating facility on hand that it would only fire up a couple times a year. A peak plant -- the one that stands between customers and a blackout -- runs only about 200 hours annually. That's a large capital good that sits idle 357 days out of 365. A third quality is that electricity doesn't travel well over long distances, though technologists are working on this. But thanks to the efforts of the New Yorker and other publications scaring people about the unproven health risks of power lines, try building a new set of lines across anybody's neighborhood anyway. These are all reasons why, in the past, it was deemed efficient to produce and distribute power within one company over a large geographic area. "Monopoly" is a bad word when used by a newspaper but not when used by an economist. It wasn't monopoly that led utilities to build expensive nuclear plants in the 1970s and 1980s. It was "cost-plus" rate regulation. In other words, any utility, as long as it could get a regulator's approval, was guaranteed to collect its construction costs and an operating profit on any plant it built. Is this a good way to encourage the building of expensive power plants, enough so that there would always be sufficient power to go around even on peak days? Yes. Result: To this day we have a system that in no way induces consumers to be rational in their usage. Looking around, your columnist right now is running a fan, two computers and umpty lights, most of which he could turn off with no impact on his comfort and productivity. In fact, the stereo has been switched on but turned down to zero since last Friday. But why get off the couch to shut it off? The sensitive, new age solution: Reward utilities not for how much they invest in construction but how efficiently they meet demand -- which, in the first instance, would mean incentives for consumers to rationalize their usage. The rough-and-ready solution: Free utilities to sock their customers with whatever prices they want, and let customers fight back by turning off lights or seeking out alternatives (which exist aplenty if you look hard enough). But California and other states have opted for a bonehead-with-a-drawing board solution: They call it deregulation but the scheme seems to have been designed with the idea that consumers still shouldn't know how much electricity costs from one moment to the next. Utilities were more or less forcibly stripped of their generation role: Now they would be middlemen, buying power on the open market. The problems with this approach range from a shortage of transmission capacity to the greatly magnified difficulty of preventing grid overloads and other nasty physical effects when the generating plants and the grid aren't under the same control. Even under deregulation, of course, utilities still have an obligation to meet peak demand. But, effectively, it's farmed out to the market, and if the power isn't there, it isn't there. And California has made sure it won't be there in the future by slamming down price controls. Maybe it's time we retired the word "market" altogether from the policy debate, since it's become one of those conjuring words that justifies everything and has ceased to mean anything. A modern economy creates or negates markets as it needs to: The real underpinning is property rights and freedom of contract. Would we tell GM to stop making engines and buy them on the open market? No, because we assume that GM has every incentive to make the most efficient decision itself. Yet government planners have decided, based on no evidence, that the age-old vertical efficiencies in the electricity business simply don't exist. By whatever route, California's solution is to allow utilities with the skill and experience to run integrated power distribution networks to get on with the job -- without either the old guarantees or the old heavy-handed restrictions on their freedom to price. Utilities can judge for themselves how much of their demand to contract out to independent suppliers. Undoubtedly there would be a need for residual regulation to protect the most vulnerable consumers and make sure universal service is available to all. But that would be far less intrusive than the "deregulation" they've been practicing in California -- and that's now unraveling in California, discrediting the idea of a more market-based electrical system. Copyright , 2000 Dow Jones & Company, Inc. All Rights Reserved.
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