KUHN CAPITAL Wednesday, March 21, 2018
Dispatches from the front

California Energy Dreamin'

January, 2006

While the great California energy debacle of 2000 - 2001 has receded from the headlines, we think the outset of this New Year is a good excuse to revisit the eventís repercussions and assess lessons learned.

Bottom line: the mess California made out of its local market continues to exercise its destructive effects not only on the state but on the entire nationís electricity industry and energy consumers. To the uninitiated that may sound extreme, but read on.

You may recall that back then the California legislature led by Governor Gray Davis imposed a set of harebrained rules on how energy in the state could be generated, bought and sold. Notable among these were:

ē Bans against state utilities entering into long-term energy contracts, thereby forcing them into spot markets to the delight of energy traders who promptly seized the opportunity to manipulate the new artificial environment;
ē Prohibitions against building new generation facilities;
ē And -- in a final ruinous fling at centralized command-and-control -- caps on the prices that utilities could pass on to their customers.
The result would be predictable to Economics 101 freshmen. Traders rigged the market to exacerbate the hysteria, spot market prices rose ten times, blackouts rolled through the state, and utilities, unable to pass along their skyrocketing energy costs, saw severe financial stress or went bankrupt.

But these anti-market rules also did more lasting damage than destroying shareholder value (e.g., Calpine and PG&E), and setting off waves of criminal and civil trials that havenít finished wrecking careers and enriching tort lawyers. The greatest tragedy was what happened to the nationís progress on industry deregulation: it froze and in some places, even went into reverse. Bureaucrats and state politicians casting about for ways to protect their lucrative local utility regulating and taxing franchises used the market meltdown as an excuse to stop progress toward open markets. And the press helped cover their tracks: instead of calling the political meddling by its proper name -- unprecedented re-regulation -- they confused the public by using the Orwellian term ďderegulationĒ to describe the root of the problem.

The California-inspired and press-abetted freeze on deregulation then resulted in the death of dozens of innovative software start-ups that depended on free market utility operations to create product demand, and drove many survivors overseas where deregulated EU markets are delivering their usual benefits to the public: lower prices, stronger investor returns, greater delivery capacity and flexible grid infrastructure.

Lessons Learned?
Now, years later, the truth about what happened is slowly seeping out. While the Federal Energy Regulatory Commission (FERC) has been mostly occupied in the intervening period with placing blame for a symptom of the disease (trader abuse) rather than focusing on the disease itself (wacko market rules), it has lately accelerated efforts to wrap up all the settlements and litigation spawned by the event and look toward getting back to the business of rational market reform.

Thatís the first step toward learning lessons about what happens when the workings of free markets are subverted to political ends, as if we didnít already have enough case studies from the fate of centralized economies and the successes of market economies throughout the world, in particular the success of energy deregulation in Europe.

But itís only a first step: what American electricity consumers still need is a clear acknowledgement from the politicians, regulators and, yes even the press, about how they would fix the countryís undercapitalized, over-priced and demoralized energy industry: let the market do its work.

Ryan Kuhn

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