California Power Crisis

To: Nikki Kantelis

From: Danielle Albert

RE: California Power Crisis

Date: May 6, 2016

California’s electricity consumption had been low compared to other parts of the U.S. until the 1990’s. The states consumption grew at fast rates and because of excess capacity from producers using renewable sources their demand was being met. California typically imported 25% of electricity and obtained 75% from instate sources; this was contingent on the season. In the 1990s three investor-owned utilities (IOUs) dominated approximately 70% of the California power industry. The industry is usually composed of utilities and non-utilities; utilities are normally given monopolistic power over certain areas with regulation from federal and state agencies. California enacted a restructuring plan to encourage competition and eliminate the monopolistic powers of utilities; they also had the stabilization and/or lowering of wholesale prices of electricity in mind. However, the regulatory structure seemed to be ineffective in the summer of 2000 when California suffered a power state of emergency. During this time, wholesale prices of electricity reached the maximum cap (set by CAISO as part of the regulatory effort) and supply was low. There are several probable factors that could’ve contributed to this power crisis but regulation played a significant role.

Regulation was implemented to protect against monopolistic pricing power and to hold utilities companies accountable for providing reliable service to consumers. The aspects of the regulatory plan contributed to the market conditions in the summer of 2000. The factors helped pushed California utilities into bankruptcy and led to supply disruptions. These components are: the freeze on retail prices, restrictions on long term contracts, and the design of PX and CAISO.

When wholesale prices rose investor-owned utilities suffered financially. At the time the restructuring plan was implemented, wholesale prices were expected to decline. The main purpose for implementing price freezes was to prevent retail prices from falling in the event that wholesale prices did in fact fall. Allowing retail prices to remain above a certain level eliminated competition at the wholesale level but kept cash flows of retailers intact. In the summer of 2000, the price freeze went from being the floor (lowest price chargeable) to being the ceiling. Wholesale prices rose above the fixed retail price. During this time, IOUs suffered great losses and had to cut services of willing consumers by way of blackouts and brownouts. At this time, retail customers had no incentive to reduce electricity use.

Policy makers worried that if long term contracts were allowed investor-owned utilities might make long term supply deals that could affect the wholesale price of electricity. Restricting long term contracts was essential to the restructuring plan because it created competition in the wholesale market. Utilities were not restricted to contracting with PX and CAISO so they often made contracts outside of the regulated structure.  If utilities were permitted to enter into long term contracts this crisis would’ve been preventable. Investor-owned utilities could’ve protected themselves from an increase in wholesale prices if they had been permitted to enter into long term contracts. Instead, due to frozen retail prices customers were exposed to all risk, including the risk of losing service.