The California power quagmire

By Charles Feldman CNN Correspondent This news analysis was written for CNN Interactive.

In this story: Price squeeze Having the means Who's to blame? RELATED STORIES, SITES

LOS ANGELES (CNN) -- The verdict is in: California's experiment with energy deregulation is not just a mess; it's a certifiable failure, according to everyone from the state's governor to the very utilities that initially backed the scheme.

Although deregulation promised lower electricity rates for some 24 million customers of California's investor-owned utilities, the state's Public Utilities Commission in January was forced to grant a temporary emergency rate hike.

	ALSO
• In-Depth: Power Crisis • Chat transcript with Charles Feldman: Power Crisis -- real or imagined? (Jan. 4)

"We are in deregulation prematurely," Democratic Gov. Gray Davis said recently. "It may be that it can never work in California because we are such an importer of power and it would take us three to five years to have online the plants necessary to mete out demand. But right now, it's broken and we need to fix it."

Just how California's electric power system broke and how it may get fixed are being watched closely by some two dozen states moving toward various forms of deregulation of their power industries. States such as Iowa and Nebraska are taking a wait-and-see attitude.

The mistakes of deregulation are much easier to see in hindsight. But interviews by CNN with state politicians, industry representatives and consumer advocates reveal that almost from the get-go, energy deregulation in California was doomed to failure.

Several mistakes are widely acknowledged and appear to come down to one simple issue: the management of supply and demand.

Big mistake No. 1: Under the 1996 deregulation measure, investor-owned utilities such as Southern California Edison and Pacific Gas and Electric were required to sell most of their power generating plants to other private companies, and to become buyers of wholesale electric power.

Big mistake No. 2: While deregulation mandated that utilities buy their power on the open market and pay market prices, it barred them from passing on increases to their customers until at least March 31, 2002.

The wholesale energy market is volatile, and prices for electricity per kilowatt-hour can fluctuate daily. Last year around this time, one megawatt-hour of electricity sold for an average of $30; last month, it spiked as high as $1,400. This week, the price was around $265.

In northern California alone, the current power deficit averages 2,000 to 3,000 megawatts per hour, according to the California Independent System Operator, the agency set up to monitor the state's power grid. Translated, 1,000 megawatts is enough power to serve 100,000 homes.

California's demand for electricity is growing 2 percent each year, according to the California energy commission.

As demand for power peaked last summer and the region experienced drier than normal conditions, California utilities scrambled to buy enough power. Many of its supplying generators are in states such as Washington where dwindling water reservoirs have affected output by hydroelectric plants..

Unable to recoup these higher costs from their customers, the utilities rapidly ran out of money, with the two largest claiming their combined losses exceeded $9 billion as of last month. Many banks grew resistant to lending more money to the cash-starved utilities. That, in turn, made generators reluctant to sell more power to California.

The federal government intervened in December 2000 to force generators to continue selling power to California utilities at "reasonable rates." But the utilities say the money situation still grows tighter daily.

Big mistake No. 3: Deregulation did not permit the negotiation of long-term contracts between utilities and power generators. Legislators were concerned at the time that utilities would get locked into higher prices and be unable to take advantage of dips in the electricity market. But the reverse has happened.

The federal government has so far refused requests by California politicians and utilities to impose regional wholesale price caps for electricity.

Big mistake No. 4: The belief in 1996 that California did not need to build any new power plants. This belief has no doubt been buttressed by the fact that, with its tough environmental laws, California is one of the more adverse places in the country to build new power facilities.

"For 20 years or more, no significant increase in the power supply of the region has taken place," says Gary Ackerman, whose Western Power Trading Forum represents electricity suppliers.

Ackerman points out that 12,000 megawatts of new facilities, enough energy for some 1.2 million homes, are on the books for California. Others say that will not help in the short run.

"We have six plants under construction, and we have another 11 in the pipeline," Davis says. "But that is a two-to-four year process to get all those plants on line."

John E. Bryson, CEO of Edison International, parent company of Southern California Edison, is now an almost omnipresent image on television, appearing in public service announcements exhorting people to conserve electricity.

"It would be valuable to have additional power supply in California, but that is not the problem 95, 96, 97 percent of the hours of the year," Bryson told CNN recently.

Where some see a crisis created by flawed reasoning, others see the potential for manipulation of supply and demand, along with the possibility of criminal price gouging by power generators, utilities or both.

U.S. Sen. Barbara Boxer of California and California Senate leader John Burton, both Democrats, have asked the U.S. Justice Department to investigate the state's energy crisis.

Critics of deregulation say that treating energy like just another product on the marketplace is morally reprehensible.

Electricity "is a commodity that is essential to our economic lifeblood," and should be safeguarded from free market economics of supply and demand, says Harvey Rosenfield, president of the Foundation for Taxpayer and Consumer Rights.

But wholesalers defend their actions, saying they are simply responding to market forces, which they point out is what deregulation is supposed to be about.

"We have been investigated up and down and sideways," said Ackerman of the power generation group, "and after all these months, nobody has found any evidence that there is any price manipulating, any gaming or wrongdoing on the part of the generators here in California or in the Western region."

Other states mulling over deregulation clearly need to think about the key question being asked in California now: just how "free" the energy marketplace should be, and to what extent, if any, the federal government should regulate energy pricing.

When California moved toward energy deregulation, it was viewed as a role model for the nation. Many in this state now think it has served that function inversely -- showing how not to do it.

CNN.com: U.S. News
CNN.com In-Depth

California Energy Commission
California Gov. Gray Davis -- home page
California ISO
California Public Utilities Commission
Edison International
Federal Energy Regulatory Commission
Foundation for Taxpayer and Consumer Rights
Official California Legislative Information
Pacific Gas and Electric Co.
PG&E Corporation
Southern California Edison
Western Power Trading Forum

Note: Pages will open in a new browser window

External sites are not endorsed by CNN Interactive.