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Electricity Deregulation in California: From Excess Capacity to Rolling Blackouts

Today, opponents of a competitive electrical industry frequently point to California as an example of what end-use consumers can expect under deregulation. However, critics note that California isn’t really an example of electrical deregulation. Instead, the industry was simply broken apart and restructured in a different way, while remaining highly regulated.

Background

• In 1978, the United States Congress passed the Public Utility Regulatories Act, opening the wholesale power market to non-utilities. This was followed in 1992 by the passage of the Energy Policy Act, administered by the Federal Energy Regulatory Commission (FERC).
• Prior to deregulation in California, the electrical energy system was dominated by three investor-owned utilities, including Southern California Edison (SCE), Pacific Gas & Electric (PG&E), and San Diego Gas & Electric (SDG&E).
• This was a vertically integrated system, with each company supplying generation, transmission, and distribution services to a specific geographical area. Customers had no choice in energy providers.
• Both the state Public Utilities Commission and local jurisdictions regulated the companies.
• By the early 1990s, California industries and larger businesses wanted to take advantage of an energy surplus to shop around for the best energy prices.
• A coalition, led by the California Manufacturers Association, lobbied the government for electrical deregulation.
• California utilities opposed the plan because they feared that their stranded costs would make them noncompetitive with plants run by newer, cheaper technologies, particularly those located outside of the state.
• In 1996, the FERC implemented orders allowing deregulated utilities to recover their stranded costs through a complex system that passed these on to ratepayers. This made deregulation more acceptable to the utilities.
• By 1996, high electricity prices in California led to increased support for deregulation from residential customers as well as business and industry.

Deregulation or Restructuring?

In September 1996, California enacted Bill 1890 (AB 1890), bringing in deregulation. In addition to wholesale access, retail access was implemented in 1998.

One of the legislators' main goals was to encourage competition and prevent the three investor-owned utilities from exercising market power. As part of the unbundling process, all three utilities were required to divest at least fifty percent of their generation portfolios, preferably to private companies out of state. In addition, the utilities were required to buy and sell electricity through a power pool, the California Power Exchange (PX), where all buyers would have to pay the highest price bid on any given day. They were also forbidden from signing long-term contracts with power suppliers outside of the state. By contrast, participation in the PX by independents was completely voluntary, and they were free to enter into private, long-term contracts.

The issue of stranded costs was also important. In California, roughly twenty percent of the generation comes from nuclear power plants, which are quite expensive to run. To recover stranded costs, a complicated mechanism was set in place that allowed the older plants to recover their costs, but also kept them competitive with newer plants coming online. As for consumers, electricity rates for business and industry were frozen at a rate above wholesale prices – either until 2002 or until the utility recovered the stranded costs of generation, whichever came first (retail customers received a ten percent discount). The underlying assumption was that wholesale prices would remain low enough to allow the utilities to recover their stranded costs.

Finally, in order to accelerate retail access, the utilities were encouraged to continue participating in the distribution of energy. Customers could choose either to continue receiving their energy from the utility, or pick a different energy provider (in which case the energy was still distributed through the utility).

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Deregulation in California: What Went Wrong?