Citation: Sharon Beder,' Deregulation disaster in California', Engineers Australia, February 2001, p. 38.

This is a final version submitted for publication. Minor editorial changes may have subsequently been made.

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Householders and businesses in California are facing power blackouts this winter as a result of deregulation of the electricity supply industry. Initially the Californian model of deregulation was heralded as a model for the rest of the USA to follow. Now other states are suspending their moves towards deregulation in the wake of the Californian crisis.

Before deregulation the Californian government set electricity rates and guaranteed the private utilities a set return on their investment. But it was argued that this provided no incentive for the utilities to cut costs. Prices were high compared to some other states, mainly because of cost overruns of billions of dollars on two nuclear power plants. Industry groups threatened to move interstate.

When it was decided that the electricity market would be opened to competition the utilities lobbied hard to influence how this would happen. Three utilities spent $US4.3 million on lobbyists and gave over $US1million in political donations.

The final plan, approved in September 1996, involved the utilities selling off their generating plant to ensure there was plenty of competition between electricity suppliers. More competition was supposed to mean lower prices. The generating plant was bought by private companies, often based in other states.

The plan also included a rate freeze until March 2002 or until the utilities had paid off their past debts, whichever came first. However the owners of the generating plant, the suppliers, had no constraints on what prices they could charge utilities, the retailers, for the power generated.

Prices were decided using a computerised market called the Power Exchange, established in March 1998. Utilities wanting to buy electricity entered the amount of electricity they would need the next day and the price they were willing to pay and suppliers offered quantities of electricity and proposed prices. Each hour the computers set the price at the intersection of the supply and demand bids.

While there was a healthy surplus of electricity the utilities bought electricity at lower prices than they sold it to consumers. The two major utilities had made more than $5billion each by the spring of 2000, according to consumer groups.

In San Diego, residents began paying market prices in July 1999 when the rate freeze was lifted because their local utility had paid off its debts. A kilowatt-hour went from 2.7 cents at peak time to 52 cents. When monthly household electricity bills reached an average $US120 per month at the end of August the government stepped in and imposed price caps.

In the summer of 2000 Californian electricity supply prices rose steeply as demand increased because of a heat wave and increased economic activity. However the prices remained high when the weather cooled and during weekends when demand fell off. This was because the power suppliers started exercising their market-power and manipulating the price. They withheld electricity during times of less demand to ensure the price remained high. Prices soared. The prices paid by the utilities on a Sunday in 2000 were seven times more than prices on a Sunday in 1999 despite electricity consumption being the same.

Power suppliers made huge profits at the expense of Californian utilities and rate payers. For example, Houston-based Reliant Energy had a 600% increase in third-quarter earnings for 2000 and more than a third of that - some $US100 million - came from California. Price increases across the West of the USA forced the closure of mines, aluminium smelters and sawmills.

Some cities such as Los Angeles are unaffected because their electricity systems are publicly owned and were not subjected to deregulation so teir citizens and industries were not at the mercy of private suppliers. In other parts of California where the utilities were unable to pass the price rises onto consumers because of the rate freeze, the utilities built up large debts. They threatened the government that unless they could raise rates they would become bankrupt.

Deregulation was supposed to make electricity cheaper by increasing competition and allowing markets to set prices. Instead billions of dollars have moved from the pockets of Californian consumers and utilities to energy companies and electricity brokers, many of them in other states. The cost of electricity to Californian residents and businesses increased by $US10.9 billion in one year.