Power for the People : Protecting States' Energy Policy Interests in an Era of Deregulation 9781315701585, 9780765611482

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POWER FORTHE

PEOPLE

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POWER FOR THE

PEOPLE PROTECTING STATES' ENERGY POLICY INTERESTS IN AN ERA OF DEREGULATION

MARY M. IIMN(Y Routledge

Taylor & Francis Group LONDON AND NEW YORK

First published2004 by M.E. Sharpe Published2015 by Routledge 2 Park Square,Milton Park, Abingdon, Oxon OX14 4RN 711 Third Avenue, New York, NY 10017,USA Routledgeis an imprint of the Taylor & Francis Group, an informa business Copyright © 2004 Taylor & Francis.All rights reserved. No part of this book may be reprintedor reproducedor utilised in any form or by any electronic,mechanical,or other means, now known or hereafterinvented,including photocopying and recording,or in any information storageor retrieval system, without permissionin writing from the publishers. Notices No responsibilityis assumedby the publisherfor any injury and/or damageto personsor property as a matter of productsliability, negligenceor otherwise,or from any use of operationof any methods, products,instructionsor ideas containedin the material herein. Practitionersand researchersmust always rely on their own experienceand knowledgein evaluatingand using any information, methods,compounds,or experimentsdescribedherein. In using such information or methodsthey should be mindful of their own safety and the safety of others,including parties for whom they have a professionalresponsibility. Productor corporatenamesmay be trademarksor registered trademarks,and are usedonly for identification and explanation without intent to infringe. Library of CongressCataloging-in-PublicationData Timney, Mary M. Powerfor the people:protectingstates'energypolicy interestsin an era of deregulation / by Mary M. Timney. p. cm. Includesbibliographicalreferencesand index. ISBN 0-7656-1148-1(cloth: alk. paper)ISBN 0-7656-1149-X(pbk. : alk. paper) 1. Energy policy-United States. 2. Energy policy-United States-States.3. Electric utilities-Govemmentpolicy-United States. 4. Electric utilities-GovemmentpolicyUnited States-States.5. Electric utilities-Deregulation-UnitedStates. l. Title. HD9502.U52T56 2004 333.79'0973-dc22 2003023974

ISBN 13: 9780765611499(pbk) ISBN 13: 9780765611482(hbk)

To our grandchildren, who will inherit the consequences of policies that we maketoday

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Contents

List of Tablesand Figures

IX

Preface

xi

I. Introduction

3

2. A Brief History of U.S. EnergyPolicy

17

3. The Statesand EnergyPolicy, 1975-1995

33

4. RestructuringElectricity

47

5. Restructuringthe California Electricity Market: A CaseStudy

63

6. Restructuringin Other States

77

7. StateEnergyPolicy in 2001

89

8. The Market and the States

99

9. Balancingthe Interestsof the Statesand the Market

113

10. The Future of Electricity Deregulation

129

II. Public Policy and the Market

143

12. Epilogue

149

Appendix 1: StateEnergy Offices and Web Sites

153

Appendix 2: Priority Areas

159

Notes

163

References

167

FurtherReading

171

Index

173

vii

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List of Tables and Figures

Tables

2.1 New Participantsin Energy Policy, Post-1973

21

7.1 StateEnergy Office Location and Electricity Restructuring

92

7.2 StateEnergyProgramActivities by Category

95

9.1 HouseholdElectricity B ills for January2001

118

Figures

4.1 Demand-sideManagementExpendituresfor Electric and Natural Gas Programs

55

6.1 Statusof StateElectric Industry RestructuringActivity

83

9.1 U.S. EconomicGrowth as Comparedwith Electricity Usage

123

12.1 PeakElectricity Demandin the IndependentSystem OperatorControl Area

151

ix

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Preface

I beganthis project in the summerof 2001 while I was living in Hayward, California. As the electricity deregulationcrisis unfolded,it demonstratedthat stateshavemany policy intereststhat arerelatedto energy policy. When one of them is turned over to the market, the stateloses control over all the others, including the price of basic electricity service. Stateenergypolicies, sincethe mid-1970s,have beendesignedto make sure that there is enoughenergyfor all usersin the stateand for economicdevelopment,deliveredat a price that all userscan pay, and generatedin ways that do not harm the state'senvironment. Nowhereare thesevaluesmore importantthan in California, where the natural beauty of the state'senvironmentis as important to economic developmentas is the availability of sufficient suppliesof electricity at reasonableprices. Deregulationpromised lower prices, but policymakersoverlookedthe hiddencostsof a restructuredmarketwhere profits arethe only interest.Indeed,it is this profit imperativethat led to the crisis in the winter of 2001, whereenergyproviderstook advantage of policy weaknesses to garnerhugeprofits as high as 100 percentover the previousyear. When electricity prices spiraled out of control and led to the bankruptcy filing of the state'slargest utility, the state steppedin to regain control overthe complexof policy interests.Chief amongthesewas reinstituting energy efficiency programsto encourageCalifornians to conserveelectricity. They were so successfulthat electricity demanddropped by more than 10 percent.In our house,we turned off lights and remote controls.I worked on this manuscriptby naturaldaylight as muchas possible. We savedmore than 15 percentof our electricity that summerand earneda rebatefor our efforts. It was not difficult; in fact, we tried to live as the Europeansdo wherebright lighting is far from the norm. xi

PREFACE

In this book I have provided researchon stateenergypolicy over a thirty-yearperiod that documentsthe valueson which thosepolicies are based.I beganthis project with a relatively openmind aboutderegulation and gatheredconsiderableinformation about it in an attempt to understandthe positive argumentsfor dismantling a regulatory structure that alwaysseemedto work pretty well. I usedthe California experience as a casestudy of deregulationin general. I have also attemptedto put electricity deregulationin the broader contextsof regulatoryderegulationand the privatizationof government movement.In doing so, I demonstratethat the interestsof the market and the stateare basedon different valuesand are in fundamentalconflict. While the statevaluespeopleand actsto moderateimpactson the leastof them, the marketvaluesprofits alone,regardlessof impactson someof the peopleor small business.I conclude,then, that statesmust recognizethis conflict and structurederegulationpolicies so that they can balancethe interestsof both the people and the market. Without sucha balance,the peoplewill alwayslose. Like all authors,I had the supportof many people on this project. First, I thank my graduatestudentsat California StateUniversity, Hayward, especiallyRachelLevine, who did researchfor chapter7 andwrote much of it; Jack Kenny, who developeda bibliography on California deregulationthat was enormouslyhelpful in gettingme started;my regulatory policy class, who read the first draft of the manuscript;and all thosestudentswhoseencouragement that year meantso much to me. I alsothankKarenaGarbesifor dataand insightson electricity in California and Dick Ottinger, former U.S. Representativeand "father" of the Public Utility RegulatoryPolicy Act, who sharedhis extensivee-mail energyfile with me. Thanksalsoto Harry Briggs, my editor, who waited too patiently for the manuscript,and severalfriends who provided onAlan Knapp and Paul Fanning, going encouragement-especially Camilla Stivers,Ralph Hammel,Al Hyde, and Dale Krane. Above all I thank my husband,Mike Monfils, whose supportfor this project and my careerhave meantmore than I can everexpress.

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POWER fOR THE THfE FOR

PEOPLE

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1 Introduction

Energy has become an important feature of national and state policymakingover the pastthirty-plus years.From 1859,when the first oil well was drilled in Titusville, Pennsylvania,to the early 1970s,national energypolicy focusedon finding new suppliesof oil anywherein the world and enablingAmerican companiesto produce increasing amountsof energyto fuel the nation'seconomicgrowth. As domestic oil sourcesdwindled, American companiesopenednew fields in Venezuelaand the Middle East.Importedoil was so cheapthat policies had to be developedto protect American companies.Two major policies before 1973 were (1) the oil depletionallowancegrantedto oil producers that gavethem tax breaksfor pumpingoil out of the groundand (2) minimum pricesfor oil sold in the United Statesset at a rate that made expensivedomesticoil competitive with the cheaperoil coming from the PersianGulf. 1 Energypolicy amounted,then,to protectingthe interests of the energy producersand ensuring a growing supply of lowpriced energy. The first comprehensivenational energypolicy was developedduring the Ford administrationin the mid-1970s,as the result of an energy "crisis" broughton by an embargoof oil exportsimposedby the Organization of PetroleumExporting Countries(OPEC),led by statesin the PersianGulf. The oil embargoawakenedAmericansto the fact of national dependence on foreign sourcesof energyandto the nationalsecurity implications of this dependency.PresidentGerald Ford appointed Vice PresidentNelson Rockefellerto develop a plan for energy independencethat would protectAmerica'snational securityinterestswhile assuringthe availability of domesticsourcesof energyto keep the national economicenginerunning. The notion of energy policy at the state level has a relatively brief

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history. Until the 1970s,statesdid not havea centralfocus on energyas a policy issue. States'energy interestswere primarily concernedwith public utility regulation,managingso-callednaturalmonopoliesof electricity and naturalgasto preventpredatorypricing and ensureadequate suppliesfor residentsand businesses.Statesthat had energyproducing industrieswere more likely to enactlaws that protectedthoseindustries in the national economy.For the most part, however,statesdid not develop energypolicy becausetherewas no needfor it. Energywas abundant and cheapin the United States.So long as the supply of all energy sourceswas equally availableto all statesthe only real policy issuewas how to set prices for regulatedutilities that ensuredthem a reasonable profit while keepingpricesdown for consumers. In the 1970s,when energypricessuddenlyincreasedas the result of manipulationof oil priceson the world market,many U.S. statesfaced serious social and financial problems. In cold regions, low-income people were hit with both high heating costs and poorly maintained housesthat leakedheat, which necessitatedhigher energyuse. In hot regions,skyrocketing pricesfor electricity madeair conditioningprohibitively expensive.The elderly poor were badly affected by both temperatureextremesas they struggledto pay utility bills out of low fixed incomes. Energy prices also affectedbusinessesand governmentaloperations as the increasingcosts had to be incorporatedinto their budgets.Energy-producingstates, likeTexasandAlaska, enjoyedhugebudgetsurplusesbecauseof royaltiespaid for in-stateoil production.Energy-poor states,like WisconsinandMinnesota,sufferedshortagesof oil andnatural gas, which had a negativeimpact on their ability to retain and attract businessin the state. It becameclear acrossthe country that all states neededcomprehensiveenergypolicies to find waysto protectthe interestsof all the people,reducethe costsof energyuseasmuchaspossible, and developways to protectagainstsupply shortages. Stateswereencouragedandaidedin theseefforts throughoutthe 1970s by the Ford and Carter administrations.In 1975, the FederalEnergy Administration, establishedby the Ford administration,beganthe processof developinga nationalenergypolicy. Therewere two foci at that time: (1) energy independenceto protect the United Statesfrom price manipulationon the internationalmar'ket and (2) energy conservation on a massivescale.The mantraof the Ford Administrationin thosedays was "A barrel of oil savedis cheaperthan a new barrel."2It was widely 4

INTRODUCTION

recognizedat that time, acrossall political ideologies,that the United Stateswastedlargeamountsof energythroughinefficient industrialprocesses,poor building and residentialconstruction,and, most emphatically, transportation.Automobilesin 1975averagedfuel efficienciesfar below 20 miles per gallon and public transportationwas unavailablein many cities in the country.3 U.S. policymakerslooked seriouslyat energy conservationfor the first time and also saw its considerablebenefits for improving environmentalprotection, a major policy issue in the early 1970s. The EnergyPolicy and ConservationAct of 1975 providedgrantsto statesto establishtheir own energyoffices to promoteenergyconservation throughpublic information campaigns.Stateswere requiredto develop plansto reducetheir energyconsumptionby 5 percentbelow the expectedlevel without conservation.Otherfederalprogramsgavegrants to statesto implement energy conservationin public buildings, lowincomehousing,schools,and hospitals.Gasand electric utilities, regulated by the states,were required to develop programsto encourage their customersto conserve.These"demand-sidemanagement"programswere hugely successfulin California until 1996 when electricity deregulationwas enacted. Statesrespondedto theseinitiatives in differentways.Generally,those statesthat arenetenergyimportersandmorevulnerableto price shocks, suchasWisconsinand Minnesota,were morelikely to developpolicies that reducedenergydemand.Stateswith indigenousenergyresources, like Texasand Alaska, or producersof surpluselectricity that could be sold to the grid, suchas Indiana and Ohio, were less likely to focus on conservationexceptto provide energy subsidiesfor low-income residents. Nonetheless,by 1980, there was a broad consensusacrossthe country in supportof energyconservation(Kash and Rycroft 1984).By the endofthe 1970s,conservationhadprovidedmorenew energyto the nation than any other source(Kash and Rycroft 1984: 238). In California, whereenergydemandwas growing fasterthan supply, Pacific Gas and Electric Company becamea national leader in conservationand demand-sidemanagementprograms. All stateshave an interestin ensuringthat they will have accessto stablesuppliesof energyat reasonableprices for all users.The states' threeprimary energypolicy interestsare the stateeconomy,the ability of all residents topay utility bills, and protectionof the state'senvironment.4 Utility costs are interwoven throughoutthe fabric of the state

5

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economy.High utility costs reducea company'scompetitivenessby increasingoperatingcosts. Theseimpactsare most seriousfor small businesseswhoseprofit marginsare narrow. Higher costsalso lead to higherpricesfor consumergoodsand services,raising the cost of living in the statein relation to its neighbors.Thus, high utility costscan force a stateinto economicdecline and make it a less desirableplace in which to live. The impactof high energycostsis felt mostheavily by lower-income residents.In colder climates,inability to pay high heatingbills has led to deaths,particularly amongthe poor elderly. Heat wavesin the summer whereair conditioningis prohibitively expensivecan also increase the deathrate among the poor and elderly on fixed incomes.In other cases,poorpeoplemustmakedifficult choicesbetweenspendingmoney on electricity or heating fuel and other necessities.Beginning in the 1970s,many statesdevelopedprogramsto subsidizeenergybills and to weatherizethe homesof low-incomecitizensto reducetheir energyusageand costs. The costof governmentoperationsalsorises with higherutility bills. Governmentbuildings, schools, hospitals, universities, andnonprofit institutionsall operateon limited budgets.Whenfunds mustbe diverted to energycosts, spendingon other programsmust be curtailed. States and cities do not have the ability to operatewith a budgetdeficit and thereforemust cut spendingon other programsin order to pay higher electricity bills. The interestsof the states,then,aresimple.They needa stablesupply of energy-electricity,natural gas, and heating fuel-at a reasonable price so that businessescan operateefficiently and residentscan afford to managetheir households,and it should be producedin such a way that the state'senvironmentalassetsare least affected.Price spikes in energycosts,including transportationfuels, requirea shift of resources from other spendingand saving that could eventually lead to a downward spiral of the state'seconomy.In California,exorbitantmarketprices for electricity in the winter of 2001 resultedin a massiveshift of state wealth to a handful of electricity tradersand producersoutside of the state.As a consequence,the state budget, which had been forecastto increasespendingdue to a projectedmultibillion-dollar surplus,had to be cut back. The surpluswas usedinsteadby the governorto purchase electricity on the openmarketin an effort to rescuefinancially strapped public utilities from economiccollapse.

6

INTRODUCTION

Deregulation and the Move to the Free Market

During the late 1970s,therewas a movementin the country to abolish governmentregulationof industry. Economistscalled for deregulation to get governmentout of the businessworld and permit the free market to provide consumerswith choicesof productsand services,at prices they were willing to pay. The focus of the deregulationmovementwas generalacrossthe economy.The first industriesto be deregulatedwere transportation,telecommunications, andnaturalgas.By the early 1980s, the airline and trucking industrieshad beenderegulatedandAT&T had been broken up by court order. Natural gas was partially deregulated during the Carter administrationand fully deregulatedafter Ronald Reagantook office in 1981. The oil companiescalledfor deregulationafterthe OPECcartelraised internationaloil pricesin the early 1970s.Oil pricesin the United States had beenregulatedsincethe 1920sin orderto protectdomesticproducers from cheaperimports. This provided a price floor below which oil prices could not fall. In 1973, when imported oil becamemore expensive, domestic price floors becamecaps. Oil resourcesin the United Stateswere declining and oil left in the ground was too expensiveto recoverso long as the price caps remainedin place. Becausea major focus of energypolicy in that decadewas to free the United Statesfrom imported oil-energy independence-industry lobbyists pressedfor deregulationof oil prices so that domesticprices for all oil would rise and domesticsupplieswould then be increasedbecauseof market demand. By the end of the decade,however,conservationand economic slowdownhad so reduceddemandfor energythat oil priceson the market beganto fall to pre-1973levels. Deregulationas a generalpolicy gainedmoreprominencetowardthe end of the decade.EconomistAlfred Kahn, chairmanof the Civil Aeronautic Board, pushedfor deregulationof air transportationand trucking, including the dissolution of his own agency. Industries gathered political supportagainstthe new socialregulations--environmental protection, consumerprotections,occupationalsafetyand health-thatincreasedtheir costsof productionwhile giving them no direct benefits. Conservativeideologueswere alsogainingpolitical groundandderegulation was one of the planks in their platform. When PresidentRonaldReagantook office in 1981,much ofthe energy policy infrastructureestablishedduring the Carteradministration 7

CHAPTER

1

was dismantled.Oil and natural gas priceswere deregulated,national energypolicy wasturnedoverto the free market,andthe emphasisshifted from reducingdemandto increasingsupply. During his campaign,the presidenthad pledgedto eliminate the Departmentof Energy, which had beenestablishedonly a few yearsearlier. He could not developthe political supportin Congressto do so. Instead,the administrationtransformed the department'smission and its budget. The mission turned from demand-sidemanagementto allowing the market to determine supply. Conservationprogramswere slashed-from$1 billion annually to $10 million in 1983, a 90 percentcut (Davis 1983: 183). The department was refocusedon aiding in the buildup of nationaldefenseand the portion of the budgetdevotedto nuclearweaponswas increased.The focus of the Departmentof Energywas fundamentallychangedthrough executiveorder, leaving it a shadowof its former self. Reagan,thus, accomplishedhis objective without congressionalapproval. As energypolicy shifted from demandto supply at the federal level, what thenhappenedto the nationalconsensusthat KashandRycroft had documented?Did the statesdiscontinuetheir programsand were their energypolicy interestsstill met?For the most part, the answersto these questionsare no and yes. Statescontinuedto fund their energyoffices, initially using"oil overcharge"allotments,moniesawardedto the states by court decisionsafter finding that the major oil companieshad overchargedcustomersduring the 1970s.Most statesreceivedseveralmillion dollars eachyearfrom 1986 to 1993. Many statesusedthesefunds to continueoperatingenergy offices and to fund various energy managementprograms,including weatherizationprojects and low-income energyassistance grants.A studyof seventeenMidwesternstatesin 1991 found that the generalconsensusof stateinterestswas still very much in place(Bailey 1993). This study is describedin chapter3. The Deregulation Juggernaut As late as 1993, most stateswere still focusedon protectingtheir primary energypolicy interests:affordability, ample supply, and environmentalprotection.Thencamederegulation.The National EnergyAct of 1992 establishedthe framework for the developmentof a national electricity marketandcreatedthe possibility for consumerchoiceamongelectricity providers. Companiessuch as Enron Corporation and Reliant Corporationin Texas and Duke Energy Corporationin North Carolina 8

INTRODUCTION

becameenergybrokersthat could facilitate the marketingof electricity throughoutNorth America. The availability of consumerchoicepromisedto leadto lower pricesfor electricity asconsumers,in theory,would shoparoundto find the cheapestprovider. Statescameunderincreasing pressurefrom industriesand big energy usersto deregulateelectricity so that pricescould fall. In 1996,California becamethe first statein the country to deregulate electricity. Industry lobbyistsconvinceda conservativeRepublicangovernorand a Democratmajority legislaturethat the price of electricity in the statewas artificially high becauseof inefficient regulation.If companiescould not havea choiceof providers,it was argued,they would move their operationsto a neighboringstate where prices were lower. To keep them in the state, electricity must be turned over to the free marketso that largeuserscould shopfor the lowestprices.Deregulation was approvedunanimouslyby both housesof the California legislature and then-GovernorPete Wilson signed the bill with great confidence that his own political fortunesas a potentialpresidentialcandidatewould be improvedas a result. Customerelectricity choicefor residentsand small businesses began in 1998. Small customerswho did not choosean alternative supplier remainedcustomersof the threeindependentlyownedutilities-Pacific Gasand Electric in the north, SanDiego Gasand Electric and Southern California Edison in the south. Los Angeles, Sacramento,and a few othercities havemunicipalelectricity generationand havelobbiedto be excludedfrom the deregulationframework.Threeyearslater, the state's deregulatedelectricity prices rose to previously unimaginedhighs and the utilities faced bankruptcy.The free-marketdreamof cheaperelectricity had turned into a nightmareof outrageouslyhigh prices accompanied by rolling blackouts during the winter and spring of 2001. Alternativeelectricity providersabandonedconsumersasthe major utilities in the stategrew unableto pay their market prices.Ultimately the statesteppedin, becamethe primary electricity buyer for the utilities, and enteredinto negotiationswith the utilities to buy their transmission lines. Calls for re-regulationwere heardfrom every comerof the state, and includedsomeof the strongestvoiceswho had advocatedderegulation. Otherstateswatchedthe debaclewith a mix of smugnessandtrepidation. Californians were portrayedas energy wastrels,wallowing in their hot tubs while their computersran 2417. The crisis was blamedon flaws in the legislation that establishedprice "caps" and forbade the 9

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1

utilities to enterinto long-termcontracts.Therewas growing fear that it could happenelsewhere. The marchto deregulationstopped.Statesthat had beenmoving toward it pulled back,othersdelayedimplementation.As of February2003, fewer thanhalf of the states(twenty-four) hadenactedrestructuringlegislation. Of these,however,sevenhad delayedimplementingretail accessandone,California,had suspended restructuringcompletely(Energy InformationAdministration,January2002).By June2003,no new state had begunderegulatingelectricity. Absentfrom the analysesof this failure was any discussionof flaws in the conceptof deregulationitself as a public policy. In California, policymakersfocusedprimarily on the excessesof the market and alleged price gouging by the electricity brokers. Protectorsof deregulation, on the other hand, scornedstate lawmakersfor developing a "flawed" deregulation policythat prohibited the utilities from entering into long-term contractsto purchaseelectricity, leaving them captives of the spot market.Had the utilities had accessto long-termcontracts,it was argued,they would not havebeencaughtin the dynamicsof a normal and volatile free-marketsystem.A true free market in electricity would, in the long run, producesuppliesat a price consumerswould be willing to pay, they said. Thus, one might concludethat the crisis was the result of either a legislative failure or a market failure or both. Another conclusion,however,just as plausible,is that it was a huge market success.The market actedjust the way free markets are supposedto, pricing scarcecommoditieshigher as demandincreasesand the purchaser'sability to pay becomesmore uncertain.At one point during the heightof the crisis, when the statetook over purchasingelectricity for the utilities, energyproviderscharged$3,880for a megawatthour of electricity that normally sold for about $300. A surchargeof $3,104was built into the price as a credit penalty becauseof fears that the utilities would renegeon payments(Geissinger2001). The companies, and eventuallythe state,had no choice but to agreeto pay. Electricity is not an optional commodity in American life, and we will generallypay whateverit takesto keepthe lights on. This is the central fault in deregulationand other mechanismsfor privatizing governmentservices.As long as utilities were regulatedas naturalmonopolies,the stateswere able to protecttheir primary energy policy interests-affordabilityand adequatesupply. Thoseinterestsare of little concernto the market, however, which has only one interest: 10

INTRODUCTION

makingthe largestprofit possibleas quickly aspossible.It is this fundamentaldifferencein focus that makesthe marketa questionablemechanism for providing universal public servicesand serving the public interest.Wholesaledevolutionof the state'spolicy intereststo the market, as is donewith deregulation,resultsin loss of political control over essentialpublic policies at the expenseofthe state'seconomyand quality of life. Purpose of the Book

This book examinesstateenergypolicy as it has developedsince 1973 and documentsthe primary intereststhat the stateshave held for their own energypolicies. It builds on a study of the early 1990sthat examined developmentsin stateenergy policy during the 1980s in the absenceof national energy policy direction (Bailey 1993). That study documentedthe states'priorities in energy policy at the time. During the summerof2001, a comprehensivestudy of stateWeb siteswas conducted to update thisinformation, and it determined thatstateenergy policy priorities had not shifted despitethe emphasison deregulation during the 1990s.California, when faced with extrememarket prices, actedto protectits primary energypolicy interests. The main thrustof my analysisis on deregulationas a mechanismfor achieving state energy policy goals and the question of whether the market can truly meet the complex policy interestsof the state. The Californiacaseraisesthe following questions,amongothers:Is the California experiencean aberrationor just businessas usualfor the market? Can any market be truly free when there are only a few providers?Is electricity a naturalmonopoly after all? Was this a political failure or a marketfailure? Are market interestsand stateinterestsin fundamental conflict? Did the marketactually work too well in California? There are no simple answersto thesequestions.They are, however, important issuesfor public policy, in general.The pressureto get governmentoff the backsof businessand to privatize public interestscontinuesacrossall sectors.Electricity is usedhereas a powerful example of the flaws of free-marketideology for achievingpublic-policy objectives. My central argumentis that the assumptionson which deregulationpolicy was madedo not servethe complex interestsof the people, nor can they. The market cannot meetthe needsof all the people-onlythe largestand most demandingconsumersreally get a

11

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1

choice-andthe relatedpolicy interestsof the statefall far behindthe interestsof the market.The book, then, is also an examinationof freemarket ideology as the basis for public policy. My aim is to demonstratethat thereis a role for governmentthat is superiorto the market in the provision of servicesto all the people,not just the biggest,richest, and smartest. Chapter2 providesan overviewof energypolicy history in the United Statesfrom roughly World War I to 2001 and of the energy policy proposedby the GeorgeW. Bush administration.This history reveals that governmentpolicy has long protectedthe interestsof the energy producersfor four of the five primary energy sources-oil,natural gas,nuclear,andelectricity. Only coal hasneverbeensubsidized,and, in fact, over the pastfifty years,policies havebeendevelopedto limit its use becauseof its negative health and environmentaleffects. Comprehensiveenergypolicy in the United Stateswas not developed until the last three decadesof the twentieth century. During this period, energy policy moved from the national to the state levels and from tax subsidiesto increaseenergyproductionprior to the 1970s,to tax creditsto increasesupply throughefficiency and demandmanagement in the Carteradministration,to deregulationof energyresources to increasesupply in the Reaganadministration.The cycle was completed with the Bush II administration'sdeemphasison conservation and demand-sidemanagementand renewedemphasison: (1) expanding the supply of fossil fuel-basedenergyresourcesin the twenty-first century; (2) relaxing environmentalprotectionlaws so that more coal generatorscould bebuilt quickly; and (3) restoringnuclearpoweras a desirablesourceof electricity. Chapter3 providesan overview of stateenergypolicies from 1975 to 1995,the yearthat California enactedelectricity restructuringpolicy. It describesthe states'problemsin the 1970sas they tried to adjustto rapidly rising energyprices and cushiontheir citizensand businesses from the impacts of thesecosts. The results of a study of seventeen Midwesternstatesat the beginningofthe 1990sdocumentsthosestates' activities in energy policy developmentduring the 1980s when the nationalenergypolicy developedduring the Ford and Carteradministrationshad beendismantled.The messagecoming out of Washington in the 1980swas that there was no needfor a national energypolicy. Natural gas had beenderegulatedand the OPECcartel had collapsed as oil prices fell, in large measureas the result of widespreadenergy 12

INTRODUCTION

conservationby Americans during the 1970s. The Reaganadministration'spolicy at the time was to let the marketdevelopenergypolicy so that the dynamic of supply and demandwould dictate the needfor new energy sourcesand technologyas pricesrose. The study found that the statesin this sampledid not adoptthis philosophybut continuedto developtheir own energypoliciesbasedon the individual needsof their residentsand businesses.Stateshad experiencedmany negativeimpactsof marketfluctuationsduring the 1970s. The poor and elderly suffereddisproportionatelyfrom sharpincreases in heatingand cooling costs.Small businesses, nonprofits,and governmentsthemselveswere forced to devotegreaterbudgetaryresourcesto utility costs.Uncertainenergysupplies,in general,had a negativeimpact on stateeconomiesresulting in migration of businessesto energyrich states.Statesworkedtoward developingpoliciesthat would ensure a dependablesupply of energyat affordableprices for all users,deliveredin ways that protectedthe state'senvironmentalquality. Documentation of these states' complex policy interestsprovides a base for analyzingthe currentinterestsoutlined in stateenergypolicies. Chapter4 describesthe pushfor restructuringthe electricity industry and deregulationof electricity pricing in the 1990s.An examination of the history of electricity regulation provides a look at the developmentof regulatoryroles of both the statesand the federal government.The chapteralso providesan overview of major federal legislation that eventually led the states to implement electricity restructuringand deregulationpolicy. The political issuesinvolved in restructuringindependentlyowned public utilities are discussed,including such issuesas amortization of the costs of strandedassets, retail wheeling,and consumerprotection.The social and environmental costsof restructuringare also considered. The California experiencein the winter of 2000-2001is used as a casestudy of electricity deregulationin chapter5. The casedocuments the developmentof electricity deregulationpolicy in California, the main featuresof the legislation,and the political dynamicsof the passageof the legislation.A detaileddescriptionof the electricity crisis in California from summer2000to summer2001 is followed by an analysisof the factors associatedwith this policy failure. Chapter6 examinesthe deregulationexperiencesof otherstates.The policiesin severalstates,particularlyPennsylvania,New York, andOhio, of statepolicies arecomparedto California's.Strengthsand weaknesses 13

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1

and their experienceswith deregulationare examinedalong with evidenceof the lessonsotherstateslearnedfrom the California experience. Chapter7 looks at whetherstateenergypolicy interestschangedwith deregulationandhow the statesthemselvesseetheir role in settingpolicy for energysupply and prices today. A study of the Web sites of all fifty stateswas conductedand a content analysis was used to identify the primary intereststhat are articulatedin describingenergypolicy at the state level. The findings are comparedto the findings from the 1990 study and analyzedto determinewhether there are significant differencesbetweenthe interestsof regulatedand deregulatedstates. Chapter8 providesa generaldiscussionof stateinterestsversusmarket interests.It establishesa frameworkfor examiningwhetherthe market can meet the complex policy interestsof the stateor if, instead,the marketactually overwhelmsstatepolicy intereststhroughdistorting incentivesand encouragingoverconsumption.The inability of the market to reduce demand-adominant state energy policy interest--except through predatory pricing is discussedalong with the policy issue of growth in supply versusreductionin demandthroughconservationand efficiency. It looks at the American lifestyle and distortedincentivesto consumemore energythat comefrom the market.A fundamentalfocus of this chapteris on the questionof whetherthe marketreally worked in electricity deregulationin the way that free markettheory claims. What are thelimits of the free marketin meetingpolicy interestsor providing public goods? Acceptingthat the deregulationgeniecannotbe put backinto its bottle at this point, Chapter9 examinesthe possibility of balancingstateenergy policy interestsand marketinterestsby designingpolicies that use the bestpart of marketmechanismswhile protectingthe interestsof the state.What was good about regulation?What is good about deregulation? Can two failures-policy and market-makea success?Is it possible to blend or balancepublic and private interests?New roles for federal and stateregulatorsare defined by deregulation.The failure of the Federal Energy Regulatory Commission (FERC) to protect California's energypolicy interestsis examined. Chapter10 considersthe aftermathof the California crisis and the future of electricity deregulationpolicy itself. The collapseof the Enron Corporation,the declineof otherenergyproducers,and the evidenceof marketmanipulationin California mustlead toa reconsiderationof electricity restructuringaspublic policy. Yet the electricity industry hasbeen 14

INTRODUCTION

transfonneddespitethe reality that over one-halfof the stateshavenot deregulated.As the FERC attemptsto make restructuringa national mandate,statesare moving to protecttheir policy interestsand evento re-regulate.I arguethat the PERCmust assumea new role post-deregulation to restorethe federal-statepartnershipand work to protect the interestsof the statesin the deregulatedmarket. The chapterincludesa philosophicaldiscussionof whether,in fact, the market really works for all the people and the role of the state in ensuringthat it does.I arguethat the states cantake from the California caseimportantlessonsaboutthe necessityto developstateenergypolicies that protectcitizensfrom the vagariesof a wildcat energymarket. The conclusionin Chapter11 considersthe proper role of government and the properrole of the market in providing public policy in a democraticpolity wherecitizensaremorethanjust consumers.It briefly considersthe purposeof economicsand questionswhetherAdam Smith himself would approveof the way that the free market operatesin the United Statestoday. Would he have seenthe differencesbetweenproducing and selling widgets and the provision of a necessityof modem life through the market?Finally, the questionof who servesthe people is posed.The answer,of course,dependson one's own belief in the value of democraticgovernanceand one'sskepticismof the ability of the free marketto producea societythat is fair andjust and inclusive of all the people,not just the richest,cleverestand most well born. Chapter12 is an epiloguethat briefly considersthe role of deregulation in the electricity blackoutof August 2003.

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2 A Brief History of U.S. Energy Policy

Before 1970,U.S. energypolicy was effectively oil and gaspolicy. The United Statesdid not have a comprehensiveenergy policy. Until the "energy crisis" in 1973, precipitatedby the Organizationof Petroleum Exporting Countries(OPEC) oil embargothat drove up prices on the world market, energy policy was largely a function of federal government policy in relation to five energysources:oil, naturalgas,electricity, coal, and nuclear power. Most policy was designedprimarily to supportthe healthand wealth of the energyproducers-specificallyoil, naturalgas,and nuclearpower-inthe nameof the greaterpublic interest, especiallynationaldefenseand economicdevelopment.Coal is the only fuel that has not enjoyedgovernmentprotection and support, althoughtherehavebeenthreedifferent government-sponsored efforts to developsyntheticoil and gas (synfuels)from coal (seeVietor 1984). The goal of pre-1973national energy policy was a commitmentto ever-largerquantitiesof energy at ever-lowerprices. Policies focused on energyfuel production to ensureabundant,stable,low-cost energy supplies."Cheap,abundantenergywas the basisof social and political stability. It provided the foundation for economicgrowth and for the acceptanceof commonsocietalrules" (Kash and Rycroft 1984: 47). Energy in all its forms was cheapin the United States.Indigenous suppliesof fossil fuels allowed the nation'seconomyto grow robustly. When domesticsuppliesof oil beganto decline after World War I, imports from the Middle Eastbecameavailable.In 1933,the StandardOil Companyof California (Socal)negotiateda 60-yearagreementwith the SaudiArabian governmentfor exclusiverights to the country'seastern oil region.Socalestablishedthe CalifornianArabianStandardOil Company which was renamedthe ArabianAmericanOil Company,Aramco,

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in 1944.By 1948,Socalhad sold interestsin the ventureto StandardOil of New Jersey(later Exxon) and SoconyVacuum(later Mobil) (Saudia Arabian InformationResource,November9,2002).In an extraordinary deal in the early 1950s,the StateDepartmentand the TreasuryDepartment agreedto credit taxesthat US. companiesearnedpumping oil in Saudi Arabia, in order to bolster the Saudi economy and establishan importantally in the region.This agreementwas known as "The Golden Gimmick" (Davis 1978: 75). BecauseMiddle Easternoil at the time was also very cheap,domesticU.S. oil producerssuccessfullylobbied for the establishmentof price capsthat set a higher price for imported oil so that domestic oil could be competitive. Oil producersalso receivedfavorabletax considerationthroughthe oil depletionallowance. This vehicle was in essencea subsidyof domesticoil companiesby the US. government. Energyusegrew in concertwith the post-WorldWar II US. economy. By the early 1970s,Americanswere accustomedto paying much lower prices for energythan were consumersin other developedcountries.A gallon of gasolinein the United States,pumpedby an attendantwho also checkedthe oil and washedthe windows,sold for about25 centsin 1972and gas stationsgaveaway premiumssuchas glasswareto attract customers.Europeansand Japaneseat the time paid the equivalentof $2-3 per gallon. Becauseof the low prices,Americanswere also accustomedto wasting considerableamountsof energy. Automobiles of the 1970s averagedfuel consumptionof 10-12 miles per gallon or less. Cars of that era were large,roomy, and heavy.After World War II, public transportation systemsacrossthe country were dismantledor pareddown. New suburbanneighborhoods,built beyond the range of public transportation, spurredthe increasein the use of personalautomobilesto get to work, shops,and recreationdestinations. Buildings constructedfrom the 1950sto early 1970swere the least energy efficient since cave dwellings. High-rise office buildings had fixed single-panewindowsandheating,ventilation,andcooling (HVAC) systemsthat were designedto be inefficient.l Tract housing was built with ill-fitting windows and doorsand with no insulation,necessitating higher thermostatsettingsfor heatingand lower onesfor cooling. Becauseelectricity and naturalgasbills were relatively low, mostAmericansgave little thoughtto the efficiency of the systemsor the quality of housingconstruction.They simply raisedthe thermostatsetting to 18

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compensatefor drafts coming through the walls and windows. Indeed, builders of housingand office buildings dependedon cheapenergyto keeptheir constructioncostsaffordable. All of this changedin the 1970s when the OPEC cartel raised oil prices on the world market and the Iranian governmentplacedan embargoon exportsto the United States.By 1974,the SaudiArabian governmenthad takenback60 percentof its oil fields.2 Overnightthe price of gasolinein the United Statesdoubledand all otherenergypricesthat were dependenton oil also increaseddramatically.Known natural gas reservesin the United Stateswere dwindling. Electricity power plants fueled by natural gas were shut down and oil-poweredgeneratorsbecameincreasinglyexpensiveto operate.Electricity generatedfrom coal was underpressureat the time becauseof new environmentalprotection laws governingair and water quality. The CleanAir Act Amendments of 1970 and the Water Pollution Control Act of 1972 imposedstringent controls on coal-burningpower plantsto reduceair pollutantsprimarily sulfur dioxide and particulate matter or fly ash. Water contaminatedwith thesepollutantsand other by-productsof burning coal was alsostrictly regulated.Midwesterncompanies,notablyAmerican Electric Powerof Ohio and Indiana,developedtall stacktechnology that pushedpollution higher into the atmosphereto reducethe ambientpollution nearthe plants.Ten yearslaterthis upper-atmosphere pollution was identified as the major sourceof acid rain in New York and New England. By 1975, however, coal had becomethe dominant choice for U.S. policymakersseekingto developenergyindependence from foreign oil producersbecauseof its abundantsupply in the United States.As the Ford administrationstruggledto developenergyindependence, domestic coal reservesbecamea centralelementin the emergingpolicy. Known U.S. coal reserveswereas substantialat the time as oil reservesin Saudi Arabia. Interestin expandingcoal production by as much as 300 percent led to the Carteradministration'sfunding of researchand development of syntheticoil and naturalgas. dramatically.It The focus of nationalenergypolicy had also changed was no longer possibleto maintain price stability and continually increasingenergysuppliesgivenglobal energymarketrealities.The OPEC embargofocused the attentionof policymakerson the relationshipof energysupply to economicgrowth and on the nationalsecurityimplicaon foreign sourcesof oil. Given that u'S.-controlled tions of dependence 19

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sourcesof oil were diminishing and known domesticdepositsof natural gas were limited, the nation was forced to examineenergypolicy more broadly. Therewasgreatuncertaintyin the country about thefuture of domestic energy supplies and their availability to continue to fuel the economic growth engine.Recognitiondawnedthroughoutthe country that energyis a preciousresourcethat shouldnot be wasted.The Nixon and Ford administrationsbeganto developa nationalenergypolicy for efficiency and conservation,basedon the realizationthat savedenergyis far cheaperthan new energydevelopmentand it hasa positiveeffect on the environment.3 Gerald Ford's vice president,Nelson Rockefeller, headeda task force that developeda plan for energyindependence that was heavily skewedtoward increasingthe productionof coal. TheAlaskan oil pipeline was alsoa significantfactor in this discussion.Although someenvironmentalistsopposedconstructionof the pipeline at all, the primary disagreementin the policy debateat that time was over the direction of the pipeline from PrudhoeBay and whetherit would cross Canadato terminatein the upper Midwesternstatesor crossAlaska to PrinceWilliam Soundwhere the oil would be loadedinto tankersdestined for refineriesin California. Nuclear power was seenas an important factor in national energy policy at that time. Atomic energydevelopmentis regulatedby the federal governmentandoriginatedaspart of theEisenhoweradministration's Atoms for Peaceprogram.In the 1960snuclearpower had beenchampionedasthe cheapestway to generateelectricity-socheapthat meters would be unnecessary. But in the 1970s,the coststo constructand operatenuclearpowerplantsbeganto escalate.Protestsagainstnuclearpower plantsby environmentaland consumeractivists madesiting new plants increasinglydifficult. In 1979, the nuclearpower plant at Three Mile Island near Harrisburg, Pennsylvania,suffered a seriousaccidentthat led to a nearmeltdownof the reactorcore.Furtherdevelopmentof nuclear powergroundto a halt throughoutthe country. The goals of energypolicy changedin the 1970sand so did the participantsin the policy process.Prior to 1973,energypolitics weredominatedby the producersof fuels-oil, gas, and coal. Their goal was to developpolicy that enabledthem to produceas much as possibleand expandtheir markets.Policieswere designedto keepthe producerssatisfied for both economicgrowth and national security. Where previous policy focused on abundanceand cheapness,two 20

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Table 2.1

New Participants in Energy Policy, Post-1973 Performance-motivated participants

Advocates of alternative technologies Energy system modelers

Impact-motivated participants

Short-term economic advocates Environmental and second-order impact activists (health, consumer)

Power-motivated participants

Domestic-policy actors (federal agencies, congressional committees, states) Foreign-policy actors Advocates for sociopolitical change

Source: Kash and Rycroft 1984: 89-106.

addedgoalsshapedthe developmentof new policy: cleannessand security (Kash and Rycroft 1984: 14-15). Cheapnessbecameimportantbecauseof hugeprice shocksin 1973and 1978thatthreatenedthe economy in nonproducingstatesand causedhardshipfor the poor and elderly. The environmentalmovementemphasizedthe polluting aspectsof energy usebasedon fossil fuels. Wherepolicy hadbeendesignedby producersandCongress,the policy arenanow included sevennew participantswho were not attachedto any particularfuel (seeTable 2.1). Energypolicy becamea contentious policy areafor a variety of interestsand no longer the sole province of fuel industry executivesand their representativesin Congress.Performance-motivatedparticipantsincluded advocatesof alternativeenergy technologiesandenergysystemmodelerswho focusedon resourcelimits andthe needfor technologiesbasedon renewableresources.Impactmotivatedparticipantsincludedenvironmentalists,healthprofessionals, and consumeradvocateswho were concernedaboutthe impactsof energy developmenton the environmentand humanhealthas well as the consumerpocketbook.Power-motivatedparticipantsencompassed domestic-policy actors (federal agencies,congressionalcommittees,the states)and foreign-policy actorsas well as advocatesfor sociopolitical change(seeKash and Rycroft 1984: 89-106). Energy productionwas increasinglyseenas linked to foreign policy and U.S. dependenceon foreign producersin the politically volatile

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Middle East. For the first time, attemptswere made to documentall known reservesof energysourcesin the United Statesand analystsdevelopedmodelsto estimatethe lifetime of thesesuppliesif userhabits remain unchanged.Studiessuch as the Club of Rome'sThe Limits to Growth (Meadowset al. 1972) spurredthe developmentof alternative energysources.More importantly,this study begana seriousdiscussion of the viability of the Americandreamand continualeconomicgrowth. Conservationwas the centerpieceof the emergentfederal energy policy. For the first time, states,with the help of Washington,were required to developtheir own energypolicies focusedon implementing plansto reduceenergyuse(seechapter3). In addition, gasand electric utilities were requiredto developprogramsto encouragetheir customers to conserve. PresidentGeraldFord establishedtwo new energyagencies:the Federal EnergyAdministrationand the EnergyResearchand Development Administration(ERDA). Theseagenciestook someof the energyfunctions that had beenhousedin the Departmentof Interior and attempted to bring energy-relatedactivities togetherwith a focus on researchand developmentof new energy resources.The ERDA was chargedwith promoting researchon technologyto synthesizeoil and gas from coal and oil shale deposits.Ford also appointedVice PresidentNelson Rockefellerto headan energyindependence taskforce. The chargewas to developa plan to expanddomesticenergyproductionand reducethe nation'sdependence on importedoil, particularly from the Middle East. The administrationbeganto discussthe possibility of tripling the production of U.S. coal, the most abundantenergyresourcein the nation. The 1976electionbroughta strongeremphasison energyefficiency. National energypolicy was the major policy initiative in the early years of President JimmyCarter'sadministration.Carterwas a nuclearengineerwho hadgaineda goodreputationin the environmentalcommunity when governorof Georgia.He appointedseveralwell-known environmentalandconsumeractiviststo high-levelpositionsin his government. Shortly after his inaugurationCarter appointedenergy administrator JamesSchlesinger,who spearheaded the developmentof proposalsfor a comprehensiveenergy policy and a new cabinetDepartmentof Energy (DOE). In a nationwide television address,Carter describedthe energyproposalas "the moral equivalentof war" (Davis 1978: 8). The new DOE was to develop (1) energyefficiency standardsfor automobiles and appliances;(2) building constructioncodes;(3) standardsfor

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thennostatsettingsin office buildings; and (4) tax incentivesfor energy conservationand solarenergypurchasesby homeownersandsmall businesses.The Synthetic Fuels Corporation was establishedto develop oil and naturalgas productionfrom coal and oil shale.The corporationsetdaily productiongoalsof 500,000barrelsof oil-equivalent by 1987 and 2 million barrels of oil-equivalent by 1992 (Kash and Rycroft 1984: 274). The corporationwas dismantledby the Reagan administrationin the belief that the market would developnew fuels as the needdeveloped. Americansrespondedpositively to theseinitiatives. Demandfor small, fuel-efficient carsgrew, particularlyaftera secondOPEC-ledprice shock doubledgasolinepricesagainin 1978.The marketfor solar-energyproducts, efficient appliances,and insulation expanded.Constructionstandards for office buildings and housing reducedoperatingcosts at the sametime that they improved the quality of construction.By the early 1980s,growth in demandfor electricity had declinedsignificantly from the previousrate at which demanddoubledaboutevery ten years.Gasoline consumptionin the United Statesdroppedso much that the OPEC cartelcollapsedandgasolinepricesfell to pre-1978levelsin 1982.Thus, the evidenceshowsthat there was widespreadpolitical supportfor energy policies that emphasizedconservationand efficiency, acrossboth major political parties,throughoutthe 1970s. Policy developmentnever occurs in a vacuum, however,and other initiatives often intersectwith a given issue.In the late 1970s,the factor that beganto influenceenergypolicy most significantly was the movement toward deregulation.Oil and gas production were heavily regulatedand that regulationwas increasinglyseenas a barrierto increasing suppliesof affordableenergy. Natural gas regulation set price capson gas that was deliveredto interstatemarketswhile intrastategas prices were not capped.Companiesin Texasand Oklahomasold their product in their own statesand withheld gasfrom interstatemarkets,creatinga shortage.The CarterAdministration supportedderegulationof natural gas via the Natural Gas Policy Act (NGPA) of 1978. The emphasisof this law was to allow prices of natural gas to rise gradually until 1985 through market mechanismsthat accountedfor the cost of exploration andthe limited supply.At the time, known reservesof naturalgasin the United Statesweredwindling anddeeperwells hadto bedrilled at.greater cost than the regulatedprices allowed. The NGPA provided partial deregulationthrough a complex systemof pricing "old" and "new" gas.

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By 1980,however,the markethad respondedso effectively that the gas shortagedisappeared(Kash and Rycroft: 210). Electricity regulationhad a different effect on pricing. Utility companies,regulatedby the states,were generally allowed to requestrate hikes that coveredtheir costsof productionplus a profit, the "cost plus" method. Many companiesinvestedin expensivenuclearpower plants with the blessingsof the regulators.Becausethey could recovertheir costsno matterwhat fuel they usedwith existing technologies,utilities had little incentiveto invest in the developmentof new technologiesto generateelectricity from nonfossil fuel sources,particularly renewable resources.In addition, becauseof the necessityto recouptheir investments, most utilities were resistantto promoting energy conservation that would reducetheir profits as well. It was difficult for companies that hadtraditionally increasedprofits by selling moreto insteadasktheir customersto use less of their product. The major exceptionto this rule was the Pacific Gas and Electric Company(PG&E) in northernCalifornia, the nation'slargestprivate utility in 1978. Facedwith projectionsof continuing growth in demandand escalatingconstructioncosts,PG&E adopted"a far-reachingprogramof subsidiesand incentivesfor conservation, cogeneration,and renewableenergy"(Lee 1983: 190). The National Energy Acts of 1978 forced utilities to get involved with renewablesand conservation.First, the Public Utility Regulatory PoliciesAct (PURPA) requiredutilities to connectqualifying facilities (QFs) to their transmissiongrids and to purchasetheir power. Qualifying facilities are cogeneratorsand small power producersthat produce electricity using renewableenergy sources.The price was to be set at the cost savingsto utilities for not having to build new capacityto generatethe sameamountof electricity (Brennanet al. 1996: 29). This section of the PURPAwas designedto force the utilities to take renewable resourcepowergenerationseriously.Becauseit openedthe grid for use by nonutility generators,however,it ultimately becamethe vehicle for electricity deregulation. Second,the National Energy Conservation Actrequired utilities to establisha ResidentialConservationServicethat would provide informationto consumerson ways to improvetheir energyefficiency, identification of conservationcontractors,andfinancing assistance(Lee 1983: 186). The EnergyTax Act provideda 10 percenttax credit to generators usingbiomass,geothermal,wind, andsolarenergy;and,finally, thePower Plant and Industrial Fuel Use Act forbadethe useof oil and naturalgas 24

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in new power plants (Brennanet al. 1996: 30). Individual homeowners were also given tax incentivesto encourageinvestmentin both conservation projects, such as window replacementand caulking, and solar energyproducts. The FederalPowerCommission,which regulatedwholesalenatural gasand electricity prices,becamethe FederalEnergyRegulatoryCommission (FERC)in 1977.The FERCschargewas to managewholesale energymarkets,to ensurethat utilities did opentheir transmissiongrids to QFs,andto protectconsumersby ensuringthat wholesalepriceswould be just and reasonable.When RonaldReagantook office, he appointed Republicansto the majority of seatson the FERC and deregulationof natural gas was accelerated.The commissionalso revisedregulations on transmissionpipelinesrequiringthemto acceptgasfrom any source. This madethe pipelinescommoncarriers.(Davis 2001: 5) The Carterconservationprogramswere phasedout or eliminatedin the Reaganadministration,principally throughthe budgetprocessrather than direct legislation.Tax incentivesfor conservationand solarenergy tax creditswere eliminated.The SynfuelsCorporationwas dismantled and researchon alternativefuels was discontinued.Energy conservation programsin the DOE were phasedout. The DOE's budget was directedtoward nuclearweaponsdevelopmentas part of the administration'smajor defensebuildup. The administrationembracedderegulationas a guiding principle wholeheartedly.The free-marketphilosophy of Milton Friedmanand otherneoconservative economistsguidedthe administration'sapproach to public policy. In this atmosphere,energywas seensolely as a market. There was no reasonfor governmentto have a role in developingnew energytechnologies,it was argued.The competitiveforcesof American ingenuitycoupledwith the principle of supply anddemandwould stimulate the marketto provideenergysuppliesat the appropriatetime and at the appropriateprice. In this conception,there was no longer any need for government-mandated conservationprogramsbecausethe market would bring prices into an equilibrium that would sendthe propersignals to consumersas suppliesrose and fell. If prices spikedbecauseof shortages,then consumerswould cut back--conserve-whichwould free up supply and bring pricesback down. In a demonstrationof classiceconomicprinciples, the world market price of oil droppedsharplyin the early 1980sbecauseof oversupply. A numberof factors led to the decline-conservation by American

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consumers,the U.S. recession,and the collapseof the OPECcartel that had limited productionduring the 1970s.The price of gasolinein the United Statesfell below a dollar per gallon by 1983. Keepinggasoline pricesdown becamean importantelementin national consumerpolicy and by 1993 the price of a gallon of gas was still lower than in 1982, despiteseveraltax hikes in the interim.4 Prices for other energy sources-electricityand heating fuelsstabilizedthroughoutthe decade.Large new depositsof naturalgasimprovedthe supplypicturefor this fuel, easingconcernsaboutavailability of heatingfuels andreducingupwardpricing pressures.Electricity prices also stabilized in most placesbecauseof slower demandgrowth, the result of conservation,new building codes,and improvedbuilding materials andtechnology.Electricity rate hikes in many placeswere linked primarily to environmentalrequirementsor earlier nuclearpower construction decisionsthat had proved costly. By the early 1990s,energy prices when adjustedfor inflation were generallylower than at the end of the 1970s. The amount of oil imported from abroad,however, increasedduring the 1980s(Davis 2001: 3). Public and governmentinterestin conservationalso declined when the pressureof high pricesdisappeared.Largecarscamebackinto fashion, thermostatswere set higher in the winter and lower in the summer, natural gas grills and outdoor lighting returnedto suburbanneighborhoods, and new commercial and residential buildings were designed with grand open spacesand lots of glass.A generalimpressiondevelopedacrossthecountrythatenergyproblemswereover. This was shaken only slightly by the gasolinelines that sprangup at the beginningof the PersianGulf War in 1989. Yet, becauseof improvedbuilding materials and constructionmethods,higher averageperformanceof automobiles, andimprovedapplianceefficiency,energyconsumptiondid not increase proportionately. During the 1980s,two major environmentalproblemsrelatedto energy production and use becameprominent-aciddeposition or rain and global warming,both of which are linked to fossil-fuel combustion. Severalstudiestracedacid depositionin the United Statesand Canada to coal-burningpowerplants in MidwesternUnited States.The discovery of a hole in the ozonelayer over the SouthPole led to international policy efforts to halt the productionof chlorofluorocarbons.There was a growing concernin the scientific communitythat fossil-fuel use was leadingto climatechangebecauseof a buildup of carbondioxide in the

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atmosphere.Extremehot weatherin the summerof 1988led somereputable scientiststo concludethat global warming had begun. Despite the growing concernamong the scientific community, environmentallegislation was stalled during the Reaganadministrationbecauseof the president'santipathy toward environmentalprotection. Democratsin Congressgenerallywithheld any environmentallegislation, including reauthorizationof the CleanAir Act, for fear of a presidential veto that they did not havethe votesto override.Bowing to pressurefrom the electric power industry, Reagancalled for more study of both acid rain/depositionandglobal warming,despitethe existenceof severalstudies by reputablescientiststhathadalreadydocumentedtheprobablecauses. Therewas effectively no federal legislativeactivity in energyor environmentalpolicy for the eight yearsof the Reaganadministration. During his campaignin 1988, GeorgeH.W. Bushpledgedto become the "environmentalpresident."Severalnew piecesof legislation were passedduring his term of office. The CleanAir Act wasfinally amended in 1990, several years beyond the statutory requirement.The amendmentsrequiredelectricity generatorsto take significant measuresto reduce acid emissionsfrom power plants, including the installation of expensivetechnologyto reducepollution from high-sulfurcoal use,the primary fuel of the midwesternpowergenerators.For the first time, the act establishedmarket mechanismsto allow power companiesto trade emissionson the market in order to reducepollution in the most efficient and leastcostly way. It also encouragedthe useof ethanolfuels in automobiles.A new law, the Intermodal SurfaceTransportationEfficiency Act of 1991, mandatedthat statesimprove transportationplanning to reduceautomobileemissionsand included the threat of loss of highway funds if they failed to considermasstransportation. One of the most influential piecesof legislation of this era, the National Energy Policy Act of 1992, focused on the efficient production and consumptionof energy in the United States,restoring the federalstateconsensusof the 1970s.While it was not a comprehensiveenergy policy as Carter'swas, it sowedthe seedsfor the developmentof electricity restructuringand deregulation.Among the requirementsof the act were the following: 1. Statesmust incorporateenergy-efficiencystandardsinto commercialbuilding codesandconsiderupgradingenergy-efficiency codesfor residentialbuildings. 27

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2. The DOE must establisha voluntary home-energyrating system for comparingenergyuse in residentialbuildings. 3. Electric utilities mustdevelopplansto promoteenergyefficiency using three approaches:(a) integratedresourceplanning, that would examineall possibleenergy fuel resourceswithin their states,including solar, hydro, wind, geothermal,biomass,and so forth; (b) investmentsin demand-sidemanagementprojects that were as profitable as investmentsin additional electricity generation;and (c) utility rate structuresthat were designedto encourageinvestmentsfor efficiency in the generation,transmission, and distribution of electricity. The act also(a) authorizedcost-sharinggrantsto industry associations to supportprogramsthat improveenergyefficiency in industry and(b) provided supportfor programsto improve efficiency ratings and standards. Federalagencieswere required by 2000 to install all energy and water conservationmeasuresin their buildings that had a paybackperiodof less than ten years.Clearly, this law emphasizedconservationand efficiency as nationalpolicy, a return to the consensusof the late 1970s. Buried in the legislation, however,was the mechanismto free electricity from the confinesof regulation.Title VII of the act reformedthe Public Utility Holding CompanyAct (PUHCA) and establisheda class of exempt wholesalegenerators(EWGs) that could generateand sell electric power at wholesalewithout being subjectto the regulatory restrictionsmandatedunderPUHCA. The principal proponentof this concept was a good friend of PresidentBush-KennethLay, CEO of the Enron Corporationof Houston,Texas.The FederalEnergy Regulatory Commissionwasdesignatedas the coordinatorfor EWGs,to assistthem in gaining accessto utility transmissionlines in the sameway that it did for QFs after 1978.The FERC was also grantedthe powerto determine reasonablepricesfor transmissionservices(Kreith andBurmeister1993: 356). Title VII is the mechanismthat eventually made state deregulation of electricity possiblealthoughit is not evidentfrom the recordthat this was the original intent of the legislation. The 1992NationalEnergyAct alsoprovidedfunding for stateenergy offices to pursueefficiency and conservationprograms.By 2001, every statein the nation had a central energyoffice that was partially funded by the DOE. The act made a nod toward global climate changeby requiring the DOE to conductfeasibility studieson the economic,energy, 28

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and environmentalimplications of stabilizing or reducing greenhouse gas emissions.Any future national energy strategies,moreover, were requiredto includea least-costenergyplan preparedby DOE to address economic,energy,social, and environmentalcostsand benefits. The act wasbasedon the Bushadministration'sNationalEnergyStrategy, releasedin February 1991. The secretaryof energy at the time, Admiral JamesD. Watkins, characterizedit as "a strategythat, for the first time in our nation'shistory, lays a comprehensivefoundationfor a cleaner,more efficient and more secureenergy future ... a balanced approachto attaining that energyfuture through sharedresponsibility" (Kreith and Burmeister1993: 8). This strategyincluded a proposalto open600,000hectaresin the Arctic NationalWildlife Refugefor oil and gasexplorationanddrilling. The proposalwas met with intenseopposition from environmentalistsand Congressand was droppedfrom the final bill. It did not surfaceon the political agendaagain until 2001, when GeorgeW. Bush took office. The 1992NationalEnergyAct was framedaroundefficiency, conservation, and renewableenergysourceswith a clear understandingof the impactsof energyproductionon both air quality and global warming. PresidentG.H.W. Bush,althoughavowingconservativeRepublicanprinciples and free-marketideology, nonethelesssupporteda balancedapproachto nationalenergypolicy that acknowledgedthecomplexof policy issuesintertwined with energypolicy. His approachevokedtraditional Republicanidealsof conservationstemmingfrom Teddy Rooseveltand Gifford Pinchot.Sucha balancecannotbe found in the energyproposal of his son G.W. Bush ten yearslater. The 1992 National EnergyAct served,for all purposes,as the energy planof Bill Clinton'sadministration.WhenClinton waselected,thecountry was in a recessionand his immediatefocus was on turning the economy around.The administration'smost controversialeffort linked to energy was a gasolinetax proposedas part of deficit reductionlegislation. The administration'sinitial proposalwas a tax of 10 cents per gallon to be devotedto deficit reduction.s The tax was widely condemned,particularly by the trucking industry. Fearingvoter backlashfrom a higher tax, Congresseventuallyapproveda tax increaseof 4.5 centsa gallon. Truckers threateneda slowdownand predictedeconomicdisasteras a result of higher prices linked to the tax. Two months later, the price of gasoline plungedto levels not seensincethe late 1970sbecauseof a glut of oil on the world market.Truckersfell silent and the tax protestfizzled out. 29

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The Clinton administrationdevotedlittle attentionto energy policy exceptto supportthe budgetof the DOE, which funded grantsto state energy offices and conservationprograms.Energy policy fell off the national agendaas oil prices stabilizedat relatively low levels and the economybegana sustainedrecoveryafter a recessionin the early 1990s. By 2000, the budgetdeficit had disappearedand economistsbeganto forecastbudgetsurplusesfor the next decade.Energy policy shifted to the stateswhereelectricity restructuringand deregulationwas initiated in severalstates. By the time GeorgeW. Bushtook office in 2001,however,the national energy supply picture had changedsignificantly. The OPEC cartel had reorganizedand was manipulatingoil supply, raising the price of a barrel of oil on the world marketto $35, the highestprice since 1982. Gasoline pricesin California roseto over $2 per gallon in the summerof 2000and over $1.50in the midwestandeasternstates.6 Natural gaspricesalsorose in the 2001 winter heatingseasonbecauseof supply shortages.Of greatestconcernwas the price of electricity in California, which had escalated to pricesunheardof when utilities were regulated. PresidentBushappointedhis vice president,Dick Cheney,former CEO of Halliburton, Inc., an oil servicescompany,to chair a task force to develop an energypolicy to get the country out of what was declaredto be an energycrisis. Bushhad alsobeenpresidentof an oil companyandhad many political supportersin the energyindustry throughoutthe country. One of his biggestsupporters,the Enron Corporationof Texas,was alsoa leadingsupplierof wholesaleelectricity. The Cheneytaskforce included many representativesof the businesscommunity and met in secret.Although the vice presidentclaimed that the task force had consultedwith environmentalrepresentatives,he later refusedto releaseto Congressa list of namesof all thoseconsultedduring the planningprocess? The energy strategythat emergedfrom the task force abandonedenergy efficiency as a policy and insteadproposeda massiveprogramto increasethe supply of all energysources.Back on the table was drilling on the coastalplain of theArctic NationalWildlife Refuge(ANWR), which wasprojectedto yield 600,000barrelsof oil per day by 2010.To increase electricity supply to meetgrowing demand,the task force estimatedthat the country would haveto build 1,300new generatingplantsover twenty years, some of them poweredby nuclear energy. While the report did include a nod toward energyefficiency, Cheneyin a nationally-televised speechdescribedconservationas a "sign of personalvirtue" but "not a 30

A

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U.S.

ENERGY POLICY

sufficient basisfor a sound,comprehensiveenergy policy" (New York Times 2001: 14). The administrationpromotedits strategyas the first nationalenergypolicy in twenty years. While the task force was meetingto designthe proposal,the price of electricity in Californiaroseto astronomicallevels.The statewasforced to stepinto the marketto buy electricity for the utilities, PG&E declared bankruptcy,and SouthernCalifornia Edison was on the brink of financial collapse aswell. Ratepayersfaced price increasesof 40 percent while the FERC refusedto order price capson wholesaleelectricity in the west.The EWGs,including Enron,Duke Energy,andReliant,posted quarterly profits above 100 percent. The Bush administrationstrategywas basedon a presumedenergy crisis linked to prices for natural gas, gasolineand electricity. By late spring, however, prices in all areasbeganto moderateand the crisis designationhad lessimpetusfor policymakers.After the September11, 2001 terrorist attacks,the administrationbeganto pursueenergypolicy more vigorously for national security reasons.Pressurewas placedon the Senateto approveboththe energystrategyanddrilling in theANWR. At this writing, no final action has beentaken. Energypolicy at the nationallevel had shiftedemphasisfrom conservation (demand)to free marketproduction(supply) during the Reagan Administration. GeorgeH.W. Bush retreatedsomewhatfrom this emphasisas he tried to developconsensusbetweenthe White Houseand Congress.His supportof drilling in the ANWR was doubtlessthe result of his experienceand pressurefrom his friends in the oil industry, but the Democrat-controlledCongressrefusedto go along with the plan. His son, who cameinto office with Republicanmajoritiesin both houses of Congress,madeit one of his first proposals.By 2001, policy makers had grown comfortablewith free-marketeconomictheory and deregulation. The statestoo were moving toward deregulationlured by the promiseof cheapelectricity. The California energycrisis, as we shall see,causedthe statesto reexaminetheir policy priorities. The recognition that stateshave other policy interestsin electricity that go beyondthe interestsof the market causedmany statesto slow down in the rush to deregulateelectricity. Before we look at electricity restructuringand the California case, itis useful to examinestatepolicy interestsandtheir historical development of energypolicy since 1974.

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3 The Statesand Energy Policy,

1975-1995

Stateelectricity deregulationpolicy was designedto meetone goal: to reducethe price of electricity. Energypolicy, however,is a complexof policy interests,the impactsof which vary by state. This chapterlooks at stateenergypolicy over the period of 1975 to 1995, the year when statesbeganto deregulateelectricity. Key questions addressedhere: What other policy interestsare linked to states' energypolicy? How havethey changedover time? I provide a description of the evolution of state energy policy during the 1970s and the refocuson deregulationat the federallevel during the 1980sastheReagan administrationeliminatedfederalsupportfor stateenergyplanning.The resultsof a study I conductedin the early 1990sreveal that statescontinued to developenergy policy in the 1980sto protect their complex energypolicy interestsagainstthe uncertaintiesof the free market. State Energy Policy Pre-1975

Prior to 1975,energypolicy in the stateswas concernedprimarily with regulation of electricity and natural gas utilities. The federal government had some regulatory powers over the interstatetransmissionof naturalgasandelectricity generationand salesbecauseof its ownership of severalpowerplants.The Tennessee Valley Authority was createdby the federalgovernmentin the 1930sto provideelectricity to rural towns in the south,and the Bonneville PowerAdministrationwas developed to market electricity generatedfrom federal dams on the Columbia River. Although powergeneratedby the federalgovernmentbecamea major sourceof electricity-25 percentby 1950-theprivate utilities

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3

continuedto expandas new usesfor electricity generatedgrowing demand after World War II. Stateenergypolicy at that time had two primary objectives.First, the public utility monopolieswere regulatedto ensurefair prices for customersanda reasonablereturnfor the utilities. This systemworkedwell, providing reliable suppliesof electricity and natural gas at affordable costs, as well as steady dividends to utility companies'shareholders. Indeed,utility stockswereamongthe mostreliable investmentsin those daysand were a significantsourceof incomefor retireesthroughoutthe country. Regulationalso protectedthe utilities from having to pay the full costsof badinvestmentdecisions,insofaras statepublic utility commissions would generally allow them to pass these costs along to ratepayers.This practicebecameone of the contentiousissuesof electricity deregulationin the 1990s. A secondgoal of state energy policy was to promote the use of indigenousfuels to generateelectricity. In somestates-Kansas, Texas, and Oklahoma,for example-powerplantsburnednaturalgasand oil. In Ohio, Indiana, and Pennsylvania,on the other hand, coal was the primary fuel usedfor electricity generation.Theseenergy-fuelindustries also had significant political clout in their statesto promoteproduction and resist attemptsto reduce the environmentalimpacts of fuel productionand use that would imposehigher costson electricity production. Stateregulatorypower changedin the 1970swhen the federal governmentassumedprimacy over a number of policy areas.Beginning with the CleanAir Act Amendmentsof 1970,environmentalprotection and regulatory laws generally were structuredto require state implementationof federal standardsin policy areasthat had previously been thejurisdiction of the states.During the early 1970s,a patternof federal leadershipin regulatory policy developedand states becamethe implementersof federal policy ratherthan developersof their own. The 1970ssaw a period of significant federal regulatory policy development in environmentalmanagement,consumerprotection, and worker safety.The primary argumentin favor of federal policy development was to establishuniform minimum standardsfor all states.This would ensurethat all Americanshad a uniform level of protectionfrom hazardsto their healthand welfare.Moreover,federal standardscreated a level playing field for companiesand industriesthat operatedin different states.It, thus, overcamethe problemof economicdisadvantage 34

THE STATES AND ENERGY POLICY,

1975-1995

for firms operatingin different stateswith different regulatory schemes. It also reducedcosts of production for companiesoperating in more than one state.For example,the automobilemanufacturerssupported the Clean Air Act's uniform standardsrequirementbecauseit would sparethemthe costsof manufacturingdifferent carsfor different states.1 Second,many oftheselaws-theCleanAir Act, the CleanWaterAct, the OccupationalSafety and HealthAct, the ConsumerProductSafety Act, the ResourceConservationand RecoveryAct, et alia-established standardsthat weredesignedto protecthumanhealthand,as such,could not be permittedto vary amongthe states.Statestandardswere subject to political manipulationby companiesthat had economicpowerin the states.Companiesnot only lobbied againsttough standardsbut also threatenedto leave the state, taking jobs and tax revenuewith them. This form of "economicblackmail" limited the ability of the statesto establishstandardsto betterprotectthe healthof their residents.Federal primacy curtailed this problem to a great extent. By the middle of the decade,the stateshadbecomeaccustomedto federalleadershipandeven comfortablewith it becauseit lifted someof the political burden that statelegislatorsand governorshad in imposingregulationson their instateindustries. After the first energy"crisis" in 1973,the federal governmentbegan to take a primary role in developingcomprehensive energypolicy. During the Nixon and Ford administrations,the national emphasiswas on independence from foreign oil producers.While therewas policy activity to increasedomesticsuppliesof oil and naturalgas at that time, includingconstructionof theAlaskanpipelinefrom PrudhoeBay to Valdez, national policy also placeda major emphasison energyconservation. Decreasingdemandwas seenas a viable meansto increasesupply in both the shortand long terms.A simplemaxim of the time was "a barrel of energysavedis cheaperthan a new barrel." Moreover,in statesthat lackedan indigenousenergyresource,conservationwastheir only means of managingsupply and demand. In the mid-1970s,Congressenactedtwo significantenergylaws that provided guidanceand funds to the statesto developtheir own energy policies: the Energy Policy and ConservationAct of 1975 and the Energy ConservationandProductionAct of 1976.The first providedfunding for states to establishstate energy offices to promote energy conservationthroughpublic informationcampaigns.Stateswererequired to developplansto reduceenergyconsumptionthroughoutthe stateby 35

CHAPTER

3

5 percentbelow the expectedlevel of use without conservation.The secondgavegrantsto statesto implementenergyconservationin public buildings, low-income housing,schools,and hospitals. State Energy Policy Developmentin the 1970s

Federalenergypolicy shifted emphasisduring this period from ensuring cheapand abundantsupply to improving efficiency and protecting economicstability and national security.2 In this new policy arena,the statesandthe federalgovernmentdevelopeda partnershipthat depended on the statesfor implementationof many conservationand efficiency programs.Many of the stateshadmuchto gain from nationalpolicy that protectedthem from price shocks and uncertain supply. Other states profited from energy price hikes, so national policy, in effect, moderatedthe shift of stateenergydollars from one stateto another. Henry Lee divides the statesand their responseto oil price shocks into four categories: 1. Thosesixteenstateshighly dependenton oil: the New England

states,the Mid-Atlantic states,Pennsylvania,Virginia, North Carolina,Florida, California and Hawaii. 2. Statesthat relied heavily on naturalgasand electricity and thus placeda greateremphasison regulatory programsfocusedtoward thesetwo sourcesof energy. 3. Energy producing states,which already possesseda sophisticated governmentinfrastructureto regulateand promote production. 4. Large agricultural or rural statesin which allocation of supply remainedan important issue, but energy programsaimed at policy issueswere of less importance(Lee 1983:162). The impactof energypolicy on the statesvariesaccordingto several factors. Statesthat have no indigenousfossil fuel resourcesare energy importersand are vulnerableto supply shortagesand price shocks.This is exacerbatedwhere there are climate extremesthat increasethe need for reliable energy suppliesand price stability. Statesin this category include Wisconsin and Minnesota,for example. statesare concernedaboutdiversion of dollars away from the stateeconomyto purchaseenergy. They have the greatestincentive to promote energy

The~e

36

THE STATES AND ENERGY POLICY,

1975-1995

conservationand the developmentof renewableenergy sourcesto improve their energy"trade deficit." Statesthat haveabundantenergyandnaturalresources,suchasTexas, Alaska, and Indiana,on the otherhand,may benefiteconomicallyfrom shortagesand price increases.Energy producersin such stateswould tend to havepolitical power and to opposestateefforts to developconservation-based energypolicies. Two other factors that influence stateenergyplanning are the environmentandthe economy.The environmentis both a positiveandnegative influence.In stateswhereenvironmentalvaluesare a high priority, low-pollution energy production andconservationwill be favored. In stateswhere pollution is high, energypolicy is stimulatedby environmentalregulations.Energyconservationprovidesa positivelinkage for thesepolicy areasbecausereducingthe consumptionof energyalso reducespollution from its production. Energy policy is directly relatedto the stateeconomyin two ways. First, energycostsrepresenta major, controllableoperatingcost for industry andcommercialbusinesses. Pricehikes and shortagesaredisruptive. Second,economicdevelopmentin the stateis dependenton having an availablesupply of affordableenergy.Maintaining an adequatesupply of energyfor all currentand potentialusersis essentialfor statesto supporttheir economicbase.Statesthat have no indigenousenergyresourceshave an incentive, therefore,to identify conservationopportunities andrenewableenergysources.Alternativeenergycanalsoprovide a new marketfor the state-ethanolfuels, for example,createan attractive marketfor agricultural states. Energypriceshavea significantimpacton governmentoperatingcosts. Statesand local governments,including schools,colleges, and other public entities, collectively have a lot of buildings, many of which are aging and poorly maintained.In addition, governmentshave a lot of vehicles-policecars,fire trucks, streetsweepers,garbagetrucks-most of which are high energy consumers.Energy costsin governmentoperations,on average,are the secondlargestoperatingexpenseafter personnel (Bailey 1984). Reducing governmentenergy costs through conservationandefficiency canreducespendingpressureon public budgets. Indeed,an industry rule of thumb predicts savingsof at least 10 percentfrom simple conservationmeasuressuch as weather-stripping and caulking doors and windows. It is importantto recognizethe interactionsof policy interestsin the

37

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3

energyarena.Environmentalprotectionremaineda strongpolicy interest throughoutthe 1970sat all levels of government,so energypolicy had to be designedto avoid significant impactson environmentalvalues.Air pollution controlsrequiredby the CleanAir Act of 1970and its 1977amendmentsraisedthe costsfor electricity generationat the same time that energyfuel costs-oil, natural gas, and gasoline-werealso rising. Consumersdemandedlower prices for electricity and all other sourcesof energy,but thesewould hamperconservationincentivesthat work best with higher prices.The nuclearpower industry was experiencing growing difficulty in siting new generatorsand rising costsdue to greaterregulation.The 1979 nuclearaccidentat the Three Mile Island power plant in Harrisburg,Pennsylvania,presagedthe beginning of the end for nuclearpower in the United States,at least for the next twenty years. Given thesecomplexities,it is not surprisingthat conservationand efficiency, or demandmanagement,becamethe policy of choice for many stategovernments.Conservationis the cleanestand cheapestway to increaseenergy supply. It reducesoperating costs for individuals, commercialbusinesses, largeindustrial users,andgovernmentat all levels. It also reducesdemandfor new generatingplants and the pollution they emit. Finally, it protectsstateinterestsagainstprice manipulation from outsidethe stateborders.The last is a seriousproblem for states that are energyimporters,such as Wisconsinand Minnesota. Environmentalandconsumeractivistsin the 1970salsobeganto lobby for policies to promotethe developmentof energyfrom renewableresources.Prior to 1973,policies to protectthe five fuels displacedfunding for researchand developmentof electricity generationfrom renewables,principally solar power, including wind, geothermal,and biomassresources.Energy production was linked to fossil fuels, and there was no real concern for future supplies of these depletableresources.Governmentsupportof the nuclearpower industry, beginning with the Atomic EnergyAct of 1956,was supposedto lead to electricity generationthat would be so cheapthat meterswould no longerbe needed. There had been no similar supportfor the solar energy industry where technologicalandmarketdevelopmentswerein their infancy in the 1970s. Electric utilities had investedheavily in nucleargeneratingcapacity by 1980, and, becauseof the decisionpolicies of stateregulatoryagencies, they were able to pass along all the costs of this investmentto ratepayers.This later becamea considerableproblem for deregulation 38

THE STATES AND ENERGY POLICY,

1975-1995

efforts as theseinvestmentsbecame"strandedcosts"that had not been paid off. The full costsof nuclearpower generation,including the cost of decommissioningthe plants and disposingof nuclear waste, have neverbeenincorporatedinto the pricing of electricity. Had companies been required to accountfor thesecosts, they might well have made more conservativeinvestmentdecisions. The energy crisis of the 1970s affected statesdifferently. In states that did not haveindigenoussourcesof energysupplies,energypolicy developmentmeantprotectionagainstthe unfairnessof the market. In these states,energy prices escalatedand suppliesdroppedduring the 1970s.Where heating costs becameprohibitive, the elderly and poor were often forced to choosebetweenfood and utility bills. There were many casesof elderly people freezing to death in the northern states. Economicdevelopmentwas also threatenedin energy-poorstatesthat could not guaranteenew businessesa reliable supply of energy at affordable prices. Oil- and gas-producingstates,on the other hand, enjoyed windfall revenueincreaseslinked to energy production, especially after price controls on "new" oil and gas were lifted. These stateswere able to reducetaxesand investin new public policy areas,including economic development.The move of companiesfrom the Rust Belt to the Sun Belt during this period significantly changedthe economiesof statesin both areas. The sixteenstatesthat were highly dependenton oil for heatingand electricity generationwere underpolitical pressureto establishaggressive energyprogramsfor different reasons(Lee 1983: 162). The northern statesfocusedon increasingsupply and reducingcostsin order to protectresidentsand attemptto keep local industries.Statesin the Sun Belt, on the other hand, were experiencingrapid growth and needed energy policies to ensurereliable suppliesfor thesenew usersand to foster more economicdevelopment. Federal funding for energy programshelped the statesto develop varying levels of expertisein energypolicy and managementduring the 1970s.Theseprogramssupportedthe promotion of energy conservation, energy efficiency, and demand-sidemanagement.By the end of the decadethe essentialcomponentsof a stablenational energypolicy systemwere in placeand therewas a broadconsensusacrossthe country in supportof energyefficiency andconservation.The resultsof these initiatives werevariableacrossthe states.Nonetheless,by the endof the 39

CHAPTER

3

1970s,it was clearthat "conservationhad providedmorenew energyto the nation than any other source"(Kash and Rycroft 1984: 238). The confluenceof three policy interests-pricestability and availability, economicdevelopment,and environmentalprotection---drove the developmentof stateenergypolicies in the 1970s.With assistance from the federal government,in the form of both regulationsand funding, states'energy policies at the end of the 1970sreflected the thennationalconsensusthat efficiency andconservationshouldbe the primary focus of U.S. energypolicy. Radical Policy Shift in the ReaganAdministration Everythingchangedafter the 1980election.Ronald Reagan'sadministration dismantledmuch of the energypolicy infrastructureestablished during the Carteradministrationandturnedenergyover to the free market, shifting the policy emphasisfrom reducing demandto increasing supply. Funding for the state energy offices was phasedout, as were individual tax incentivesfor conservationand solarenergytechnology. The Departmentof Energy (DOE) budgetwas shifted from supporting energyconservationand the developmentof syntheticfuels from coal and oil shaletoward supportof nuclearweaponsdevelopment.During the 1980campaign,Reaganhadpledgedto dismantlethe DOE. Lacking the political supportto do so, the administrationusedthe budgetprocess insteadto changethe agency'spriorities. Loss of federal funding, however,did not lead to wholesaleclosings of state energy offices or programs.Many statesreceived new funds through "oil overcharge"allotments.Court decisionshad held that the major oil companieshad overchargedcustomersacrossthe country during the 1970s.Multimillion-dollar fines were levied againstthe companies, to be paid out to the statesover a multiyearperiod. In the absence of any feasible mechanismfor returning the overchargesto individual customers,the funds were apportionedto the statesaccordingto population and gasolineconsumptionfor the period. Most statesreceived severalmillion dollars eachyear from 1986to 1993. Becausethe monies belongedto all taxpayers,oil overchargefunds were to be usedfor projectsthat had broadenergybenefits.Many statesusedthesefunds to continueoperatingenergyoffices and to fund various energy managementprograms.A lot of oil overchargemoneywas usedfor weatherization projectsfor low-incomepropertyownersand energyassistancefor

40

THE STATES AND ENERGY POLICY,

1975-1995

the poor. In the 1980s,without energypolicy leadershipin Washington, statescontinuedto fund their energyoffices. A new policy issue linked to energy production and use-global warming-appearedon the horizon in the 1980s.The responseof the Reaganadministrationwas to ignore the growing indicationsof global warming in the absenceof what they consideredto be strong scientific evidence.The signsincreasedthroughoutthe decade-thediscoveryof an expandinghole in the ozonelayer overAntarcticaand a few recordbreakinghot summers.Many reputablescientistsbeganto expressconcern about theeffect of human activities in altering the climate of the planet. Global warming, when it happens,will have different impacts on eachstate;the strongesteffects,from a policy perspective,will be on energydemandand, ultimately, on economicdevelopment.Statesthat presentlyhave high heat loads will seethe numberof air-conditioning use days increase.Agricultural statesmay experiencedeclining crop yields as high heat wilts crops nolonger suited to the areaclimate. Increaseddemandfor irrigation becauseof droughtinducedby heatwaves will strain waterresourcesas well as increasedemandfor electricity for pumping water. State Energy Policy DevelopmentDuring the 1980s Stateenergypolicy during the 1970shad beenmandatedby and largely funded by the federal government.JamesL. Regenshas argued,however, that statesalonecould havedevelopedenergypolicy. In 1979, he studiedstatepolicy responsesto energyproblems.He found that a number of energypolicy measureshad beenimplementedat the statelevel without federalmandates(Regens1979).His analysissuggested,moreover, that public perceptionsof the importanceof energyas a problem were not significant in the developmentof stateenergypolicy. He concludedthat "the extentto which stateschooseto developenergypolicy options appearsto be primarily relatedto their structuralcomposition, particularlytheir existingenergysupply-demandsystem"(Regens1979: 54). Regenspostulatedthat the statescould take a vigorous role in the energypolicy processindependentof the federal government. In the early 1990s,I studiedwhetherstateshad continuedto develop energypolicy during the period 1980-93,in the absenceof federal leadershipin this policy area.The aim of the projectwas to assessthe extent to which the consensuson energypolicy that developedduring the 1970s 41

CHAPTER

3

had beenmaintainedin the states.3 SeventeenMidwesternand western states wereincluded in the study: Colorado,Idaho, Iowa, Illinois, Indiana, Kansas,Michigan, Minnesota,Missouri, Montana, Nebraska, North Dakota, Ohio, SouthDakota, Utah, Wisconsin,and Wyoming. The researchdesign used both quantitativedata collection and case studies. Generaldata were collected through a mail survey to state energyagencies.Casestudiesof selectedstatesweredevelopedthrough examinationof publishedenergy policy documentsand personalinterviewswith individuals representingthe executivebranch,the legislature, and citizensgroupsin eachstate. The survey instrumentwas designedto producegeneralinformation about(a) the existenceand natureof energypolicies in the states, (b) energy managementinitiatives taken by the state government, (c) regulatoryand otherbarriersto improving energyefficiency, (d) potential impactsof energypolicy on stateindustries,(e) transportation and environmentalprotectionpolicies, and (f) awarenessof potential global warming impactson the state. A comprehensivequestionnairewas sent to the directors of state energy offices in each state.After repeatmailings, completedquestionnaires were returnedby twelve states:Colorado, Indiana, Iowa, Michigan, Minnesota,Missouri, Montana, North and South Dakota, Utah, Wisconsin,and Wyoming. While this sampleis obviously limited, it is representativeof the nation in that it includesstatesthat have severeweatherconditionsin both winter and summer(Missouri, Kansas,North Dakota),4statesthat are energyproducers(Colorado,Indiana, Kansas,Wyoming), and states that are energy importers (Minnesota,Wisconsin,Missouri). The findings from this study were comparedwith a study on energymanagementand conservationpreparedby Frank Kreith and GeorgeBurmeisterfor the National Conferenceof StateLegislatorspublishedin 1993. Face-to-faceinterviews were conductedin seven states: Michigan, Indiana, Illinois, Minnesota,Missouri, Kansas,and Colorado. Telephoneinterviews were conductedin two additional states,Iowa andWisconsin.The purposeof the interviewswas to developa set of state profiles to identify the political dynamicsthat influenced the developmentof energypolicy. Face-to-faceinterviewswerearranged with (a) the energyoffice, (b) a legislative staff memberor legislator, and (c) an environmentalorganizationin the seven Theseprovided a triangulationof independentperspectivesto addressproblems

~tates.

42

THE STATES AND ENERGY POLICY,

1975-1995

of bias and validity within the researchdesignthat could result from individual interviews. Eachintervieweewas askedthe samesetof questionsbut the conversationswere open-endedand heuristic.The questionsfocusedon several factors: their personalexperiencewith energypolicy development and managementin the jurisdiction, their personalfeelings about the importanceof energy policy for economicdevelopmentand environmental protection,their perceptionsabout generalpublic and political support for energy policy development,and their impressionsabout public awarenessof global warming issuesin the state. In our sample,nine statesreportedthat they either had a formal energy policy or were developingone: Indiana,Iowa, Kansas,Minnesota, Missouri, Montana,SouthDakota,Utah, andWyoming.5 Wisconsinhad developeda formal plan in 1986at the requestof GovernorTony Earle (Stateof Wisconsin 1986). Wisconsinis an energy-importingstateand the plan emphasizedconservationand the expandinguseof indigenous energyfuels suchas wood pulp and biomassfor heatingand electricity production.It also maderecommendations for the useof anticipatedoil overchargefunds to fund programsin local governmentoperationsand energy programsfor low-income people. Earle, a Democrat,was defeatedfor reelectionin 1986by Tommy Thompson,a conservativeRepublican. The energy policy was discontinued,although many of its recommendationsfor oil overchargefunds were implemented. Among those statesthat had energy plans. there was considerable consensusaboutthe components.The primary componentsof stateenergy plansfrom 1991 to 1993: • • • • • • • • •

Subsidizeheatingcosts/weatherization for the poor. Increaseconservationby stateand local government. Requireutility companiesto promoteconservation. Develop energymanagementprogramsfor state/localfacilities. Develop awarenesspublic relationscampaigns. Reviseconstructioncodes. Developenergystandardsfor commercialbuildings. Promoteuseof alternativefuels. Develop state-sponsored demonstrationprojects.

Severalsecondarycomponentswere identified by many states,indicating some agreementon the linkages betweenenergy and other policy areas,namely,the environmentandthe economy.Theseincluded

43

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3

developing a comprehensiveenergy resourcedevelopmentplan; tax incentivesfor conservationby individuals and business;research grants to universities or business;tree planting programs;and increasedmasstransit. What stimulated the developmentof theseenergy policies in the 1980s?The most critical energy problem identified in the survey was "lack of indigenousfuel supply," followed closely by "increasingcosts dueto federalregulations."Otherproblemscited includedenvironmental concernsand radioactivewaste.A few statesindicatedthat excess power generationin the stateservedas a barrierto the developmentof energypolicies becauseit providedno incentivesfor conservation. Stateswereaskedto identify the priorities of their energyplans.These are shownbelow in order of importance(i.e., 1 =most important). 1. 2. 3. 4. 5. 6. 7. 8. 9.

Increaseconservation. Savemoney. Improve environmentalquality. Developeconomy. Use/marketfuels indigenousto state. Comply with mandates. Reducegreenhousegases. Mitigate price shocks. Increasesupply

Thereare two points of interestin this list. First, increasingthe supply of energyplaceddeadlast as a priority of stateenergypolicy. The statesclearly saw conservation(reducingdemand)and saving money on energy costs, linked with environmentalquality and economicdevelopment,as their primary interests.Second,it was remarkableto find that reducinggreenhousegasesplacedin the ranking at all. There was considerableuncertaintyat the time aboutglobal warming. The federal government,underboth Reaganand Bush I, refusedto developglobal warming policy until they recognizeda greaterconsensuswithin the scientific and industrial communities.Thus, it was noteworthyto find that global warming was of at leastmarginalconcernto thosestatesthat developedenergypolicies in the 1980s.Stateenergyofficers identified severalpotential impactsfor their statesfrom global warming, including both positive and negativeimpactson agricultural productivity, increaseddemandfor electricity for cooling, and increasedenergysalesto

44

THE STATES AND ENERGY POLICY,

1975-1995

otherstates.Their greatestconcernfocusedon the state'senvironmental quality. One energy officer put it succinctly, "If the environmentcollapses,it's hard to run an economy." The interviews revealedthat in many statesnew federal legislation had stimulatedinterest in energy policy development.Three bills, in particular, led statesto think about policies that would moderatethe impactsof theseregulations:The 1990CleanAir Act Amendments,which included transportationfunding sanctionsfor noncompliancewith all air pollution standards;the IntermodalSurfaceTransportationEfficiency Act of 1991, which enhancedfederalfunding for transit and authorized $6 billion for transportationprojectsto help improve air quality in the states(Weingroff 2003); and the 1992 National Energy Policy Act (NEPACT). Thus, demandside-management, required by theselaws, forced examinationof conservationeven in thosestatesthat enjoy energy surplusand wherethe electric utilities are powerful political players. To that extent, then, statescould be seen as acting to defend themselvesagainstfederal regulation. This studyrevealedtwo factorsthataresignificantto the currentstudy. First, the datashowedthat energywas no longera single policy issuein the states.Whereasin the 1970s,energy policy was developedfor its own sake,in 1990, it was seento be linked with other policyinterests, principally the environmentand the economy.In the 1970s,statesdevelopedpolicies to meetthe mandatesof the federal government,even when such policies did not fit with state priorities. In the absenceof federal mandatesfor energypolicy in the 1980s,however,statesdevelopedenergyplansthat worked with regionalneedsandconditionswhile respondingto federal regulationsin other areas. The studyalsorevealedthat the states'interestsin this complexpolicy areawereoften in directconflict with the promisesof free-markettheory to deliver cheapenergy through competition. While the statesranked savingmoneyas a priority, nonereportedthat cheapenergypriceswere the way to do that. To the contrary, many energy managersexpressed concernabout falling prices as a disincentivefor conservation.Cheap energy encouragesoverconsumptionand stimulatesdemandfor more energy supply. The statesrevealedclearly that their primary interests includedenvironmentalquality, economicdevelopment,and protection againstprice shocks. Increasingthe supply of energy was the lowest priority becausein most casesincreasingsupply can also lead to environmentaldegradation. 45

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Although this study was completedin the early 1990s,electricity deregulationwas not being discussedat the time this researchwas completed.Energymanagersdid favor privateresearch,development, and marketingto improve energyconservation.The NEPACT had not been fully enactedwhen the data were being collected. None of the peopleI interviewedmentionedelectricity deregulationas a possibility, including the chief lobbyist for the electricity industry in Indiana.6 It is not apparentto me today that thesestate policymakershad any intentionsof restructuringelectricity in 1991. This implies to me that deregulationbecamea policy issueonly after the establishmentof electricity wholesalegenerators (EWGs)in the NEPACT. The development of EWGs madeit possibleto buy and sell electricity acrossstate lines, somethingthat would have been difficult before 1992. These new entities also becamepowerful lobbyists for the creation of new marketsthrough restructuring. What is very clearfrom this studyis that statesviewedenergypolicy as being coupled with economic welfare and environmentalprotection. Theseinterestsremainedconsistentover time from the beginnings of state energy policy developmentin the 1970s. In the early 1990s, manystatesrecognizedthe negativeeffects of market uncertaintieson their residentsandbusinesses and weredevelopingpolicies to overcometheseeffects. Within a few years,however,electricity restructuringsurgedacross the country,focusing stateenergypolicy on onegoal, reducingthe price of electricity through competition and consumerchoice. The consequencesof this narrow focus were felt first in California, which ultimatelyreactedby steppingin to protectits otherpolicy interests.Chapter 7 examineswhether stateenergy policy interestshave changedsince 1992. The next three chapterslook at electricity restructuringand the experiencesof California and other stateswith deregulation.

46

4 Restructuring Electricity

An examinationof the origins of the electricity industry revealsa strong relationship betweenthe industry and governmentagenciesaimed at encouragingthe developmentof this new energyresourcein a way that was productivefor both the companiesand the nation. Electricity becamea viable commodityduring the late nineteenthcenturyduring the sametime that governmentregulationwas born. Today we tend to forget that businesspeople supportedgovernmentinterventionin the market in thosedays,especiallywhereit protectedthe interestsof companies through limiting entry into the market and overcomingpredatorymarket practices. Whencreatinga new industry,producerscanincur high start-upcosts and high risks of failure. Electricity generationrequireslarge investmentsfor the constructionand operationof generatingplants.A second major investmentis incurredin constructingand maintainingthe distribution system:poles,wires, andconnectorsto the final user.In the early years,companiessawclearly the advantagesof a regulatedmarketplace to protecttheir investmentsfrom unbridledcompetition. History of Electricity Regulation

The first power plant in the United States,the Pearl StreetStation in Manhattan,owned by ThomasEdison, was openedin 1882. The industry was unregulateduntil 1907 when New York andWisconsinestablishedthe institutions and rules by which utilities would conduct businessin thosestates(Brennanet al. 1996: 21). In a typical political strategyof many industriesof the time, "the privately owned electric utilities actively sought governmentprotection from what Samuel Insull, oneofthe industry'sfounders,called 'debilitatingcompetition'

47

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and to counteractgrowing municipal ownership"(Brennanet al. 1996: 21). Insull was Edison'sprotege andowner of Chicago Edison, now CommonwealthEdison. He believedthat electricity was a natural monopoly becausethe costsof competitionin generationanddelivery would be too high (Smeloff and Asmus 1997: lO). In 1920, Congresscreatedthe FederalPowerCommissionas part of the FederalWater PowerAct to regulatethe pricesof interstatesalesof electric power and the field pricesof natural gas,the priceschargedby interstatenatural gas pipeline companies(Joskow 1975: 17). The electricity industry grew rapidly; small private companieswere eventually taken over by holding companies,reducingthe numberof firms providing electricity nationwide. In 1935, Congressenactedthe Public Utility Holding CompanyAct (PUHCA), after investigationsby the Securities andExchangeCommission(SEC) found evidenceof stockmanipulation. Prior to the PUHCA, holding companiesspannedseveralstatesand createdcomplex corporatestructuresfor generation,transmission,and distribution of electricity. The PUHCA was implementedby the SEC, which, over a ten-yearperiod, createdsimple corporatevertical structures in which one companygenerateselectricity, transmitsit to local regions,and distributesit to the final customers(seeBrennanet al. 1996: 23). Eachcompanywould operatewithin stateborderswith stateregulation of their businessoperations.Transmissionlines were interconnected acrossstatelines, but therewas little interstatetransmissionof electricity. Until the 1960s, utility companieswere able to increasecapacity fast enoughto keep up with growing demandwithin their own states. In 1965, a major power failure blackedout the northeasternUnited Statesfrom New Jerseyto Canada.This led to the developmentof the North American Electric Reliability Council (NERC), establishedby the utility industry to bettercoordinateelectricity transmissionin cases of powerfailures.The NERC establishedten regionalcouncilsthat were responsiblefor maintaining the reliability of three transmissiongrids, the EasternIntertie, the WesternIntertie, and theTexasgrid. Thesegrids span the United States,Canada,and parts of Mexico (Brennanet al. 1996: 26), making it possiblefor statesexperiencinga shortfall in generating capacity to buy excesscapacity off the transmissiongrid from utilities operatingin anotherstate.This was one of the importantfactors in restructuringthe electricity industryforty yearslater. In August2003, a muchmoreextensiveblackoutoccurredacrossthe northeastfrom New York to Michigan and throughoutOntario.This blackoutwas causedby 48

RESTRUCTURING ELECTRICITY

excessdemandon the now-deregulatedgrid in a seriesof power grabs. Seethe Epiloguefor a broaderdiscussionof this event. The underlyingrationalefor regulatingthe industry wasthat electricity generation,transmission,anddistributionconstitutenaturalmonopolies. A natural monopoly exists when the costsof producinga product would be lower when one companyprovidesit than when two or more firms competefor the market. Becausethe costs of electricity generation were high and economiesof scalewere necessaryto maintainefficiency, electricity generationwas consideredto be a natural monopoly becausecompetitioncould reduceprices below the cost of production. Transmissionis arguablya true naturalmonopoly in that competitionin transmissionwould require duplicate systemscrisscrossingthe landscape.In addition to the aestheticproblemthis would present,the costs of constructingand maintaining such systemswould be prohibitively high. Retail competition was likewise consideredto be a natural monopoly so that multiple wires would not be strungalong city streetsand neighborhoods.The impetusto deregulatethe industry camewhen one to be seenas a poelementof the vertical system-generation-began tential competitivemarket and no longer a natural monopoly. Electricity is a uniquecommodityin many ways. Unlike naturalgas, becauseit cannotbe stored,companiesmust produceenougheachday to meet the estimateddemand.In a free market, producerswill try to generateonly enoughelectricity to meetanticipateddemandsothat there is not a surplus on the market that could drag prices down. Demand varies throughoutthe year accordingto weatherand economicconditions in a state.Under regulation,powerplants were built to a size that would meet peak demand,the highest demandanticipatedduring the year. As a result, a portion of the entire generatingcapacityof a utility companywould be idle for mostof the time, exceptduring high demand periods,generallyin the summermonthswhenair conditioningis needed. Accordingto SmeloffandAsmus,"the electric utility industry usesonly abouthalf of all the generatingcapacitythat hasbeenbuilt in the United States.That meansthat fully staffedpowerplants are being paidfor by captiveratepayers,yet remainidle for half the time" (SmeloffandAsmus 1997: 76). Anotherfeatureof electricity that makesit different from othercommodities is that once electrons areput into the grid, they are indistinguishablefrom all other electrons. In other words, the electricity purchasedfrom CompanyA is mixed with that from CompanyB and

49

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the final customercannotchooseto buy only that electricity generated by CompanyA. In addition, customerscannotreceiveonly thoseelectronsproducedby nonutility sourcesor generatedfrom renewablesources like solar,biomass,or hydro. As discussedin chapter2, the Public Utility RegulatoryPoliciesAct (PURPA),enactedin 1978,requiredutilities to purchaseelectricity from nonutility sourcesor qualifying facilities (QFs) as an incentivefor the utilities to increasethe percentageof electricity generatedfrom renewablesin their mix. Taking the QF concept further, the 1992EnergyPolicy Act (EPACT) createda classof exempt wholesalegenerators(EWGs)that cangenerateand/orsell electricity as wholesalersin competition with the utilities themselves.In a deregulated market, customerscan chooseto purchaserenewableelectricity by contractingwith providersthat put thoseelectronsonto the grid. Exempt wholesalegeneratorsare regulatedby the FederalEnergy RegulatoryCommission(PERC), which is responsiblefor authorizing accessto the utility's transmissiongrid if it is determinedto be in the public interest.The PERCis legally obligatedto ensurethat EWGs are charging'just andreasonable"prices.It operatesasan oversightagency in much the sameway that the Securitiesand ExchangeCommission regulatesthe stock market. Before deregulation,the PERC'smission was to prevent collusion and price fixing betweenEWGs and public utility companies.Sincederegulationits primary role is to ensureagainst price gougingand marketconcentrationthat could constitutemonopoly conditions.This role was seriouslycompromisedduring the California electricity crisis. Thesedevelopmentsin the EPACT are seenas the final piecesthat made deregulationof electricity a real possibility. The industry had changedover two decadesso that many of the conditionsthat madeit a naturalmonopolyno longerexisted.Prior to 1970,the big utilities were able to achieveeconomiesof scale by building large generatorsand high-poweredtransmissionlines. To sell their excessgeneratingcapacity and continue to increaseprofits, the utilities encouragedelectricity consumption.Industrial customersreceivedvolume discounts;residential customerswere advisedby Reddy Kilowatt, a cartoon advertising character,that electricity was the biggestbargainin their family budgets. In the early 1970s,growth in demandfor electricity was about 7-8 percentper year.The numberof powerplantswas doubling aboutevery ten years.Many utilities plannedto meetthis demandwith nuclearpower plants. By the end of the 1970s,however,nuclearpower had become 50

RESTRUCTURING ELECTRICITY

exorbitantlyexpensive because of safetyandenvironmentalregulations, as well as the costsof constructionand operations.The 1979 nearmeltdown at the ThreeMile Island, Pennsylvania,nuclearplant effectively halted new constructionof nuclearfacilities in the United States.The remainingplants representeda huge expensefor the utility companies that ownedthem, an investmentthat becamea complicatedpolicy issue during deregulationefforts.1 Electricity costsincreasedthroughoutthe 1970sand demandgrowth dropped to about 2 percentper year (Smeloff and Asmus 1997: 17). Utility executiveswho hadworried abouta capital shortagefor building new generatorsfound insteadthat they had surpluscapacity.New technologiesfor energyefficiency weredevelopingalong with environmentally benignpowergenerationin thy form of cogenerationandthe useof renewableresources;the regulatedutilities resistedtheir widespread adoption.For most companies, with big investmentsin expensivegenerating capacity, it was simply not in their best interest to encourage their customersto uselesselectricity. As mentionedearlier,Pacific Gas and Electric in northern California was one of the exceptionsto this rule. The companywas unableto meetgrowing demandfor electricity in the 1970sand so developeda programof subsidiesand incentivesfor conservationthat savedthe companybillions of dollars in costsfor new generatingcapacity. Frustratedwith the large utilities and their resistanceto shifting away from fossil fuels or nuclearpower to renewablesourcesof generating electricity, Congressenactedthe requirementin PURPAthat utilities buy electricity from privatecompanieswhenthat was a lower-costalternative to building their own powerplants(SmeloffandAsmus 1997: 18). The most effective form of suchelectricity camefrom cogeneration, wherewasteheatfrom an industrialprocessis capturedand usedto tum turbines to generateelectricity. Cogenerationplants that use combustion turbines (jet engines)had been shown to have efficiencies of 75 percentor higher. This compareswith an efficiency of lessthan 50 percentfor coal-generatingplants.The new combustionturbine generators were small, could be built quickly, and better matchedload growth (Smeloff andAsmus 1977: 19) so that the cost of electricity generation could be significantly lowered. Electricity generationhas heavy environmentalimpacts.The industry produces72 percentof the nation'ssulfur dioxide emissionsand 36 percentof carbondioxideemissions(SmeloffandAsmus1997:2). Sulfur 51

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dioxide from power plants in the Midwest is a primary componentof acid rain and acid depositionin the northeasternstatesand southern Ontario. Transmissionof emissionsis a seriousproblemfor areasthat are downwind ofthe plants.In fact, if New York and New Jerseywere to eliminateall in-statesourcesof sulfur dioxide, they still would not be in compliancewith the CleanAir Act. Coal-burningpower plants alsoemit largequantitiesof small particulatesor dust that causerespiratory problems.Coal mining, especiallysurfaceor open-pit mining, also degradesland and waterin areassurroundingthe mines. Nuclearpower plants are often cited by the industry as being pollution free insofaras they do not producethe air and waterpollution that coal plants do. They have their own set of problems,however. First, they generatenuclearwastethat mustbe safely containedfor thousands of yearsbeforeit will finally reacha decontaminated state.At the present time, most spentnuclearfuel rods are storedin pools of water nearthe plants,someof themperchedaboveor nearmajor sourcesof fresh water like the GreatLakes or major estuaries,suchas Chesapeake Bay. Every material that touchesthe radioactivecomponentbecomesradioactive itself. Low-level radioactivewaste,such as protectiveclothing, hasto be storedsafely away from environmentalcontactuntil it is deemedto be safe,often for hundredsof years.In addition, the nuclear power plants themselveshave a limited life-twenty-five to thirty years-because of the degradationof materialsexposedto radioactivity. This meansthat decommissioningold nuclearplantswill also create large amountsof high-level radioactivewastethat hasto be disposedof safely.Contaminatedbuildingsandstructureshavebeenexposedto varying levels of nuclearradiation.The U.S. governmenthasbeenworking for decadesto solve the problemof nuclearwastedisposal.It is an intractableproblemthat can have severepolitical consequences for state andlocal governmentleaderswho cooperateto havenuclearwastestored in their jurisdictions. Nuclearpower plants are seenincreasinglyas a major hazardto the residentswho live and work nearthem. Becauseof the increasein terrorist activity in the United Statessince September11, 2001, nuclear power plants are seenas a potential target. Efforts to close the Indian Pointnuclearpowerplant locatedin Buchanan,New York, approximately thirty miles north of New York City, gainedmomentumafter the attack on the World Trade Center. This effort was strengthenedby a statecommissionedreport published in early 2003, which found that the

52

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evacuationplan for the areafollowing a terrorist attack or an accident was seriouslyinadequate(Witherspoon2003). Nuclear power is often promotedas a cleanerfuel becauseit does not producecarbondioxide (C02 ), a greenhousegas that contributes to global warming. Fossil fuels burnedfor electricity generationare a major sourceof greenhousegasemissions.All combustionin the presenceof air createscarbondioxide, our most plentiful greenhousegas. Natural gas burns more completelythan coal and generatesless CO2 per kilowatt hour, but the more electricity producedthe more greenhousegasesare also generated. There are other ways to generateelectricity without adding carbon dioxide to the atmosphere:solar, hydroelectric,wind, and geothermal power.About 15 percentof electricity in California is alreadygenerated by hydro, wind, biomassand geothermalpower (www.energy.ca.gov/ electricity/generation_ownership.html), and the stateis planningto increasethat to 25 percentby 2020(Stateof California 2003: 5). Sunshine in the westernstatesmakessolar power a viable option for individual generatingfacilities for both businessesand homeowners.In response to the 2001 crisis, the statedevelopeda subsidyprogramfor homeowners and commercialbusinesses to help coverthe costsof installing rooftop photovoltaic cells (www.consumerenergycenter.org/rebate/index.php). During sunny days,thesesystemsactually put electrons backonto the grid and buy electricity only at night or on very dark days. Wind poweris anothersignificantsourceof renewableenergy.A 1992 study of the Midwest by the Union of ConcernedScientistsfound that wind powerin many statescould be generatedfor lessthan 5 centsper kilowatt hour (Brower et al. 1993). At the time, retail prices for regulated electricity generatedfrom fossil and nuclear fuels ranged from 4.83 centsper kilowatt hour for industrial customersto 8.21 centsfor residentialcustomers(Energy Information Administration!Annual Energy Review 2002: 25). California has severalwindmill generatorsand the potentialfor more. The statewith the mostpotentialwind resources is Kansas,which also has the largest known reservesof natural gas. Both are locatedin the westernend of the state. The 1992 act stressedgreenhousegas reduction as a componentof nationalenergypolicy. First, utilities were requiredto do integratedresourceplanningto help them identify the costsof all optionsfor adding peakload capacity,including new powerplants,modificationsof existing plants, purchasingpower, energyefficiency and load management 53

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measures,improving transmissionlines, and alternativerate structures (Smeloff andAsmus 1997: 52). Utilities were also requiredto develop demand-sidemanagement(DSM) programswhereinvestmentsin conservationand energyefficiency could be shown to be as profitable as investmentsin additional electricity generation;and finally, they were encouragedto developrate structuresthat would foster investmentsfor efficiency in generation,transmission,and distribution of electricity. Figure4.1 showsinvestmentsin demand-sidemanagement programs in California from 1993 to 2000. It showsthat utilities madesignificant investmentsin theseprogramsto reducepeakdemanduntil 1997 when the investmentsdroppedoff and continuedto declinethroughthe endof the decade.This coincideswith the passageof deregulationlegislation in California and other states. The 1992law alsoprovidedfunding for stateenergyoffices andcostsharinggrants toindustry associationsthat were implementedthrough the Rebuild America program.In the 2003 Departmentof Energy budget, funding for nongrantstateand community programs,presumably including the stateenergydepartments,declined from $123 million in 2001 to $93 million in 2003 (U.S. Departmentof Energy). Rebuild America hasbeenreorganizedinto the Weatherizationand IntergovernmentalProgram(www.eere.energy.gov/weatherization.html) and funding was increasedfrom $230 million in 2002 to $277.1 million in 2003 (U.S. Departmentof Energy). The Road to Deregulation By 1993, vertical integrationof the electricity industry was becoming indefensible.The PURPA had openedthe transmissionlines to outside providersof electricity and the EPACT had authorizedthe formation of exemptwholesalegeneratorsto serveas brokersfor the saleof electricity throughoutthe North Americangrid system.Severalcompanies,including large public utilities, transformedtheir businessesin order to becomeparticipantsin this new market. The final pieceof the deregulationpuzzlewasthe technologyrevolution. With computersand integratedinformation systems,it was now possiblefor brokersto identify suppliesof daily excesselectricity anywhere in the market and to negotiatehourly prices to sell electronsto areaswith a shortfall. It was now also possibleto link buyersto sellers directly to enablethemto find the lowestmarketrates.Theold arguments 54

RESTRUCTURING ELECTRICITY

Figure 4.1

Demand-side Management Expenditures for Electric and Natural Gas Programs

300

1893

Energy

1893

Energy

sell

1893

1893

1893

1Gae

1N9

1$K1O

1181

1~ 1893

1893

184

, • .5

1988

' . .1

11&8

Source: California Energy Commission, Energy Commission, PublicationNo. P400-99-012,September29, 1999,Figure 3, p. 6.

for having one company to produce,transmit, and sell electricity no longer persuaded.Nor was it necessaryfor consumersto be serviced only by companieswithin stateborders. Natural monopoly was declaredto be dead as severalstatesbeganto developderegulationstrategies.In April 1994,the California Public Utility Commissionissueda proposalto deregulateelectricity within four months in a bid to becomethe first statein the nation to enterthis new world.

Issuesin Electricity Restructuring Deregulatingelectricity is not a simple matter. Severaldecisionshave to be madeabout how consumerswill interactwith the electricity marketers and how electronswill be delivered over the jointly used, privately owned transmissiongrid. The principal issuesthat have to be addressedare whethercompetitionshould be at the wholesaleor retail level (retail wheeling); how to market contractsbetweenproducers, marketers,and final customers;and whetherutility shareholdersshould be reimbursedfor so-calledstrandedcosts. Strandedcosts may be utility investmentsthat have not yet been amortizedand/orlong-termcontractsthat the utilities haveenteredinto. Competitionis supposedto bring down prices by openingthe marketto 55

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companieswith the highestefficiency and lowest costs.If their prices are set to achievea reasonableprofit, then theywill pushthe more expensiveplantsout of the market.In theory,old, inefficient coal-generating plants shouldbe shut down as a result of competitionbecausethey cannot reducetheir prices to the desirablemarket level. This should improve a utility's efficiency. Most strandedcosts are linked to investmentsin expensivenuclear plantsthat were approvedby stateregulatorswho also allowed the companiesto increaseratesto coverthe costsof the investments.The utilities arguethat sincethe statepublic utility commissionsapprovedthe investmentsandtheir concomitantrates,the statesnow havea moral obligation to ensurethat the company'sshareholdersrecovertheir investments. How to deal with strandedcostsis a major political issuein developing a deregulationscheme.Brennanet al. (1996) offer six proposalsfor strandedcostrecovery:(1) contractrenegotiation,(2) transmissionsurcharges,(3) compensatoryexit fees,(4) accelerateddepreciation,(5) auctioning off transmissionfacilities, and (6) making recoverydependent upon environmentalimprovements(Brennanet al. 1996: 105-7). In contractrenegotiation,utilities would renegotiatecontractswith wholesalecustomersto obtaincompensationfor strandedcosts.Transmission surchargesrequirecustomersto pay an additionalfee for useof the utility-owned transmissionsystem,until strandedcosts have been recovered.Exit feeswould be paid on top of the surchargeby thosecustomers who buy electricity from other suppliers,thus contributingto the problem of strandedcosts.Accelerateddepreciationwould simply allow companiesto increasethe capital recoveryallowanceusedto compute rates. Utilities might also be allowed to auction off their transmission lines on the premisethat the funds would be used to cover stranded costs.Another proposalwould require utilities to bring existing plants into compliancewith new sourceperformancestandardsof the Clean Air Act in order to be eligible to recoverstrandedcosts. Each of theseproposalshas strengthsand weaknesses.The fundamental questionof whether utilities should be treatedany differently than other businessesthat suffer strandedcostsis difficult to address. On the one hand, utilities made investmentsin expensivegenerating plants with the assurancethat they would be able to recovertheir costs becausethey serveda captiveregulatedmarket.Thus, they madedecisions that might not be made in a competitive market where there is uncertainty about investmentrecovery. On the other hand, regulators

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generally approvedrate increasesso long as they were basedon fair recoveryof investmentswith limited profits. The companieshad no incentiveto developlow-costalternativesfor generatingpowerso long as regulatorsset prices on a "cost plus" basis. Their shareholderswere promiseda steadyreturn on their investments.Therewas, in a sense,a covenantbetweenthe regulators,the companies,and the shareholders. California policymakersapproveda transitionsurchargefor a three-year period or until the strandedcosts for each utility were amortized. In exchange,the utilities agreedto a price cap and an across-the-board 10 percentdiscountfor all customers. Thereareprecedentsfor strandedcostrecoveryduring the regulatory era. Two utilities, Long Island Lighting Company in New York and American Electric Power in Ohio, were allowed to recover from ratepayersthe costsof convertingnuclearpowerplantsto coal-burning plantsprior to completionof the construction.In both cases,the companies had investedhuge sums in theseplants-theShorehamplant in New York and the Zimmer plant near Cincinnati, Ohio--only to have constructionand operatingcostsescalatedramatically.The Shoreham plant was ultimately doomedbecauseof safetyconcernsabouta nuclear generatorlocatedin a denselypopulatedarea. The Zimmer plant was deemedto be simply too expensiveto operate.Both states'regulators approvedrate increasesto pay for what amountedto bad businessdecisions. After the Three Mile Island accident,ConsolidatedEdison was permittedto place a surchargeon electricity ratesto partially compensateshareholdersfor the costsof the accident. Theseexamplesalsodemonstratethe partnershipthat existedbetween the statesand electricity utility companiesduring the regulatory era. Electricity is a vital product in the economyof the United States.In a regulatedmarket, the privately held utilities are critical links to maintaining the standardof living to which Americanshave grown accustomed.Regulatorsthuswereobligatedto ensurethefiscal healthof these companiesbecausethe statescould not afford to losetheir product.This samescenariowas played out in a different way during the California crisis, which will be discussedin the next chapter. Retailwheelingrefersto the ability of individual customersto buy electricity directly from any provider who "wheels" it onto the transmission grid. Thebiggestconcernwith retail wheelingis that if the largeindustrial usersbuy power directly, then other consumers-smallbusinessesand residentialconsumerswho cannotnegotiatewith providersdirectly-will

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becomecaptive customersof the utilities and their higher priced product. Becauseutilities would still own the transmissionsystems,they could add chargesfor transmissionof electricity from outsidesources that would raise customerprices and diminish the advantageof direct contracts.The only way to avoid this would be for individual suppliers to build their own transmissionsystems,a prohibitively expensiveproposition as well as environmentallyand aestheticallynegative. The alternativeto retail wheeling is expandedwholesalecompetition. In this variation, only the generationsegmentof the industry is deregulated.Generatorsuse the wholesalemarket and utilities distribute electricity to final customers.Local distributorskeeptheir monopoly franchisesfor selling electricity to retail customersand continueto be regulatedby the states.Customers canchooseto purchaseelectricity from any wholesalerbut are connectedto the grid throughthe regulated utility. Integratedutilities are required to divest their generatorsfrom the distribution system.This is the mechanismthat was chosenin California. The utilities were required to sell off most of their generating facilities. Customerswould choosea providerwho deliveredelectricity throughthe utility's lines and retail distribution system. Thereare two principal marketingmethodsfor electricity services: bilateral contractingand a pooling mechanismknown at the time as a "pooleo." Bilateral contractingrefers to transactionsbetweentwo and distributors, partiesunderspecific supply contracts-generators marketers,or final customers.A pooleo is operatedby a coordinator that provides for short-termpower transactionsthrough a centralized spot market. In bilateral contracting,generatingcompaniesmake contractswith local distribution companieswho pay the generatorsfor the electricity. An independentsystemoperator(ISO) is responsiblefor balancingthe supply and demandof electricity on the transmissiongrid. Distribution companiesdeliver power to the customers'premisesand receivepayment for the service(Brennanet al. 1996: 45). The ISO can also enterinto contractswith generatingcompaniesor large usersto changetheir supplyor usageaccordingto the demandson the system.In periodsof shortage,large usersagreeto cut backdemand in returnfor favorabletransmissionrates.Likewise, in periodsof excess supply, generationcompaniesmake themselvesavailable for shutoff. Becauseelectricity cannotbe stored,there is nowherefor excesselectrons to go. Somekind of balancingmechanismis essential. 58

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The poo1comodel can have the coordinatingresponsibilitiesof the ISO and alsothe operationof a centralizedspotmarketfor electricity. It servesas a wholesalebroker, soliciting bids from generatorsregarding the prices and amountsof power they are willing to sell during each hourly segmentof the following day. Its proponentsbelievethat it is the only way to make sure that electricity is provided at the lowest price. Long-termcontractswere consideredundesirablebecausea generating companymight operatea high-costgeneratorundera contractat a time when a lower-costgeneratorowned by anothercompanyis idle. Spot marketsencouragethe generatingcompaniesto resell low-costelectricity during thoseperiodsratherthan producetheir own higher-costelectricity (Brennanet al. 1996: 56). Thus, spot marketswould, in theory, producethe lowest-pricedelectricity with the highestmarketefficiency. On the other hand, a poo1comight also createmarket powerrather than facilitating true competition. "A highly concentratedgeneration market increasesthe chancethat generatorswould collude to manipulate the spotprice-thatis, they could limit the amountof powersold in the marketin order to raisethe price and thus their profits" (Brennanet al. 1996: 58). And the poo1coitself could becomea market power. "If the poo1cois the sole gatekeeperto participationin an electricity market, it could exercisemarketpower-charginghigh ratesto powerdisif it werea monopoly tributorsandoffering low pricesto generators-as sellerand monopsonybuyer" (Brennanet al. 1996: 58). Another concernabout deregulationwas the loss of investmentsin demand-sidemanagementand energy efficiency. In a free market of electricity buyers and sellers, no provider would have reasonto promote efficiency. This is true evenfor companiesthat provideelectricity generatedby "green" energysources.In orderto get enoughcustomers to demonstratethat thereis a demandfor greenelectricity, the companies have to sell as much electricity as they can.2 Thus, they are in the ironic positionof encouragingconsumptionandincreasingdemandwhile advocatingenvironmentalprotectionat the sametime.

Social Costsof Electricity Generation Generatingelectricity has somesignificant social costs.It is questionablewhetherthesecanbe dealtwith fairly in a deregulatedmarketplace. The two most importantcostsare social equity and environmentalprotection. Electricity is not an ordinary commodity that consumerscan 59

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chooseor not chooseto buy dependingon price. It is a necessityof modem life the absenceof which cancauseseverehardship.One rationalefor stateregulationwas to managethe price of electricity so that it was not out of the reachof low-income citizens. Deregulation,or market-based electricity, was advocatedto the statesas the only way to achievethe lowestpossiblemarketprices.Regulatedutilities were assumedto be inefficient and over priced solely becausethey were monopolies. The experiencein California illustrates,however,that marketprices go in two directions. When prices spike as they did, the impacts are harsheron the poorerand more vulnerablecitizens.In the past,utilities were required to provide low-priced servicesto low-income citizens. The federalgovernmentsubsidizedpowersystemsandrural electrification programsthat brought electricity to farms and sparselypopulated areas.Companiesin a competitivemarkethaveno reasonto providefor social equity. Their primary responsibility is to their shareholdersand not to the community.Indeed,most of them are not evenlocatedwithin rangeof the communityif the marketsystemworks as it is supposedto. In addition, electricity generationand transmissionhavea heavyimpacton the environment.The negativeexternalitiesassociatedwith electricity are air pollution, including sulfur emissionsand fly ash (soot); water.pollution, including the dischargeof heavy metalsand hot water into lakes, rivers, and estuaries;nuclearwaste; potential health effects from electromagneticfields; and greenhousegas emissions, primarily carbondioxide andnitrogenoxides.Acid deposition/rainfrom coal-burning plantsfalls in areasfar distantfrom the sources.Transmissionlines are unsightly andenvironmentallyintrusive.Their location may present an environmentaljustice problem as well if they are located in lowincome or rural neighborhoods.Coal mining for electricity production leavesscarson the land andcontaminateswateras well asdamagingthe healthof its workers. Since the 1970s, severalenvironmentalprotection laws, as well as the OccupationalSafety and HealthAct, have tried to reducethe environmentalimpactsof electricity production.The industry lobbiedagainst these laws, but under regulation they were held to an expectationto protect the public interest as well as the industry'S. In a deregulated market,however,the emphasisis on producingelectricity at the lowest cost. Many economistshavearguedthat competitionshouldencourage the use of more efficient, low-cost power plants (Brennanet al. 1996: 115). It is alsotrue, however,that oneway for companiesto reducecosts 60

RESTRUCTURING ELECTRICITY

is to shift the costof externalitieslike pollution onto the public. The Bush II energy proposalarguesfor exactly that by emphasizingthe need to relax environmentalregulationsin orderto build more powerplants. The loss of incentivesfor integratedresourceplanningand demandside managementcounts among the greatestsocial costs of deregulation. Individual companiesmaking individual decisionswill opt for building plants at their lowest costs. For the near term that probably meansusing some form of fossil fuel, most likely natural gas. Even though the 2001 CheneyTask Force recommendedincreasingnuclear powergeneration,the socialandpolitical problemsrelatedto its useand disposalare still formidable. The costsfor constructionand operation are many times greaterthan the costs of natural gas or coal-burning generatingfacilities. Safedisposalof radioactivewasteshasnot yet been developed.The heightenedfear of terrorist attackson theseplantssince September11,2001,also makesit unlikely that nuclearpower will becomemore widespreadin the nearfuture. Without someform of governmentcoordination,the market is not likely to producea mix of fossil, renewable,andefficiency methodsthat can comecloseto that designedthrough integratedresourceplanning. Conclusion This chapterhasprovidedan overviewof the history of electricity regulation and the major eventsthat led to deregulationand restructuringof the industry.By 2001, most stateshad consideredderegulatingand several had implementedit. California was the first stateto implementderegulation. The legislation was enactedin 1995 and the market was openedto consumersin 1998.The next chapterprovidesa casestudy of deregulationin California: how the featuresof the legislation were developed,how it workedin practice,andan analysisof what went wrong. Reverberations from the Californiaelectricity crisis havebeenfelt around the country sincethe summerof 2001.The casestudy servesas a tale of cautionfor governmentslearninghow to operatein the market.

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5 Restructuring the California Electricity Market A CaseStudy

In July 2000, San Diego Gas and Electric Company(SDG&E) tripled electricity rates. A year earlier, the company had recoveredall of its strandedcostsl and the California Public Utility Commission(CPUC) had authorizedthe utility to begin chargingmarketrates. Becausethe companywasbuying electricity on the spotmarketat the hottesttime of the year when demandfor electricity is highest,it was paying the highest price per megawattthat the market would bear. Wholesaleprices soaredand SDG&E passedthe costsalong to its customers. Not surprisingly, consumerswere outraged.Deregulationhad been heraldedasthe way to lower prices;now consumerswerepaying significantly more for electricity each month than they had under regulation. Throughthe summer,a seriesof poweremergenciesand localizedblackouts occurredall over the state. In August, the CPUC approveda rate stabilizationplan for SDG&E customersto caphouseholdratesat $68 per month, retroactiveto June1, 2000, and extendingthroughDecember31, 2001.Legislationenactingthis plan extendedthe cap through2002. The crisis seemedto be contained-untilNovember2000 when Pacific Gas & Electric (PG&E) in northernCalifornia and SouthernCalifornia Edison (SCE), the other major independentlyowned utilities (lOUs), suddenlyfaced drastically increasedpricesfor megawattspurchasedon the short-termwholesalemarket.Over the next threemonths, retail electricity pricesjumpedfrom 8 centsperkilowatt-hourto asmuch as 35 cents.The utilities were still prohibitedfrom passingthe full costs of electricity along to ratepayersbecausethey had not yet recoveredall their strandedcosts.Under the terms of the state'sderegulationpolicy,

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they werealsorequiredto give all residentialcustomers,including those who contractedwith anotherprovider, a ten-percentreductionon electricity charges. The IODs retainedthe responsibility for transmission anddistributionof electricity, regardlessof customerchoiceof provider, and were required to refund to customersthe difference betweenthe rates chargedby alternateproviders and the price-cappedelectricity deliveredby the IODs. The scenewas set for a financial disaster. By the endof the month it was clearthat the statewas facing a crisis of unknownproportions.In early December,the utilities askedconsumers to savepowerduring peakdaylight hours by waiting until 8 P.M. to tum on their Christmaslights. The IndependentSystemOperator(ISO), the entity responsiblefor coordinatingelectricity transmission,issued its first-ever StageThree alert on December7. A StageThree alert is orderedwhen the statehaslessthan 1.5 percentof its electricity reserve. StageThree alerts enablethe ISO to increasethe power supply by requestingvoluntary reductionsfrom large users.The ISO can also order rolling blackoutsas the needoccurs. Just after Christmas,the price of natural gas in the statejumped to four times the prior-yearprice. This further increasedthe price of electricity generatedby naturalgas-about50 percentof supply.2 This put more pressureon PG&E's cashflow becausethe companycould not passthesenew costson to retail customers.Suppliersbecamereluctant to contractwith thecompanybecausethey wereuncertainthat they would be paid. In January,the CPDCapproveda price increaseof 1 centperkilowatthour for PG&E andSCEcustomers.This failed to shoreup the utilities' financial condition, however,and both Moody's InvestorsServiceand Standardand Poor'sdowngradedthe companies'credit ratings to one level abovejunk bond ratings,effectively curtailing their ability to borrow moneyto buy electricity on the openmarket.On January10, PG&E askedthe state for help in buying natural gas, arguing that it did not haveenoughcashcomingin to pay its bills. By the middle of the month, the company'scredit rating had beenfurther downgradedto low junk statusand it was in default on bank loans and credit lines. Electricity suppliersrefusedto continueselling to the utilities. Finally, on January17, the ISO orderedstatewiderolling blackouts. GovernorGray Davis declareda stateof emergencyand authorizedthe stateDepartmentof WaterResourcesto enterinto contractsdirectly with electricity suppliers.The statewas desperateto developa longer-term 64

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solutionto this crisis, which wasexacerbatingthe economicdeclineand increasingcosts of operationsfor governmentas well as businessand residents.On February1, the California legislatureapprovedlegislation allowing the stateto negotiatelong-termcontractswith energy suppliers and to sell up to $10 billion of revenuebondsto buy power. The FederalEnergy Regulatory Commission(PERC), which is responsiblefor ensuringthat wholesaleprices of electricity are "just and reasonable,"refusedto order price caps for the westernstates.Curtis Hebert,chairmanat the time anda protegeof then-Senate majority leader Trent Lott, arguedthat the problemwas one of supply and demandthat the marketwould overcomeif left to operatefreely. Newly electedPresidentGeorgeW. Bush, a Texasoilman with closeties to Enron CEO KennethLay andotherenergyindustryexecutives,refusedto intercededespite the pleasof governorsfrom California, Washington,and Oregon. As the crisis worsenedthroughoutthe winter, the price tag grew by millions eachmonthandrolling blackoutscontinuedthroughoutthe state. Eventually, the independentelectricity providers abandonedthe retail marketand returnedtheir customersto PG&E and SCE. The stateinitiateddiscussionsto buy the transmissionnetworksof the two utilities as a way to improve the companies'cashbalances.Pacific Gas and Electric filed for bankruptcyprotectionbefore signing the agreement.Just before filing for bankruptcy,however,PG&E awarded$50 million in bonusesandraisesto 6,000seniormanagersandemployees.SCEagreed to provide low-cost power for ten yearsin exchangefor the statepurchasingits transmissionlines for $2.7 billion. The governor delivered a statewidetelevisedaddress,urging residentsto conserveelectricity. Legislationwasquickly enactedto supplementexistingprogramsfor low- incomeassistance andenergyefficiency and to developseveralnew programs.Pacific Gasand Electric and the stateEnergyCommissionrestoredincentivesfor demand-sidemanagement, which had been developed prior to deregulation.Theseincluded rebatesto consumersfor purchaseof compactfluorescentlight bulbs, installation of photovoltaic roof panels,and the replacementof older appliances,especiallyrefrigerators. The stateultimately negotiateda contractto purchaseelectricity over ten yearsat a price of $138 per megawatt(Gaudette2001). The agreementwasbasedon priceson the spotmarketat the time of negotiations, long-term prices, and estimateddemandper month assumingnormal weatherconditionsandcontinueddemandat historicallevels.Evenwith 65

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the contracts,therewerepredictionsof rolling blackoutsthroughoutthe summer,in anticipationof normaldemandfor air conditioning.In June, a heatwave broughtrecord high temperatures-as much as 20 degrees above normal in northern California-but no blackouts.Californians hadtakenseriouslythe needfor conservationandhadreducedtheir electricity useby as much as 20 percent. By this time, the federalgovernmenthadbegunto sendsignalsto the market that helped to bring prices under control. In May, the PERC, undernew chairmanPatrickWood, a former utility commissionerfrom Texas,finally imposeda price cap on wholesaleprices in the western statesafter refusingto do so all winter on the premisethat the free market would work best to solve the problem and price caps would only drive suppliersout of the market.In contrastto thesepredictions,price capsstabilizedthe marketand supplierscontinuedto offer their product at prices below the caps.By the end of June,wholesaleelectricity was selling for $100 per megawattdown from $750 per megawattthe year before. Then in July, the heatwave dissipatedand recordlow daily temperatureswereposted.Demandplummeted.The state,which hadcontracted to buy 30,000megawattsper day at $l38 per megawatt,was forced to sell as much as twenty percentof it back to the market at much lower prices.The price for theseexcessmegawattswas around $25eachand somecritics accusedthe stateof selling its electricity for as low as $1 per megawatt(Gaudette2001: 1). Electricity Restructuring in California What causedthis experiencein the first stateto restructureits electricity industry?Many voicesblamedthe state'sderegulationpolicy itself for the problems.Consumergroupsarguedthat it was a stategiveawayto big businessand the utilities. Energy companiesand someeconomists assertedthat the statedid not go far enoughin deregulatingthe electricity market. The statehad only partially deregulated,they said, by capping retail prices while opening up the wholesalemarket. The biggest criticism was that pricesskyrocketedbecausethe utilities were prohibited from enteringinto long-termcontractsand insteadwere requiredto purchaseelectricity on the volatile spot market. To determinethe validity of thesecriticisms, it is helpful to understandhow deregulationwas developedin California, what the aims of

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the policy were, and why thesepolicies, which look so foolish in hindsight, were adopted. The original proposalto deregulateelectricity in California was developedby Daniel Fessler,then-chairmanof the CPUc.Fessleradmired the efforts of British Prime Minister John Major to deregulateelectricity in Britain. In addition, the CPUC believedthat California electricity rateswere too high and that competitionin the free marketwas the only way to bring themdown. In April 1994,Fesslerproposedthat deregulation be orderedin four months,with written commentson the proposal duein only thirty daysandno scheduledpublic hearings.Then-Governor PeteWilson, alsoa free marketconservative,enthusiasticallysupported this proposalto make California the first state in the United Statesto openelectricity to competition. The controversialproposalimmediately drew strong criticism from severalquarters-theutilities, environmentalists,consumergroups,and small business.It was strongly supportedby the California Large Energy ConsumersAssociation,which hadlobbiedfor its membersto have the ability to buy electricity directly from suppliersin neighboringstates morecheaplythanfrom the state'sutilities. Therewerealsoveiled threats that large users would move out of the state if they could not obtain lower electricity ratesthroughthe market. The final plan was not signedinto law until 1996. Direct purchasing, or retail wheeling,was eliminatedin favor of a wholesalepowerpoola poolco called the PowerExchange(PX)-which would set the prices that would be paid for bulk poweron the spotmarket.A nonprofit IndependentSystemOperatorwould coordinateand schedulethe delivery of electricity overthe transmissionsystem.The energywholesalerEnron lobbied to ensurethat the PX would be separatefrom the ISO (Lazarus 2001).The PowerExchangewould be monitoredby the FederalEnergy RegulatoryCommissionas it has authority over wholesalepower sales underthe FederalPowerAct. The utilities would retain ownershipof their own transmissionsystemsbut were requiredto sell most of their generatingplants.This was intendedto preventthemfrom exercisingmonopolypowerin the transmission and distribution of electricity. The companiessold their generating facilities to other companies outsidethe state,suchasDukeEnergy in North CarolinaandReliantEnergyin Te?Cas.Pacific GasandElectric also set up a holding companyso that it could competeas an energy marketerin the new restructuredmarket.While the retail companywas

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going bankruptduring the 2001 crisis, the parentholding companywas postingrecord profits. It is importantto understandhow strongly policy makersand power expertsat the time believedthat thefree marketwould bring down prices of electricity dramatically.Simpleeconomictheory assumesthat sellers will reduceprices in order to gain a greatershareof the market when buyers are able to choosefrom severalproviders. In the mid-1990s, when the proposedpolicy was being debated,there was a surplus of powerin the westernstates.Californiautilities werealreadybuyingpower from neighboringstatesto meetpeakdemand.It was assumedthat this surpluswould continueandthat it would keeppriceslow after deregulation. It was alsoassumedthat companieswould rushto build generating plants to meet growing demandand that competition alone would increaseelectricity supply. Moreover, becausethe companiescould buy electricity at wholesaleprices from anywhereon the continent,it was also believedthat they would seekout the lowest pricesavailable. The independentlyownedutilities wereoriginally opposedto deregulation. Their biggestconcernwas their ability to payoff their stranded costsif forced to reducepricesor lose customersin the face of competition. Thesecosts were linked to past investmentsin nuclearpower facilities that the CPUC had approvedunder regulation. The companies arguedthat becausethey madetheseinvestmentsto benefitall ratepayers, their shareholdersalone shouldnot be left with the costs. At the sametime, policymakersfearedthe potentialmarketpowerof the utilities. Threelargecompaniesdominatedelectricity generationand distribution in California. After deregulation,thesecompanieswould be forced to carry othercompanies'electronson their transmissionlines and distribute them to the utilities' former customers.A very real concern was that the utilities would crowd out othercompaniesand load up transmissionsystemswith their own electricity. To control any remnantsof monopoly powerand to offer the possibility of maximumconsumerchoicein electricity provider,the legislationrequiredthe utilities to sell many of their generationfacilities. The companieswere left with the most expensiveplants, including unamortizednucleargenerators, which could not be sold. To offset thesecosts, legislatorseventually approveda surcharge,the CompetitionTransition Charge,which utilities could chargeretail customersfor five years or until their investmentsin thesestranded assets hadbeencompletelyamortized,if sooner. The utilitiesalsoretainedownershipof the transmissionanddistribution

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REsmUCTURING THE CALIFORNIA ELECTRICITY MARKET

systems.Electricity would be deliveredto customersin the sameway as beforebut the serviceprovider would be optional. The IOUs were required to continue serving customersthat did not choosea direct serviceprovider. Pacific Gas and Electric split into two companies-aholding company,PG&E Corporation,that was ableto competeasan exemptwholesalegenerator(EWG) and Pacific Gasand Electric Companyto handle retail distribution. Another subsidiary,PG&E National Energy Group, owns thirty powerplantsin ten stateswith othersunderdevelopmentor construction.From 1997to 1999,Pacific Gas& Electric Companytransferred $4.1 billion in generatingassetsto the parentcompanyand its subsidiaries(Oppel and Holson 2001: AI7). During the spring 2001 crisis in California, the retail companydeclaredbankruptcywhile the parentcompanyand subsidiariespostedrecordprofits. To encouragethe utilities to reducetheir costs,the CPUC approveda price cap, settingthe maximumprice that the utility could charge.The price cap was usedas a performance-based ratemaking device. Under this concept,companieswould be encouragedto buy electricity at prices below the cap and would be allowed to keepany balanceleft over after salesas profit. Thus, the price cap was a free-marketdeviceto encourage efficient operation.It also servedas a floor to protect the utilities from predatorymarketpricing, so the companieswere guaranteedthis price no matter how low the market price might be. This ultimately becamethe mechanismthat drove the companiesinto bankruptcy.Like the price ceilings on oil in the 1970s(seechapter2), the price capson electricity weredesignedto be a floor below which pricescould not fall. In the midst of the crisis, the floor becamea ceiling insteadthat drove the California companiesto bankruptcy. The legislation also requiredthe utilities to give all residentialcustomersa 10 percentrate reductionwhetheror not they purchasedtheir electricity from an alternativeprovider.The price capandratereduction were designedto protectresidentialand commercialcustomersand to show immediatesavingsfrom deregulation. All of the legislation was basedon the belief that the free market would bring greatly reducedprices and abundantsupply to meet the needsof the growing California market.That is the way it is supposedto happenaccordingto everyEconomics101 textbook.What went wrong? Was California a caseof marketfailure, political failure, or, in reality, a grandmarketsuccess?

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Explaining the Crisis As we examinethe situationin the winter of 2001, severalquestionscome to mind. To begin with, what causedthe suddenincreasein pricesin the winter, a time of normally low demand?A numberof causeswere suggestedby experts,economists,and pundits.It was assertedthat excessive demandhad developedin the five yearssincederegulationcoupledwith the absenceof constructionof new generatingfacilities in the statesince 1990. The surplusof electricity in 1995 at the start of deregulationhad becomea deficit by 2000 as the demandfor power to run dot-cornsand Internetserverfarms had grown in the state'shot economy.Second,the state'sstrict environmentalprotectionlaws were said to be a deterrentto building new plants, making the approval processtoo lengthy. During 2000 alone, environmentalistsand local politicians had quashedat least threeproposednew powerplantsin northernCalifornia. Many blamedthe state's"flawed" restructuringplan that deregulated the wholesalemarketbut continuedto regulatethe retail market.Enron Corporation'sCEO Kenneth Lay assertedthat the statereally needed morederegulationandnot a returnto "inefficient regulation"(Lay 2001). By requiring the IOUs to purchasewholesaleelectricity on the volatile spot marketinsteadof throughlong-termcontracts,the critics said, the statehad only partially deregulatedthe market, and, as a consequence, jeopardizedthe financial healthof the utility companiesand ultimately the stategovernmentitself. According to this argument,moreover,had the utilities beenable to passthe higher wholesalecostsalong to retail customers,the balancebetweensupply and demandwould have been reachedmore quickly as customersreducedtheir demandthus freeing up more supply. The loudestvoicesat the time blamedCalifornia consumers,who, it was alleged,had drastically increasedtheir consumptionof electricity. The stereotypicalCalifornianswere depictedas sitting in their hot tubs sipping wine while their computers,lights, and gadgetsran 2417, with no concernfor the amount of electricity they were using. What was mysteriousto mostresidentsand policymakers,however,was how suddenly this "excessdemand"had appeared.Until November2000, there had been no public warnings from the companiesor the government about demandoutpacing supply.3 Indeed Californians, like people all over the country, had beenencouragedto consumebecauseof the roaring economyandto keepit roaring.Furthermore,deregulationadvocates 70

RESTRUCTURING THE CALIFORNIA ELECTRICITY MARKET

had promisedthat the market would rush in to meet any demandcustomerscould buy electricity from companiesanywherein the country at low prices. Was there an electricity shortageelsewherein the countrythat would explainthis supply-demandimbalancethat was driving prices up so precipitouslyin California? At the time, there was a shortageof electricity in Oregonand Washington becauseof a droughtthat had reducedthe generatingcapacityof hydroelectricfacilities. This was one factor that constrainedsupply in the regionalmarketat the time. I know of no reportsof electricity shortagesin otherpartsof the country that winter. Moreover,by spring,companiesin WashingtonStateand British Columbia had learnedhow to manipulatetheir supply in orderto take advantageof the lucrative California market. Bonneville PowerCompany,ownedby the federal government,paid farmers$330for every acrethat they did not farm so that irrigation water they had contractedfor could be usedto generateelectricity to sell to California at $375 to $400 per megawatton the spot market (Harden 2001: AI8). Companiesin British Columbia and the Los AngelesWater and PowerDepartment,a municipally ownedplant, also moved to provide electricity at theseattractivehigh prices. Onefactor that significantly limited in-statesupplyin Californiafrom Novemberto March was the closureof threemajor generatorsfor maintenance,removingas much as 15,000megawattsof electricity from the market.Winter is traditionally a time of lower demand,so mostmaintenanceis performedduring this period. Thesewere plants that the utilities had been forced to sell. Under utility ownership of theseplants, suchmaintenanceclosureswere staggeredin order to ensuresufficient generatingcapacitythroughoutthe period.Historically, accordingto statistics kept by the California IndependentSystemOperator,less than 3,000 megawattsat a time would be off-line becauseof plant maintenance.In December1999,2,569megawattswereoff-line comparedwith 8,988megawattsin December2000.This imbalancecontinuedthroughout the winter of 2001. In April 2001, a total of 14,911 megawattswere off-line comparedwith 3,329the previousApri1.4 The fact that so much capacitywas down at the sametime raisedeyebrowsamongstateleaders and citizens and increasedsuspicionthat manipulationof in-state supply was relatedto a largerindustry schemeto hike prices. In addition,excessdemanddid not play the role allegedby the state's detractors.It turns out that Californians are far from the energy hogs they aredepictedto be. Indeed,California rankedforty-sixth amongthe

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statesin energy use per capita in 2000 thanks in part to the IOUs demand-sidemanagementprogramsover the fifteen years leading up to deregulationin 1996(EnergyInformationAdministration,StateEnergy Data 2000). Neighboring statesof Nevada,Oregon, Washingtonand New Mexico rankedhigher. Texas was ranked sixth in energyuse per capita. While there was somedemandgrowth in California during the last half of the 1990s,populationgrowth in the neighboringstatesincreaseddemandthereat a faster rate. BecauseCalifornia had beenimporting excesselectricity from thesestates,their demandgrowth thus reducedthe amount of excesscapacity that had been in place before California deregulatedits market. Nor was the supply picture as drasticas had beendepicted.The governor dedicatedseveralnew generatingfacilities in the late spring and summerof 2001,plants thathad beenin developmentbeforethe crisis. In early 2001, the stateembarkedon a fast-track plan to build power plants.Environmentalrules were softenedandthe approvalprocesswas shortenedin order to bring as much power on-line as quickly as possible. By May, plant maintenancehad beencompletedreturning 15,000 megawattsto the market. The new capacityin Juneand July helpedto increasethe supply availablewithin the state. The otherfactorsthat helpedthe stateavoid blackoutsafterJunewere conservationand weather.Californiansknow how to conserveenergy; they have been doing so for twenty years. In an addresson April 5, 2001, GovernorGray Davis askedresidentsto take strongconservation measuresto lessenthe threatof summerblackouts.It was predictedat that time that the statewould face a seriesof rolling blackoutsover the summerbecauseof normal peak demand.Emergencylegislation was enactedthat provided$1 billion to supplementexistingenergyefficiency programsand createnew programs.The IOUs offered residentsa discount if they reducedtheir usageby 15 percentover the previoussummer. The state developeda subsidy program for residential and commercialinstallationof solar roof panelsto self-generateelectricity. Commerciallighting was dimmed, hot tubs were turnedoff. The blackoutsneverhappened.To be sure,the summerweatherwas unusuallycool exceptfor one heatwave in June,but there is no doubt that conservationmade the difference (see Krugman 2001). Peakdemandin Junewas 14.1 percentlower than in June2000, a reductionof 5,570 megawatts(Gornstein2001). Even during the June heat wave, demandneverapproachedthe limits of availablesupply. 72

RESTRUCTURING THE CALIFORNIA ELECTRICITY MARKET

In responseto thejudgmentthat deregulationpolicy itself wasat fault, the statebeganto developthe institutional capability to participatedirectly in the market.The stateDepartmentof Water Resources(DWR) was authorizedin January2001 to contractdirectly with power suppliers, after they had refusedto sell to the utilities becauseof fears of nonpayment.The DWR eventually obligated $12.5 billion from the state general fund, effectively wiping out the state'sbudget surplus at the time. The staterequestedapproval from the CPUC to issue a bond in that amountto repay the statecoffers. On May 16,2001,the governorsignedlegislationto createthe California ConsumerPower and ConservationFinancing Authority as a meansof gettingthe statemore actively involved in the electricity planning and developmentbusiness.The authority was given broadpowers to issue$5 billion in bondsto buy, leaseor build generatingplants. Of thesefunds, $1 billion was earmarkedfor conservationprograms.The governorappointedS. David Freemanto head the authority. Freeman hasa long history in the energybusiness,having led both the Tennessee Valley Authority and the Los AngelesDepartmentof Water and Power. He was coordinatorof energypolicy in the administrationsof Lyndon Johnson,Richard Nixon, and Jimmy Carter. The new agencywas designedto protectthe interestsof consumersby providing enoughgenerating capacity to avoid future shortagesin the retail market. It is to emphasizeenergyconservationand efficiency asmeansto increasesupply and to focus on integratedresourceplanning for energy development,thusreinstatingprogramsthat wereeliminatedduring restructuring. By the end of August, the crisis was sufficiently mitigatedthat there were no longer any fears of rolling blackoutsin the state.Many problems lingeredon, most notably the state'sefforts to reachan agreement with SouthernCalifornia Edisonto purchasetheir transmissionlines. The experimentin deregulationseemedto be at an end as the state developedits own capability to managethe market and assumeda far more prominentrole in electricity productionthan it had underregulation. The CPUC suspendedconsumerchoice-directaccessto power providers-inorderto guaranteethe stateenoughcustomersto pay for its long-term contracts.It also grantedthe DWR the authority to increase ratesas neededif prices increasedbecauseof fuel price hikes. Many of the DWR contractshad beennegotiatedwith suppliersthat use natural gasfor powergeneration.The price of gaswasexpectedto rise becauseof increasingdemandforcing up the price of electricity as a result.

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Questionslingeredaboutthe behaviorof the EWGsduring the height of the crisis. The statepetitionedthe FERC to investigateprice gouging by the companiesand claimedthat California had beenoverchargedby as muchas $9 billion. In the spring,evidencebeganto emergethat companieshad acteddeliberatelyto withhold electricity from the marketto drive prices up. A year later, documentsfrom the failed Enron Corporation outlined severalstrategiesthat the companyusedto manipulatethe marketand drive up prices (Kahn 2002). EI PasoNatural Gas Companywas found to have manipulatedthe supply of naturalgasinto the statethat also increasedthe price of electricity. The FERC analystsreportedevidencethat EI Pasoalong with Enron and othercompanieshad manipulatednaturalgaspricesin California. California imports 85 percentof the gas it consumesand the state has a shortageof gas pipelines into and within the state (Oppel 2001: AI). EI Pasowas found guilty in September2002 of illegally withholding natural gas from the statein order to drive up prices. The chief administrativelaw judgeof the FERC,CurtisL. WagnerJr., found that the company'spipeline usedonly 79 percentof its capacityandthat "half of that unusedcapacitywas causedby severalfactors including a failure to operatethe pipeline at a high enoughpressureand nonessential maintenancethat could have beendone at other times" (Oppel and Bergman2002: C2). In March 2003, the companyagreedto a $1.7 billion settlementwith the stateof California, and implicated SempraEnergy as a coconspirator.Semprais the parent company of Southern California Gas Company and San Diego Gas and Electric (Douglass 2003: C2). The Aftermath By September,the crisis had passed.The stateexperiencedno blackouts, new electricity generatingplants were either operatingor under construction,and conservationprogramscontinuedto encourageconsumersto reducedemand.Pricescontinuedto fall, astheeconomymoved toward recessionfollowing the terrorist attacksof September11,2001. By Novemberelectricity was trading for as little as $19 per megawatt and the statewas seekingto renegotiateits contracts.5 Deregulationitself becameoneof the victims of the California crisis. The CPUC approvedeliminating consumerchoice in September2001 and returnedall retail customersto the IOUs to ensurethat they would 74

RESTRUCTURING THE CALIFORNIA ELECTRICITY MARKET

be able to recouptheir debts.The statewas still attemptingto take control of the transmissionsystem.Ironically, the failed experimentin deregulation,designedto free the industry from governmentintervention, resultedin greater government control over the marketplace. Governmentalentities beganto developplans for self-generationof electricity. Having learnedthe lessonof the importanceof having control over supply,municipalitiesacrossthe statebeganto considerdeveloping municipalutility districts (MUDs) to generatetheir own electricity. Thepowerful examplesof Sacramento,Los AngelesandAlameda,where MUDs had protectedtheir residentsfrom the crisis, servedas momentum for thesestudies.When the original deregulationlegislation was enacted,municipally owned utilities had successfullylobbied for exemptionfrom deregulation.The Los AngelesDepartmentof Water and Power and the SacramentoMunicipal Utility District were designated as energyprovidersand eligible to tradeon the statepowergrid. Their customerswere not eligible for the mandated10 percentratereduction, as a result (KrauI1996).Throughoutthe crisis, however,the companies were ableto providetheir customerswith electricity at stablepricesand sold excesselectricity to the grid at the height of the crisis, thus reducing their costsof operation. East Bay MUD, the water districtin AlamedaCounty to the eastof SanFranciscoBay, held public meetingsin the springof 2002to discuss branchingout into the electricity business.In November2001, votersin SanFrancisconarrowly defeateda ballot initiative that would haveauthorized the city to take over PG&E by eminentdomain and operateit as an MUD. The city of Haywardbegana study to determineifthe city shouldbecomean exemptwholesalegenerator.The city would be able to buy wholesaleelectricity from a proposedgeneratingfacility to be built in the city or from any electricity supplierand sell it at retail to its residents. Individual citizens also moved to protect themselvesfrom another crisis broughton by marketextremes,whethernormal or manipulated. Salesof solar electricity systemscontinuedto increase,helpedby the state's50 percentrebateprogram. Gains in electricity supply due to conservationcontinuedin part becauseof stateprograms,but also becausemany residentshad madepermanentreductionsin usagethrough the purchaseof new energy-efficientlighting fixtures and appliances. Market theory was perhapsthe biggest victim of all. None of the sweepingpromisesof the championsof deregulationwererealized.Prices

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did not comedown; suppliersdid not rush in to serveconsumerchoice. A regulatedsystemthat most ordinary citizens thought worked well enoughhad beenabandonedin favor of a wild and volatile free market that servedthe interestsof a few largecompaniesat the expenseof small businesses andretail usersin the state.Thereseemedto be lots of losers in the stateand only a few winners-mostprominentof which werethe energy-tradingcompaniesthat had lobbied aggressivelyfor the plan in the first place. Many Californianstend to be skepticalabout big businessin the bestof circumstances.Thus, this marketfailure for the state and marketsuccessfor the companiesbecamea major political failure aswell. Somepartof deregulationmay remain-theISO, for examplebut major componentsof the plan are likely goneforever. Deregulation'sgrandvision fell so short of meetingthe state'sother energypolicy intereststhat it is unlikely that any California politician would risk supportinga return to the free market any time soon. This may be the ultimate penalty for the free marketeerswho so skillfully used the market to their own advantagewithout considerationfor the policy and political interestsof the peopleof California.

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6 Restructuringin OtherStates

While California blackedout in the winter of 2001, otherstatesderegulated electricity seeminglywithout a hitch. Pennsylvania,for instance, attractedninety-sixstart-upcompanieswhenfull retail choicewent into effect on January1,2001.Discountedelectricity ratesdue to deregulation resultedin savingsof up to 20 percentover the next year. By May of 2002, however, 27 percentof the startupshad droppedout of the market and 44 percentof their customershad returnedto the big utilities. The savingsalso droppedto 2 percentcomparedwith the utility charges(Lowe 2002). Other statesthat beganderegulationafter California, suchas Texas, Ohio, and New York, did not experiencethe sametroubles.They were able to attract other providersand offer their consumerschoice. Electricity supply remainedsufficient to meet demandwithout the price shocksCaliforniansexperienced. Why was deregulationapparentlyso much more successfulin other statesthan in California? Was it simply that the California policy was fundamentallyflawed?Did otherstateshavesmarterpolicymakerswho were able to build betterprotectionsinto their policies?Are there significant differencesin thesestates'deregulationpolicies?Or were they just lucky that California was first and thereforethe sacrificial lamb for marketabuses?

DeregulationPoliciesin OtherStates All statederegulationpoliciescontainroughly the samefeatures:a timetable for implementingretail choice; requirementsfor utilities to give otherprovidersaccessto utility-owned transmissionlines; amortization of strandedassets;and restructuringof the major independentlyowned

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utilities (IOUs). A fundamentalquestionfor all statesis how to contain the marketpowerof the IOUs. In California and many other states,the IOUs were required to sell their generatingfacilities but continue to operatethe transmissionand retail distribution systemsas regulated monopolies.The IOUs could then form otherentitiesto competeas energy providerswith start-upcompaniesand otherenergyproviders. In Pennsylvania,the IOUs werenot requiredto divesttheir assetsand continuedto control about 80 percentof electricity production in the state(Lowe 2002).Start-upcompaniesboughtelectricity from the IOUs. When the IOUs raisedwholesaleratesbecauseof increasedfuel costs, the new companieswere forced to raisetheir own rates.The IOUs thus retainedsignificant market power in the deregulatedmarket. An additional constraintin the Pennsylvaniamarketis the reserverequirementfor all providersimposedby the PJM Interconnection,the independentsystem operatorfor Pennsylvaniaand New Jersey.Eachprovideris required to have a reserveof electricity capacityfor emergencies.This rule was probably enactedin the wake of the 1967 East Coast blackout. In the deregulatedmarket,it penalizesprovidersthatdo not own their own power plants becausethey must buy reservecapacity from the IOUs but not resell it. This raises their businesscosts while providing no benefit to them.Relaxingor eliminatingthe reserverequirementwould reducethese costsand improve the market in ordinary times. It is wise to remember, however,that regulationis about protectingthe interestsof consumers, not the market.Having no reservewhen an emergencystrikeswill result in the samekind of price spikesseenin Californiawhenthesupplydropped. When statesrequire their IOUs to sell their operatingfacilities, the purchasersare often a new subsidiaryof the existing IOU (Pacific Gas and Electric) or a subsidiaryof an IOU in anotherstate(Cinergy, Duke Energy).The major differencein operationsof theseplants is that they areno longersubjectto many of the regulationsthat they wereunderthe IOU's ownership.This restructuringled to one of the critical factors in the California crisis when severalplantsin the statewere shutdown for maintenanceat the sametime. The numberof megawattsoff-line was triple what had beenthe practiceunderregulation.Without a coordinator eachcompanyplannedclosuresindependently,resulting in a major shortageat the time of year when there is normally a surplus. Pennsylvaniahad somemajor advantagesover California. It beganderegulationwith a surplusof generationsupply in 1999andthe transmission systemthat allowed for easyaccessto the grid acrossthe Mid-Atlantic

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states.It also benefitedfrom a plethoraof retail providersthat cameinto the market.While Pennsylvaniahad ninety-six competitors,California consumershad fewer than five. Virginia was unable to attract outside providers becausethe price there was already relatively low (www. americanhistory.si.edulcsr/powering/past). Without a competitiveprice to offer, new providers will not enter the market, and consumerswill have little incentiveto switch providers.Anotherroadblockto building a competitive market where prices are already low is that companies will be drawn to statesonly where they can chargehigher prices and make higherprofits. The companiesthemselveshave little incentiveto entera marketin a statewherepricesare alreadylow. Texasbeganfull deregulationon January1,2002.Six monthslater, only 4 percentof ratepayershadswitchedto alternativeproviders.Some regions of the statewere exemptfrom retail choice becauseof the absenceof a regional transmissionsystemin thoseareas.Texasrequired its utilities to divest 85 percentof their generatingcapacity.The state, home of the Enron Corporation,was not immune to the problemsthat plaguedCalifornia. An Enron affiliate, New PowerHoldings, folded in the spring of 2002, after booking almost a third of all switchesduring deregulation(Piller 2002). Enron was also fined by the TexasPUC for usingphony"washtrades"to drive up pricesandrevenues(Piller 2002). Wash trades,also known as round-trip transactions,are shamtransactions in which a companysells a productand buys it back.This inflates the company'ssalesfigures. The PUC also actedto preventcompanies from creatingcongestionon the grid and driving up prices artificially. Ohio's deregulationprogramalso beganon January1,2001.At the time, the Ohio PUC had certified thirty-eight energy suppliers;by the end of 2002, only two remainedin the market (Tongren2003). Ohio's law permits municipalitiesto establishan opt-out communityaggregation buying group. Thesegroupsnegotiatewith providersto obtain low prices for their members.Consumerscan opt out of thesegroups and choosetheir own provider.The Ohio Consumers' Counsel(OCC) found that by the end of 2002, about98 percentof Ohio's residentialcustomers had switchedthrougha group and that supplierswerenot marketing directly to individual customers(Tongren2003). The OCC also found that there was very little competitionin large areasof the state. If provider choice was the rationalefor deregulation,it doesnot appear to be working very well. In all statesthat have deregulated,the original number of competitorshas declined considerablyover time. 79

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Somestates--CaliforniaandVirginia, for example-attracted few competitorsin the fIrst place.A studyby the NationalCenterfor Appropriate Technology,publishedin September2002,reportedthat few companies were willing to serve residentialcustomers."In Ohio, Massachusetts, and New York, thereare eitherno marketersor only one or two marketersoffering competitiveelectric serviceto residentialcustomersin most utility serviceterritories" (FosterElectric Report 2002). The study examinedelectricity deregulationin Ohio, Massachusetts, Texas,andpart of New York, andnaturalgasderegulationin Georgia.It found that residentialcustomers,particularly low- and middle-income residents,were generallyworseoff after deregulation,especiallyif they were subjectto short-term pricepass-throughs.Low-income residents aremoreproneto be chargedhigherpricesbecausethey canbe switched to a providerof last resortthat hasno competitors.The exceptionswere found in Ohio and Massachusetts wherecustomersare involved in optout aggregation.Becausethesebuying groupsare coordinatedby a political jurisdiction, all residentsenjoy the benefIts unlessthey opt out. The poor or the less clever negotiatoris not disadvantagedin the marketplacein thesecases. The California energy crisis spurreda numberof delays in the deregulationplansof somestates,and in one case,Nevada,the governor reversedderegulationlegislation altogether.The justifIcation for the delayswasprimarily to allow statestime to studythe stateelectrictransmission systemsand the generatingcapacity to support competition, that is, to build power generatingplants if needed.Thesestatesare apprehensiveabout deregulationafter watching California's experience. Here are someexamplesof how the California energy crisisprompted other statesto react: • The governorof Kentucky called a previouslyunscheduledEnergy Policy Board meeting,in order to discusswhetherthat stateis at risk for powershortagessimilar to thosein California, and whether the state power grid can handle the new power plants slated for development. • Montanadelayedthe transition period toward deregulationto the year 2007, while simultaneouslyproviding low-interest loansfor new or upgradedtransmissionfacilities or generationplants. • Oregon'sgovernorcalled on residents,businesses,and local governmentsto reduceusagein order to conserve.

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• West Virginia placedits deregulationplans on hold until a study could be conductedto differentiatethe situation in California and that state,as well as to conducta study on tax law changesneeded before deregulationtakes hold. In addition, West Virginia's electricity programoffers lighting grantsfor schools,nonprofits, hospitals, and local governments.In February 2003, the Energy InformationAdministrationdescribedrestructuringin WestVirginia as inactive (Energy Information Administration 2003). • Minnesotadecidednot to undertakederegulationbecauseof energy supply shortagesin the region. • Nevada'sgovernorissuedthe NevadaEnergyProtectionPlan that spells out a strategyto both protectconsumersfrom skyrocketing prices and develop power plant transmissionline construction (www.eia.doe.gov/cneaf/electricity/chg_str/nevada.html). In New York, wherederegulationwent into effect in June2001,cities and entrepreneurs beganto developalternativeenergysources,suchas fuel cells to generateelectricity for homes, along with demand-side management(Johnson2001).The electricity surplusthatexistedin 1996, when the legislation was enacted,was supposedto last until 2005. Insteadsuppliestightenedand pricesroseby forty percentbetween1999 and 2001 (Banerjeeand Perez-Pen a 2001).

Choiceand the Market Consumerchoiceis one of the primary purposesof deregulation.Without choice,there is no competitionand without competition,pricescan only go up, or so basic economictheory assumes.Choice/competition was supposedto lower electricity prices after deregulation.Yet most statesthat deregulatedalsorequireda certainreductionin pricesduring a transitionperiod so that residentswere not subjectimmediatelyto the volatility of market prices. Consideringthe objectionsthat consumers raisewhengasolinepricesfluctuatein responseto seasonaldemandand world marketconditions,it is not hard to seewhy policymakerswanted to cushiontheseeffects for an initial period. Yet choice is not forthcoming in many statesthat havederegulated. All stateshave seenthe numberof providersshrink while somestates have not been able to attract many providers in the first place. Prices that fell initially haverisen in all stateswith deregulation,as fuel price 81

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hikes are passedthrough to consumers.Along with price uncertainty, consumersalsoface supply uncertainty,as statesno longerregulateplanning for new capacity. Given theseuncertainties,it is not surprisingthat fewer than half the stateshaveactive deregulationplans as of July 2003. Figure 6.1 shows the statusof deregulationin the states.No new deregulationpolicies havebeenenactedin the pasttwo years. The electricity marketis now a hodgepodgeof regulatedand deregulated companieswith the deregulatedcompaniesamassinggreaterpolitical power to pressurestatesto deregulate.The FERC has proposed nationalpolicy to requirederegulationto makethe marketuniform. This might make sensefrom an industry perspective,but not from a public policy perspectivein individual states.

What CompelsStatesto Deregulate? RhodeIsland's StateEnergy Office Web site offers a glimpse into the high hopesthat the statelegislaturehad when it enactedderegulation legislation in 1996: The legislaturefinds anddeclaresthe following: (1) that lower retail electricity rates would promotethe state'seconomyand the healthand general welfareof the citizensof RhodeIsland; (2) that currentresearchand experienceindicate that greatercompetition in the electricity industry would result in a decreasein electricity pricesover time; (3) that greater competitionin the electricity industry would stimulateeconomicgrowth (www.rilin.state.ri.uslPublicLaws/law96316.htm).

The reality for RhodeIsland'sderegulationdid not matchtheseexpectations. In fact, consumershave paid higher electricity costs,due to increasedfuel price hikes,andtherearefew alternativesfor peoplewanting different powergeneratorsthan what was originally offered underregulation. Of the small numberof customerswho chosealternativeproviders, most quickly returned to IOUs (Rhode Island Public Utilities Commission2001). The impetus to deregulatecame originally from the 1992 National Energy Policy Act and, more specifically, from the efforts of Kenneth Lay, CEO of the Enron Corporation,to developexemptwholesalegeneratorstatusin that law. Lay then embarkedon a major lobbying effort

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Figure 6.1

Status of State Electric Industry Restructuring Activity (as of February 2003)

law

Restructuring Delayed Restructuring Delayed Restructuring Suspended Restructuring Not Active

Source: U.S. Departmentof Energy Web site; availableat: www.eia.doe.gov/

cneaf/electricity/ch~str/regmap.html.

to get deregulationpolicies enactedinto law in individual states.ThenGovernorBush(Texas)phonedthen-GovernorRidge (Pennsylvania)to put in a good word for Kenny-boy (Bush'snicknamefor Lay). The otherthrusttowardderegulationcamefrom economistsandconservative think tanks that favor privatization over governmentmanagement. Their messagehas consistentlybeenthat regulationkeepsprices up and deregulationwill automaticallybring pricesdown throughcompetition. The fIrst statesto adoptderegulationwere, in fact, those statesthat have long had high electricity prices. They had strong pressurefrom large electricity users(industrial and large commercialfacilities) to allow themto contractwith electricity providersother than the regulated utilities. Residentialcustomersand small businesses stoodto gain much lessfrom deregulation-because they userelatively little electricity comparedto big users,their potentialsavingsindividually are proportionately 83

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small. Their political supportwas neededto get the legislationenacted, however,so statesgenerallysweetenedthe pot by mandatingminimum price reductionsat the initiation of choice. Except in New York where the plan was institutedthroughgubernatorialfiat, deregulationwas approvedby statelegislatorsfor the governor'ssignature. Note that the stateswith high prices also appearto be stateswith high demand,for example,New York, California, Pennsylvania,and Massachusetts. Hawaii, which has the highestprices in the nation, is unableto deregulatebecauseit cannotconnectto a transmissiongrid. Thus, the high price/highdemandstateshad a strong incentiveto deregulate.Stateswith low prices and low demandhave generally not deregulated,and Virginia's experienceillustratesthat it is hard to attract competitionwhenpricesare low to begin with. On the otherhand, thosestatescanbecomeexportersof electricity to their wealthierneighbors and enrich the statecoffers without taxing their own residents. This was the situation when California deregulated.With its high demand and high prices, California was persuadedby large users and other businessesthat unlessthe statederegulatedso that prices could comedown, the companieswould move acrossthe borderto Arizona, Nevada,or Oregon.Federalenergypolicy law would ultimately make it possiblefor thesecompaniesto contractdirectly with lower-priced providersin any case.Becausethere was a surplusof electricity in the westernstateswhenthe policy was developed, California policymakers and consumersexpectedprices in neighboring statesto remain low and even to go down more afterderegulation.By the time deregulation beganin 1998, however, demandin California and neighboring stateshad risen. Populationgrowth in Nevadaand Arizona drove up demandin those states.Drought in Oregon and Washingtonfurther limited the supplyof electricity in the winter of 2001. WhenCalifornia's prices rose, those providers diverted electricity from their own customersto capturehigher profits from California, driving up prices in their own statesas well.

Why Do Electricity Prices Vary from Stateto State? Three factors principally accountfor most of the difference. First, stateswith thriving economiesand/or population growth will have high demandfor electricity,andin-state supply does not keep pace with it. Energy demandcorrelatespositively with economicgrowth.

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A secondfactor is the fuel used to generateelectricity. Prices in Washingtonand Oregon have been historically low becausehydro plantsare usedto generatemuch of their electricity. So long as there is normal rainfall in the Pacific Northwest,the "fuel" will be abundant. Fossil fuels like coal, on the other hand,are more expensiveto use primarily becauseof environmentalregulations.Natural gas is becomingthe fuel of choicefor newer-generationelectricity plants, but this fuel is also subjectto price fluctuations. A suddenincrease in the priceof natural gas in December2000 contributedto the price shocksin California. Nuclearpowerplantsalsodrive up prices.These plants are one of the principal reasonsthat the utilities demanded recovery of their "strandedassets"in return for their political support for deregulation. Third, statesthat have stringentenvironmentalprotectionlaws will havehigher prices. Theseregulationscover the siting and construction of power plants as well as pollution control for burning fossil fuels. Stateswith strongenvironmentalprotectionlaws-California,Pennsylvania, and New York, for example-havehigher electricity prices than stateswith less stringentlaws-Arizona,New Mexico, and Texas,for example. With regulation,statesmaintaineda balancebetweensupply and demand for industrial use, economicdevelopment,and residential/commercialpurposes.Thosestateswhereenvironmentalprotectionis a strong public policy value also managedthe trade-offsbetweengeneratingcapacity and the environment.Under deregulation,however, statesare pressuredto loosenenvironmentalregulationsin orderto streamlinethe approvalprocessfor constructionof new power plants. This was particularly the caseduring the California crisis. The statewas beratedfor not havingapprovedconstructionof new powerplantsduring the 1990s. In response,the state weakened environmentalprotectionand sped up the review processsothatmorecapacitycouldbe built in the statequickly. Oncethe economycooledoff, however,few of thoseplants were actually built, leaving the statevulnerableto future supply shortageswhen the economyrecovers. Deregulationmay also pushpricesup in lower price statesthat abut high-price states.Prices rose in Oregon,Washington,and British Columbia during the winter of 2001, partlybecauseof the generaldrought conditions,which reducedelectricity supply,but alsobecausethe companies reducedin-state supply further by selling to California at greatly 85

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inflated prices.In any market,companieswill act to maximizetheir own profits with little concernfor the effect on consumers.With no legal constraintson predatorymarketbehavior,companieswill behaveexactly the way they did in the westernmarketduring the winter of 2001.

How Much Can or Will Prices Fall WhenDemandDrops? In theory, prices should come down when demanddrops becauseof either increasedsupply or economicdecline.The promiseof deregulation was lower pricesbecauseof increasedcompetitionand supply.The reality is somewhatdifferent, however,as the statesare learning. Most of the new competitorsin the electricity marketare not producerswho would build new capacity.They are only traders,middlemenwho buy electricity from a providerand auctionit off to statesthroughtheir independentsystemoperators.In general,supply is not increasing,only the numberof sellers,and pricesare not falling with decreaseddemand.In California and New York, retail prices rose after deregulation,offset slightly by mandatedreductionsin the deregulationlegislation.In Pennsylvania and New Jersey,savingsvirtually disappearedless than two yearsafter deregulation(Lowe 2002).Montanasuspendedderegulation when prices rose precipitously.

How Much Can Prices Fall? Economic theory promisesthat competition-manyproducers--can automaticallybring pricesdown becauseofthe supply-demanddynamic. In a marketwhere start-upand operatingcostsare high, however,how far can prices fall? Becausenew plants are expensive,producersin a free market will not invest in new capacity during a slow economy. They prefer, logically, to maintain supply at the current level so that pricescan be maintainedat the level neededto covertheir costsof construction and operations.Without a guaranteedprice, they standto experiencesignificant lossesby building new capacitythat would drive pricesdown. From their perspective,an increasein demandabovecurrent capacity is preferable.From the states'perspective,however, an increasein supply with declining prices is preferableto meet peakdemand needsand attract economic development.Without the kind of market managementavailable under regulation, statesno longer have the ability to plan electricity supply and demandor to moderateprices acrossall customers. 86

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Who Really Benefits from Deregulation?

In theory, everyonebenefitsin a deregulatedmarketwhereusershavea choiceamongmany suppliers.In electricity restructuring,it appearsthat most of the benefits so far have gone to the energy companiesthemselves, including energy traders,companiesthat did not exist before deregulation.Many of the old-line utilities createda separateenergytradingcompany,especiallythosethat were forced to sell their generating assets.Largeelectricity usersalsobenefitbecausethey cancontract directly with energyprovidersand lock in favorableratesthroughlongterm contracts. Overall, choice for retail customershas declined everywherethat deregulationhasbeenimplementedand priceshavenot maintainedlow ratesover time. In somestates,thereneverwas much choice.Pennsylvania and Ohio initially had a large numberof new energycompanies competingfor retail customers.Thosenumbershavefallen within a relatively short period of time as the start-upshave fallenvictim to rising costsof electricityfrom the sameutilities that they arecompetingagainst. Studiesof deregulationare finding that promisedsavingshave not materializedoutsideof those mandatedby legislation, most of which are in effect only until strandedassetsare paid off. Consequently,we could concludein summer2003 that residentialand small commercial customerswere no betteroff than theywere underregulation,and some Texas,Ohio, and part of New were worseoff. A study of Massachusetts, York by the National Center for Appropriate Technology found that choiceand lower prices were achievedonly through the use of opt-out aggregation(FosterElectric Report 2002). In this strategy,municipalities or other branchesof governmentaggregateall users within their jurisdictionandnegotiatewith providersfor the bestpricesfor the group. Individual customerscan notify the governmentif they want to opt out of the group.Only OhioandMassachusetts usethis strategyso far. Such buying groups were not legal during regulation. So, ironically, local governmentsin thesestateshaveassumeda strongerrole in determining the price of electricity than they could have without deregulation. While the experiencesof other stateswith electricity restructuring havenot beenas catastrophicas California's,they do not appearto provide a strong argumentto persuadeother statesthat have yet to implementderegulation.Therisk of anotherCaliforniamarketcrisis is probably small becausethe backlashagainstthe companieshasbeenso

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damagingto them. Whetherother statesare willing to take this risk remainsto be seen.Deregulationactivity hascometo a halt for the time being and the weak economyhas also easedthe demandfor electricity. The memory of Enron's manipulationsis still fresh, and California is still trying to recoup$9 billion in overchargesfrom the winter of 2001. In June2003,thePERCruled that contractsnegotiatedduring the height ofthe crises werevalid (FederalEnergyRegulatoryCommission2003). California was thusdeniedauthority to renegotiatethe contractsdespite above-marketcosts. Statesare dealing with large budgetdeficits that require major spendingcuts or tax increases.Policymakersmay feel that the political price that they would pay to restructureelectricity in their statemay simply be too high at this time. In chapter7, we look at what the statesreportedastheir energypolicy interestsin the late 1990s,after the beginningof deregulation,in comparisonwith my 1992 study.

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7 State Energy Policy in 2001

In the summerof 2001, the Mission Statementof the California Energy Commissionread as follows: It is the California EnergyCommission'smissionto assess,advocateand act through public/privatepartnershipsto improve energy systemsthat promotea strongeconomyand a healthy environment. It is the vision of the California EnergyCommissionfor Californians to haveenergychoicesthat are affordable,reliable, diverse,safeand environmentally acceptable.(www.energy.ca.gov/commission/mission_ statement.html)

These statementsillustrate succinctly the intereststhat the state of California holds for its energypolicy. Despitethe rushto turn electricity over to the free market,the state'senergypolicy interestsappearto remain the sameas they were a decadeearlierbeforerestructuringbegan. The 1992 study outlined in chapter3 revealsthat the states'energy policy interestsare inextricably linked to policies for the poor, the economy,and the environment.1 These findings are consistentwith studiesconductedin the late 1970s.Electricity restructuringcreates an energypolicy that is linked primarily to marketinterests.The advocatesfor market-basedenergypolicy imply that priceswill fall so low that the poor will haveno difficulty payingandthe economywill thrive as well. Impactson the environmentare dealt with throughthe choice option. In a market,peoplewho value the environmentwill show their preferencesby choosingto pay a higherprice for electricity generated from "green"sources.And becausethereis no longerany requirement for the stateto produceits own supply of electricity, environmental valuesin the statecan be protectedby buying electricity from sources outsidethe state.

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The reality of the California experienceof 2000-2001differed markedly from this theory. In the aftermathof the experiment,all consumers were payingmuchhigherelectricity ratesthan they werebeforederegulation, the economywas flagging,2 and the stateapprovedconstruction of new powerplantsall overthe state,relaxing environmentalstandards to speedup construction.The missionof the StateEnergyCommission, however,continuesto representthe energypolicy goalsof the majority of Californiansand the state'spolicy interests. This chapterexaminesthe energypolicy interestsof the statessince deregulationbeganto spreadacrossthe country. The researchfor this chaptersoughtto documentthe states'energypolicy intereststen years after the studydescribedin chapter3. Visiting the web sites of all fifty states,we identified the missionsand programsof their energyoffices. State Web sites were identified using links from the Web site of the NationalAssociationof StateEnergyOffices (www.naseo.org/members/ states.htm).Information was gatheredon the following factors: • the location of the stateenergyoffice within the stategovernment structure; • the mission of the stateenergyoffice, if provided; • the primary programsof the state energy office, as statedon the Web site; and • any programsspecifically relatedto electricity. As the primary sourcesfor this researchare Web-based,the results may not reveal the entire rangeof activities of the stateenergyoffices. While the majority of the Web sitesare fairly detailed,othersare lessso. This point aside,the resultsdo provide a useful framework for discussing stateenergyoffice activities circa 2001. Definite patternsand trends were detectedin all of the focus areas.

StateEnergyOffices Stateenergyoffices were initially establishedin the 1970swith funding from the federal government.When that funding disappearedin the 1980s,many statescontinuedto fund the offices using allocationsfrom court decisionson oil overchargesin the 1970s.In the first Bushadministration, the passageof the National Energy Policy Act of 1992 mandated the establishmentof state energy offices and restoredfederal funding to supportthem. 90

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Location of StateEnergy Officesin the StateGovernment OrganizationStructure The location of the energyoffice is a clue to the state'senergy policy priorities. All stateenergyoffices are supposedto promoteenergyefficiency and demandside management.The major purposeof theseprograms-for example, economic developmentor environmental protection-variesamongthe states. Twenty-two stateenergyoffices are locatedin a type of Department of Economic and Community Affairs (Alabama,Alaska, Florida, Illinois, Maine, Michigan, North Dakota,and Tennessee);Economic Development (Arkansas,Hawaii, Massachusetts,Mississippi, Nevada, Ohio, South Dakota, Washington,and West Virginia); Departmentof Commerce(Arizona, Indiana,Minnesota,andOklahoma);andthe Wyoming BusinessCouncil. Ten stateshavea type of Departmentof Energyindependentof other stateentities(California, Colorado,Kentucky,Maryland,Nebraska,New York, Oregon, Rhode Island, South Carolina, and Utah). Only seven stateenergyoffices are under the jurisdiction of types of Departments of Natural Resources(Idaho,Iowa, Louisiana,Missouri, Montana,New Mexico, andPennsylvania).Two are locatedin a Departmentof Administration (North Carolina and Wisconsin) and two are locatedin a Departmentof Facilities (Delawareand Georgia).The othersare underthe jurisdictionof completelydifferent agencies,suchasthe Office of Policy andManagement(Connecticut),the Boardof Public Utilities (New Jersey), the Comptroller of Public Accounts (Texas), the Departmentof Mines, Minerals and Energy (Virginia), and the KansasCorporation Commission.Appendix 1 provides the Web addressfor eachstateenergy office. The clear link betweenenergypolicy and economicinterestsis evident in the fact that almost half the stateenergyoffices are housedin departmentsthatfostereconomicdevelopmentor commerce.Six of these statesare also energyresourceproducers(Illinois, Ohio, West Virginia, Indiana, Oklahoma,and Wyoming) indicating an emphasison marketing for indigenousfuels as a focus of stateenergypolicy. We looked at the correlationbetweenthe location of energyoffices and the individual state'sprogresstoward electricity restructuring.Figure 6.1 showsthe statusof electricity restructuringactivity in the states as of February2003. The only changein the map after June2001 was 91

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Table 7.1

State Energy Office Location and Electricity Restructuring State

Energy office location

Arizona Arkansas California Connecticut Delaware Illinois Maine Massachusetts Michigan Montana Nevada New Hampshire New Jersey New Mexico New York Ohio Oklahoma Oregon Pennsylvania Rhode Island Texas Virginia West Virginia

Department of Commerce Industrial Development Commission California Energy Commission Office of Policy and Management Division of Facilities Management Department of Commerce and Community Affairs Department of Economic and Community Development Department of Economic Development Department of Consumer and Industry Services Department of Environmental Quality Department of Business and Industry Governor's Office of Energy and Community Services Board of Public Utilities Energy, Minerals, and Natural Resources Department State Energy Research and Development Corporation Department of Development Department of Commerce Office of Energy Department of Environmental Protection State Energy Office Comptroller of Public Accounts Department of Mines, Minerals, and Energy Development Office

for WestVirginia andOregon.Oregonis now actively restructuringelectricity, and West Virginia has discontinuedrestructuring.The location of the energyoffice doesnot appearto correlatewith restructuringactivity in thosestatesthat havecompletedlegislation,as shown in Table 7.1. Of the twenty-threestatesthat had begunto restructure,only ten had energyoffices in Departmentsof Commerceor EconomicDevelopment. More important,perhaps,is that twelve of thesestateshaveindigenous energy resources(coal: Illinois, Montana, Ohio, Pennsylvania, Virginia, and West Virginia; gas and oil: California, Oklahoma, and Texas;oil shale: Nevadaand New Mexico; renewables:California and Oregon). Of the stateswhere there was active considerationof restructuring, sevenout of eighteenare resource-rich(coal: Colorado,Indiana, Kentucky, and Wyoming; gas and oil: Alaska and Louisiana; renewables: Washington).Of the eight statesthat had made no movementtoward deregulation(Alabama,Georgia,Hawaii, Idaho,Kansas,Nebraska,South Dakota,Tennessee), only Kansas,with largedepositsof naturalgas,has

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significant suppliesof indigenousenergyresources,althoughTennesValley Authority. seebenefitsfrom the presenceof the Tennessee This study did not attemptto developcorrelateswith suchfactors as political partiesof the governorand the legislature,or the influence of the businesscommunity. A glance at the map revealsthat a high percentageof the early statesthat deregulatedhad at least a Republican governor(Arizona, California, Connecticut,Illinois, Maine, Massachusetts,Michigan, Nevada,New Mexico, New York, Ohio, Pennsylvania, Texas, and Virginia). Many of thesestatesalso have energy resource industriesor electricity providers. Missions of State Energy Offices

When we examinedthe mission statementsof the energy offices, we found uniformity of emphasison energyefficiency regardlessof location, althoughtheir purposesvary. The Texas StateEnergy Conservation Office (SECO) mission statementprovidesa historical context of the birth of stateenergyoffices, specifically with regardto funding: Createdin responseto the Arab oil embargoof 1973 and the resulting nationalenergycrisis, the Texasenergyoffice hasevolvedfrom its original function of respondingto statefuel shortageemergenciesandadministeringfederalenergyconservationgrantsto its currentrole asa statewide promoterof energyefficiency and provider of energy managementservices, which [has] a positive impact on state energy expendituresand local propertytax rates.The primary funding sourcefor SECOprograms has been oil overchargesettlementsof alleged violations of price controls in effect for crudeoil and refined petroleumproductsbetween1973 and 1981. While the U.S. Departmentof Energy is the federal agency responsiblefor ensuringcompliancewith the court settlements,the state's responsibility is to return thesefunds to the citizens of Texas through promoting and supportingenergyefficiency and renewableenergyprogramsaccordingto stateand federal guidelines.

The mission statementof New Mexico's Energy Conservationand ManagementDivision, underthe auspicesof the Energy,Minerals, and Natural ResourcesDepartment,is succinct: "encouragingefficient energy usein New Mexico by offering programsand informationfor state agencies,companies,and individuals." The missionof Ohio's Office of EnergyEfficiency is more visionary

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in that it statesa broaderjustification for the work it does: "It is an essentialgovernmentfunction and public purposeof the stateto promote the efficient utilization of energy... for the creationof jobs and employmentopportunities,the encouragement of economicgrowth, the promotion of the generalwelfare, the protectionof public health and safety,and the protectionof environmentalquality." Severalstateshave an especiallystrong economicemphasisin their missions.For example,Indiana'sEnergyPolicy Division of the Departmentof Commercestates:"By improving the energyefficiency of Indiana businesses,we can improve their ability to compete in the marketplace;by improving the energyefficiency of Indiana'sconsumers, we can increasetheir spendingand saving powers." Tennessee's Departmentof Economicsand Community DevelopmentEnergyDivision talks of theripple effectsthatenergyefficiency hason the economy: " . . . every dollar that is spent on energy efficiency rather than consumptionis reflectedexponentiallyin local economicgrowth." Typical phrasesfound in stateenergy office mission statementsinclude: managementof energy;developmentof scienceand technology; efficient energy systems;grants; management,conservation,compliance,and enforcement;environmentallysound;and financially viable. Programs of State Energy Offices

Stateenergyoffices vary in their levels of activity and in the programs they offer to the public andbusinesses. Stateenergyoffice programsare shownbelow accordingto type of programand numberof statesoffering them. Table 7.2 identifies the types of activities for each kind of programand the numberof statesthat report the activity as part of their energyprogram. First order programsare those that have traditionally been part of energyprogramssince the 1970s.The majority of statesoffer many of theseprograms.The low numberof statesoffering weatherizationand recycling programsis surprisingand may meanthat theseprogramsare offered by other state agencies.Secondorder programsare those offered by a few statesand tend to be focusedon state-specificinterests. Third orderprogramsuseemergingtechnologiesto improve energyefficiency and focus on global energy issues.Becausestatesmay have activities that overlapthesecategories,it is not possibleto identify individual statesas subscribingexclusivelyto onetype of program.Appendix

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Table 7.2

State Energy Program Activities by Category Program category

Activities (no. of states providing each)

First order

Residential and commercial energy efficiency codes and standards (19) Consumer tips on energy efficiency (29) Weatherization assistance (12) Primary and secondary school energy education programs (8) Technical assistance and energy audits of residential and commercial buildings and schools (23) Energy tax credits, low-interest loans, or grants for energy efficiency for residential and commercial buildings and schools (20) Transit programs, including carpooling, vanpooling, ride sharing, alternative fuel vehicles (26) Alternative energy development (34) Recycling, including compost education (9)

Second order

Statistics on state energy usage (8) Air resources management (7) Water resources management (8) Industry-specific energy efficiency programs' (8) Treatment, storage, disposal of low-level radioactive waste, and brownfields cleanup (7)

Third order

Technical assistance for businesses on telecommuting (2) Training energy management personnel to monitor or control energy consumption (5) Software packages for municipalities to track energy use and costs (6) Teaming with a university to undertake special energy projects (7) Sustainable developmenVsmart growth initiatives (3)

'Seafoodindustry (Alaska),cruiseindustry (Florida), coal industry (Illinois), aquaculture (North Carolina),swine wastebioremediation(North Carolina),mine subsidenceinsurance(Pennsylvania),farm methaneproject (Vermont), glassindustry (West Virginia).

2 providesthe list of statesthat offer eachprogramactivity. Electricity programsare discussedin a separatesection. Colorado,New Mexico and Oregonfocus on global environmental issuesand are taking the lead in developingcarbondioxide emissions standards,smart growth initiatives, and sustainabledevelopmentprograms.Colorado'sOffice of SmartGrowth offers technicalassistanceto local governments dealingwith the impact of growth. Such assistance includesdevelopinga vision, land useplanning,policies andregulations. 95

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In addition, the office maintainsa list of mediatorsupon whom municipalities can call to settledisputes. New Mexico'sEnergyConservationand ManagementOffice ties its pollution preventionprogram to sustainabledevelopment.The pollution preventionprogrampromotesthe efficient useof naturalresources andreductionof wasteby assistingbusinesses in identifying and implementing strategies. Oregon'sOffice of Energy leadsthe nation in reducingenergyfacility carbondioxide emissions.The office has a detailed energy facility siting processand partnerswith a nonprofit organizationthat buyscarbon dioxide offsets with funds providedby power plant developers. Severalstatesprovide grantsto local collegesor universitiesfor a variety of energyprograms.Someexamplesare: the University of Alabamaprovidestechnicalassistance to industrieson reducingenergycosts; North CarolinaAgricultural and TechnicalStateUniversity undertakes researchin energy use and efficiency in buildings and industrial processes;Emory University provides electric shuttle service in Atlanta; Maryland Energy Institute offers an energy managementcurriculum throughcommunity collegesand providestechnicalassistanceto local governmentson purchasingenergy;University of SouthCarolinaSchool of EnvironmentalEngineeringbuilds a sustainableHabitat for Humanity home; ClemsonUniversity offers a landscapedesign program for energyefficiency; andthe University of Texasinstallsphotovoltaiccells abovea garage.Suchstateprograms,if adoptednationwide,might make it possiblefor the United Statesto achievethe reductionsrequiredby the Kyoto Agreementon carbondioxide emissions,without seriouseconomic dislocation.

StateElectricity Programs Traditional stateelectricity programcomponentsinclude using the Energy Star rating program for energy-efficientappliances;conducting businesses; energyauditsof governmentbuildings, schools, homes, and providing building codesfor energyefficiency; and developingrenewableenergysourcessuchaswind, biomass,and solarpower.Public utilities have promoted demand-sidemanagement(DSM) and utilized integratedresourceplanningsincethe early 1980s.Both are vehiclesto help utilities offset rising demandand reducethe needto constructnew generatingplants.

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Theseprogramswere halted with the breakupof the utilities as part of deregulation.Companiesin a deregulatedmarketno longerhaveany incentiveto promoteconservationor efficiency. In California, DSM had slowed the rate of electricity demandby 15 percentbetween1983 and 1996. Theseprogramsstoppedwhen deregulationbeganbecausethe plants were no longerownedby a regulatedutility.

IntergovernmentalAspectsof StateEnergyPrograms While statesdemonstrablyare taking responsibility for their own energy futures, the role of federal policy is still significant. The Energy Policy Act of 1992, which madeelectricity deregulationpossible,also establisheda federal role in funding and supportingstateenergymanagementprograms.All fifty stateshave receivedgrantsand programmatic supportfor their energyoffices overthe pastdecade.Severalstates were still using oil overchargefunds, derived from court decisionsof the early 1980s,to fund their energyprograms.Many statesidentified the programRebuild America as one of their activities. This program was developedand funded by the U.S. Departmentof Energy to create public-privatepartnershipsto redevelopinner city areas.Energy managementis one of the elementsof the program.Continuedfunding for state energy offices and programslike Rebuild America is uncertain, given the Bush II administration'senergy policy priorities for energy developmentand the free market.The 2003 budgetfor the Department of EnergyreducedRebuildAmerica to funding weatherizationalone.

Conclusion While nineteenstateshave deregulatedelectricity, the study of state energy office Web sites identifies the broad intereststhat encompass stateenergypolicy. Theseinterestshavenot changedsignificantly over the past thirty years, except for the addition of programsto promote sustainabledevelopmentand carbondioxide reduction. States'energy policy goalscontinueto includethe complexof affordability for all customers, sufficient available supply to meet the needsof current residentsandbusinesses, andenvironmentalprotectionin a variety of forms. States,by and large,losecontrol overthis complexof policy interests when one segmentof energyis turnedover to the market.Statescannot risk the lossof control over theseinterestsas marketsrise andfall either 97

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throughthe businesscycle or manipulationof the market.The primary value of regulationfor the stateslies in the ability to plan and manage all of thesepolicy interests. Even as California becamethe ftrst stateto turn electricity provision over to the free market,the state'simmediateresponseto the crisis was to step in to defendits fundamentalenergypolicy goals and protectits complex interests.Other states,watching California, pulled back from implementingderegulation.In thosethat did open theirmarkets,many found that prices did not fall as predictedand competitorsdid not rush in to serveresidentialandcommercialcustomers.Even in the economic downturnsince2001, electricity priceshavenot fallen, despitethe fact that supply now exceedsdemand. This chapterhas documentedthat stateenergypolicy interestshave remainedconstantfor thirty years. The reaction of other statesto the California electricity crisis and the continuedfunding of energy efficiency programsin the statesdemonstratethat the statesdo haveenergy policy intereststhat differ from those of the market. The next chapter discussesthe market'sinterestsand the fundamentalconflicts that exist betweenthe marketand the states.

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8 The Market and the States

The companiesdidn't do anything wrong. That's the way the marketworks. -JeffreySkilling, then-CEOof Enron Corporation, speakingto Lowell Bergmanon Frontline, broadcastby PBS, June5,2001 Public policymakershavebeenpersuadedsincethe early 1980sto tum many governmentfunctions over to the marketon the premisethat the market is the most efficient way to achievepolicy goals as well as to make and sell productsand services.This chapterexaminesthe evolution of market-driven public policyandthe assumptionsof markettheory. The interestsof the market are evaluatedin relation to the interestsof the State! to addressthe questionof what happensto the public interest in a marketdriven by profit. In otherwords, how doesthe marketwork and can the Stateprotectthe public interestthrough the market? Economicsand Public Policy Until the late 1970s,U.S. policymakersassumedthat there were public intereststhat could not be met by the market,and,consequently,hadto be met by government,either through direct service provisionor through regulation-government interventionin the marketplace.Economistseven define "public goods"as thoseservicesand productsthat the marketeither cannotor will not provide becauseof the lack of profit opportunity. Regulationwasdevelopedinitially to overcomeso-calledmarketfailuresthat resultedin monopolyor predatorypricing or restraintof trade.2 Regulationincreasedduring the 1930sas the Franklin D. Rooseveltadministrationworked to stabilizethe economyafter the 1929 collapseof

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the stock market. Laws establishedat that time governedbanking and securities,aviation,andcommunications.Regulatorylaw protectedcompaniesas well as the public from unfair businesspractices. The next waveof regulatorypolicy developmentcamein the 1970s. Regulationsenactedin this decadefocused on protecting individual rights to clean air and water, workplace health and safety, and consumerproduct safety.Theseregulationsimposedsignificant costson businesswhile the benefitsaccruedto individuals outsideof the firm. At the time, regulatorsgenerallyemployedcommand-and-control enforcementmethodsthat requiredall companiesin an industry to meet andthe costs the samestandardsregardlessof individual circumstances, of compliancerose dramatically. Regulationcame under increasingattack in the 1970sfrom economists who arguedthat governmentwas imposingunreasonable costson businessandproducinglittle benefit.A betterway, they asserted,would be to use market incentivesto encouragebusinessesto achieveregulatory goals. Then the market could work efficiently to achievepolicy goals at much lower cost than the cumbersomecommand-and-control methodsof the governmentbureaucracy. The economicsargumentcoupled with questioningof government efficiency in generalbeganto reachsympatheticearsin both political parties,and the ideaof deregulationas a policy gainedmomentum.Deregulation of transportation-truckingand the airlines-wasinitiated in the Carteradministration.RonaldReagan'sadministrationexpanded on this baseand brought an ideological preferencefor free marketsto the forefront of government. There was an internationalmovementtoward privatization of government servicesat that time. The Thatchergovernmentin Britain complementedthe interestsof the Reaganitesandfree marketconservatism seemedto be sweepingthe world. Economistswere appointedto high-level positionsin the U.S. government;economicstheory beganto supersede democratictheory in schoolsof public administration.Murray Weidenbaum,an economicsprofessorwho becameChair of Reagan's Council of Economic Advisers, arguedthat all governmentprograms should be subjectedto cost-benefitanalysis(Weidenbaum1981). E.S. Savas'sbook on privatizationof governmentservices(1983) becamea widely usedtext in public administrationprogramsand a guidefor governmentat all levels. Servicesthat governmentshad provided for over seventyyearsbeganto be contractedout to private providers. 100

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The underlying rationalefor privatization and deregulationwas the questfor efficiency. Government,it was argued,is inherentlyinefficient becauseit does not have a bottom line and it is a monopoly. Furthermore, any governmentbureaucracyis weigheddown with policies and proceduresas well as unnecessarypaperworkthat only add to the costs of whateverthey do. The private sectoris far more efficient, according to this line of thinking, and can provide the sameor betterquality service at lower coststo the taxpayers. This logic carriedoverto theelectricity restructuringdebatein theearly 1990swith the addedfeatureof consumerchoice. Governmentprovides only one product--onesize fits all at one price. Regulatedutilities, althoughprivately owned,offer one productat setprices.The marketplace, on the otherhand,offers consumersmanychoicesof the sameproductsat various prices so that they can buy the productsthey want at the prices they are willing to pay from the vendorthey prefer.Why shouldgovernment interfere in such market transactions?Furthermore,it is alleged, governmentregulation inhibits the innovation that a free market stimulates by encouragingfirms to introducenew and improved productsthat expandthe rangeof choicesfor consumers.Regulatedcompanieswith a captivemarkethaveno incentiveto be innovative,so it is assumed. Theseargumentslent momentumto the movementto deregulateenergy andrestructurethe electricity industry.The vertical companieswere portrayedas fat and complacentbecauseof regulation thatassuredtheir profitability evenwhenthey madebadinvestmentdecisions.They were inefficient, it was said,becausethey hadno incentiveto shutdown costly generatorsso long as they could raise rateswith governmentapproval. Utility stocks representeda solid investmentin many portfolios, but they did not promisethe kind of gainsthat unregulatedcompaniesmight. They also carried little risk becausethe companieswere guaranteedto makea profit by the states. The utilities alsohadfew friends amongthe generalpopulation.Both consumergroupsandenvironmentalistscriticized the companiesfor their refusal to alter their ways of doing business.Consumersargued that electricity prices were too high and that they were inequitable,giving large industrial usersdiscountsthat were not available to residential usersand small businesses.Environmentalistscriticized the companies for their pollution, their reluctanceto invest in renewableenergy,their investmentsin nuclearpowerwithout regardto wastedisposal,andpricing policies that encouragedconsumptioninsteadof conservation. 101

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Thesecritiques intersectedwith the deregulationmovementin the conceptof choice. If the electricity market were openedto choiceretail wheeling-thenall consumerscould buy electricity at the lowest price. Environmentalistscould contract with providers of electricity generatedfrom renewablesources,thus encouragingthe market to investin suchfacilities. Utilities competingin this marketwould be forced to innovate to be more efficient and would respondfavorably to the demandfor cleaner,"greener"energy. Deregulation,then,fulfills a numberof public interests,at leastin theory. In the reality of California, however,it failed to meetany of theseinterests.Wasthis dueto a flawed deregulationplan?Haveotherstateslearned from this experienceand will deregulationelsewherebe successful?Is this just an isolatedcaseor are therefatal flaws in markettheory when it intersectswith theState'sinterests?Is therea fundamentalrole to beplayed by governmentin the marketplaceof a greatdemocracy?

How the Market Works The market is neutral to public interests.It simply operatesto provide productsthat customerswill buy. If manufacturerspollute the environment and consumerswant a cleanerenvironment,then theywill somehow signal their willingnessto pay higherpricesfor productsmadewith less pollution. Businesscustomers,however,will seekopportunitiesto reducecostsby moving to statesthat offer a more beneficial business climate,that is, fewer regulationsincluding pollution control. Equity is not a concernof the marketbecauseit is assumedthat the mix of goods availablewill offer somethingfor everyoneat pricesthey can afford to pay. It is also assumedthat consumerchoiceis a matterof preferenceor willingnessto pay and not a matterof economicprivation. If consumers were forced becauseof their poor circumstancesto buy only certain products,then they would not really havea choice.Thus, it is generally assumedin economicsthat what peoplebuy reflects their true desires. California's experiencewith electricity deregulationcan be seenas typical for a volatile market. Market theory basesprices on the supply and demandof a product.In a marketwheredemandis difficult to predict, as in electricity use, suppliers will try to gaugehow much of a productwill be neededat a given time so that they do not overproduce. Excesselectricity cannotbe stored;companiesthat generatetoo much will haveto sell it at reducedprices,if they can evenfind a buyer. 102

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The samething can happento buyerswho contractfor delivery of an amountof electricity that exceedswhat they needon a given day. They will thenbe forced to offer the excessto the marketat a lower price than they must pay for it. This was anotherlessonthat California's energy managerslearnedin the summerof 2001. Long-term contractssigned during the height of the crisis, for what seemedlike reasonablepricesat the time, becamewhite elephantswhen pricesdroppedlater in the year. California'sderegulationplanprohibited theutilities from enteringinto long-termcontractsfor electricity andrequiredthat they purchaseit from the spotmarket.The fear of policymakersin 1995 wasthat the companies would enter into long-term contractsto buy electricity at higher prices than could be obtainedon the spot market.Lawmakerswere certainthat priceswould go down with a competitivemarketandobtainingthe lowest priceswould be possibleonly in a day-to-dayexchange. Whenthe spotmarketdemonstrated that pricesgo up as well asdown andgeneratorsrefusedto sell to the utilities becauseof fears of nonpayment, the statewas forced to stepin to purchaseelectricity for the utilities. Economistsand energycompanyexecutivescriticized the statefor developinga deregulationplan that foolishly dependedon the volatile spot market. So, the California Departmentof Water Resourceswas authorizedin January2001 to negotiatelong-term electricity contracts at reasonableprices.At that point, "reasonableprice" had a very different meaningthan it did in the halcyondays of 1995 or during the economic downturn later in 2001. Negotiatorsestimatedelectricity needsbasedon normalpeakdemand for summeruse and contractedfor delivery of sufficient megawattsto meet this demandon a daily basis.Even so, they still forecastenergy shortfallsfor the summerof 2001 anddevelopedprogramsto encourage customersto conserve.When electricity use failed to rise to the forecastedlevels of demand,the California negotiatorswere caught with too muchsupply that could not be sold at the price they were payingfor it. Electricity that they werecontractuallyobligatedto purchasefor $130 per megawatthad to be auctionedoff to essentiallythe lowest bidderas low as $25 per megawatt-justto offset someof the state'scosts. This is not the result of poor negotiations.It is simply the way the market works. If you try to reduceyour risk through long-termagreements, then you have to be preparedto be wrong some of the time. Electricity cannotbe stored;it must be distributedas it is produced.So electricity producedfor a contractis delivered whetherthe demandis 103

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there or not. That increasesthe supply on the grid and lowers the price for all othercustomers.This is, in fact, why the deregulatorswantedto prohibit long-termcontractsin the first place. If the statewere a corporation,the loss would be a merebookkeeping entry. Corporations,after all, can afford to make mistakesinsofar as they can passon the coststo their customersor write off a loss on their tax returns.The state,on the other hand,hasno way to write off a loss. All of its mistakesarerevealedon the front pageof the daily newspaper andbecomethe leadstory on the six o'clock newscast.Moreover,spending public money on unusedelectricity draws funds away from other stateprogramsand operations.Spendingfor education,healthcare,social services,transportation,and otherstateprogramshadto be reduced in California in orderto pay for electricity contracts. States andMarket Interests The studiesof stateenergy policy have shown clearly that the states' energypolicy interestsare a reliable supply of energyat an affordable price for all usersin the state,producedin a mannerthat is environmentally acceptable.So far, the markethas not shownthat it can meetthese interestsor that it even wants to meet them. Both the leadersof the energyindustry and the BushII energytaskforce3 demonstratedthat to them a soundenergypolicy would requiredotting the countrysidewith power plants and extractingfuel resourcesfrom every piece of ground that might contain a little oil or gas to meet the demandof an energyhungry market.If we take theseleadersto be representativeof the market, then we canassertconfidently that, at best,the markethasdifferent intereststhan the states,and, at worst, the market'sinterestsare often in conflict with the states'interests. As we have seenin chapters3 and 7, the states'basic interestsin energy policy have not changedover the past twenty-five years. The states,more than the federal government,are responsiblefor the wellbeingof their citizens,their environmentalquality, and their economies. While the federal governmentcan look at the macroeconomyfrom an academicperspective,stategovernmentsseeit up close. Statesalso have a responsibility to protect their residentsfrom inequitabletreatmentor lack of accessto necessities.Their concern in energy policy is to make sure that all residentscan afford to pay what is necessaryto heat,cool, and light their homes.As we saw in \04

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the 1992 study, stateswere far aheadof the national governmentin beginningto developpoliciesto deal with global warming.The states, then, have concernsthat override those of the national government and the free market. .

The Market and Social Values

Americanindustry is extremelysuccessfulat flooding the marketplace with all kinds of goodsthat mayor may not have any social value, but they all carry some kind of social cost. Environmentalpollution is a major social cost of electricity generation.Governmentregulation requires companiesto make huge investmentsin environmentalcontrol technology,althoughthe CleanAir Act now authorizesthe use of economic incentivessuch as emissionstrading to help companieschoose the most efficient methodof cleanupand control. Economistsargue that if the public really wants a cleanerenvironment they will show their willingnessto pay higherpricesfor products that are producedin an environmentallysafe manneror that operate moreefficiently. Yet mostconsumersdo not havethat informationwhen makinga purchaseandlower pricesdo influencetheir shoppingchoices. In energy use, higher prices have beenshown to be a strong incentive for conservation,but deregulationpromisesto lower prices,thus counteractingefficiency and conservation. During the late 1970sand early 1980s,high energyprices and governmentsubsidiesled Americansto lower energydemandsignificantly throughconservationand the useof renewableenergy.The demandfor small efficient cars, most of which were built by foreign companies, convincedAmerican companiesto offer their own lines. Gasolinedemandfell so low that the pricesof Organizationof PetroleumExporting Countriescartel collapsed.Higher pricing also spurreddemandfor energy-efficient building materialsand appliancesto amelioratethe effects of high heatingand cooling bills. Regulation of electricity was originally conceivedas necessaryto overcomeanotherkind of marketfailure, the high costsof competition in a marketwherecompaniescould not be certainof making a fair rate of return. Stateregulationmadeit possiblefor utilities to earnfair rates of returnfrom a guaranteedcustomerbase.Deregulationwasmadepossible when the companiescould expandthat basebeyondstateborders and when small generatorsbecameeconomicallyviable. 105

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Oneof the fundamentalfunctions of the regulationof electricity is to managesupply so that it can meetthe demandwithin the statethroughout the year. Excesscapacityis built to provide sufficient electricity to meetpeakdemandneedsfor summerair conditioning.These"peakers" sit idle or operateat reducedcapacityuntil their productionis needed. Plant maintenanceis managedso that sufficient capacitywill be available while somegeneratorsare off-line. Utilities in California invested in conservationand efficiency programswhere it could be shown that they "produced"supply more cheaplythan building new power plants. They alsomanagedcapacityso that generatingcapacity couldbe added as demandincreased. Coordinatedplanningwas lost as soonas deregulationbecamea real possibility. With a free marketthereis po centralmanagementof supply and demand.Energy companieswant to sell as much product as they can at the highestprice they can get. Thereis no mechanismfor ensuring that the capacity will be available when and where it is needed. Companiesdo not build "peakers"becauseidle capacitywould increase costsand reduceefficiency. Nor is thereany incentivefor any company to encouragea customerto conserve,that is, use less product. Consequently, the messageto consumersis to buy and use productsthat require electricity with no regardto the latter'sfuture availability. The Profit Imperative

What happenedin California is simply a consequenceof the "profit imperative."Profit is all that countsto Americancorporationsand their shareholders.Thereis really very little to preventcompaniesfrom selling anything that will producea profit, regardlessof its social costs.I often tell my studentsaboutmy experienceasa youngmarketresearcher in a Fortune500 chemicalcompanyin the early 1960s.At that time, the fastestgrowing marketin the chemicalindustry was disposablepackaging. Chemicalcompanieswere madly competingto developall kinds of packaging:shrink-wrap,blister packs,coatedpapers,soft drink bottles, and so forth. I askedmy supervisoroneday how "we" would disposeof all this stuff. His responsewas "That's not the industry'Sproblem. It's government'sproblem."Clearly the solid wasteproducedby thesecompanieshas indeedbecomea major problemfor governments.We often think that America has always beena "disposablesociety," but, as this story illustrates,we havebeenencouragedto becomeso by the market. 106

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The questfor profits requiresa continualeffort to convinceconsumersto spend.Appliancesarebuilt with a limited life expectancy(planned obsolescence)so that they have to be replacedoften-moreappliance sales.Product models are frequently changed(new and improved) to entice consumersto buy again. Advertising shows us that we "need" things we neverthoughtabout before.And if we do not have the cash, thereis always a credit card companywilling to help us out.4 The U.S. economyis consumerdriven; it dependson consumersto continuouslyspendsothatcompaniescankeepmakinghigherandhigher profits and the economycangrow. The marketcannotcareaboutsocial equity or environmentalcostsso long as it must focus on the profit imperative.Any requirementsto internalizethesecostswill reduceprofits. At the height of the energycrisis in California, energycompanieswere posting hugeprofits and were the darlingsof Wall Streetinvestors.Pacific Gas and Electric (PG&E) Corporationpostedrecordthird-quarter profits in October2001 while still working to bailout its retail company from bankruptcy. The market sendssignalsto consumersto overconsume.New products are introducedall the time. Throughmassmedia,Americansat all economiclevels are shown the things that are deemednecessaryfor a prosperouslifestyle. Fifty yearsago, the distinctionsbetweenrich and poor were not so clear. Peoplewho camethroughthe GreatDepression and World War II tell us that they did not really know that they were poor. Todaytelevisionandnewertechnologiesprojectimagesthat readily demonstratethe productsneededto show that oneis not poor. Advertising tells us what we needto live the goodlife. Poorchildrentoday know that they are poor and still demandthe sameexpensiveshoesand electronic toys that rich children have. Since 1945, the economy in this country has grown impressively. The standardof living, measuredas grossdomesticproductper capita, is the highestin the world and in the history of the world. This measure, however,is really a dollar measureof how much stuff is producedand owned in this country and not a qualitative measureof living. It is not balancedagainstthe costsof commutinglong distancesto get to work in order to pay for the big housein the suburbs,the electric and electronic gadgetsit holds, and the SUV usedto get there and back. These costs,too, are folded into the GDP and standardof living calculation. Theseare actually hiddencostsof the consumermarket. During the electricity crisis, Californians were portrayedas energy

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hogs, crying abouthaving to pay too much for electricity for frivolous useslike hot tubs and computergadgets.Yet, theseproductsare usedall over the country, evenin climateswhereit takesmuch more electricity to heata hot tub. It is fair to ask, I think, whetherAmericansare energy pigs or marketvictims. If the marketoffers productsthat useelectricity without any concernfor the increasingpowerdemandthat they collectively represent,are consumersat fault if they then createthat demand? Shouldconsumersnot expectthat the electricity to operatetheseproducts would continueto be providedat low prices?Is that implicit in the explosionof electricity-usingproducts?Or is this just anotherone of "government'sproblems?" Market theory tells us that energy-producingcompanieswill rush in to producethe electricity neededfor growing demand.Yet that did not happenin California. The companiesinsteadreapedhuge profits from their existing suppliesand then castigatedthe stategovernmentfor not encouragingthe building of new powerplantsin the state.But this leads to anotherquestionabouthow the market is supposedto work. If consumersin a deregulatedmarketcan buy electricity from any providerin the country and most of the continent,then why doesthe statehave to have its own sourcesof electricity? Is the marketnot supposedto meet this demand?If the statehas to guaranteethat power will be available within its borders,then why shouldthe statenot alsoregulatethe industry to ensurethat generatingcapacity will be available when needed? Furthermore,in an unregulatedmarket, in-statepowerplants are under no obligation to sell their product locally if they can get a betterprice outsidethe state.Residentsof Oregonand Washingtonlearnedthis basic lessonduring the height of the California crisis, when their prices shot up as supply in the statedroppedwhile the companiesrushedto servethe California market. This casealso demonstrates that the marketdoesnot carehow profits are made.Many companiestoday do not make productsor offer direct servicesto consumers,they just make money. The energy wholesale generatorsare a prime exampleof this phenomenon.Most do not produceelectricity themselvesbut arebrokers-middlemen-who buy electricity from producersand then sell it to retail customersat the highest price they can command.They are under no obligation to offer all the electricity they have availableto the market at any given time but can withhold supply until they can get a better price. Becausetheir only productis money,they will seekthe greatestfinancial gain they can. 108

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This is apparentlypart of what happenedin California. Energycompaniesseizedthe opportunityto gain hugeprofits by limiting the supply availableto the market. Demanddid not rise significantly in the winter of 2001, but supply fell off sharply and prices for megawattsrose dramatically. This was done partly by taking generatingcapacity off-line for maintenance.It was also doneby deliberatelywithholding capacity when it was neededmost. The independentlyowned utilities and the customerswere left with no alternativebut to pay whateverthe market demandedfor a necessaryproduct. This resultedin a massiveshift of wealth from the stateand consumersto a few large energycompanies, mostly in Texas. In this kind of market, consumerchoice cannotbe said to be sovereign. There was no low price alternativeavailable. Consumerscould not choosenot to buy the product. Consequently, itcannotbe argued that this representsa truly free market. Free marketswork only where thereis completefreedomon the part of sellersand buyersto participate in the market.Wherebuyersmustacceptwhateveris offered,thereis no choice.Wheresellerscansetpricesthat arenot affectedby competition, thereis no free transactionin the market.This is preciselythe problem that SamuelInsull foresaw in supportingregulation of the electricity industry in the beginning.This is also why many economistsand state policymakersare now questioningwhether electricity deregulationis good public policy.

The StateInterest vs. the Market Interest Markets are relatively simple, accordingto conventionaltheory, but statesare complex. Stategovernmentsoperatein a political environment that must meetcompetingpublic needsin orderto maintaineconomic and political stability. Political leadersmust be sensitiveto the interestsof variousconstituenciesand must havea concernfor equity. It is said that politics is about who gets what, where, and how. Politicians who make the wrong decisionsabout thesefactors can jeopardize their own careers. The policy to restructureelectricity in California was developedin responseto the demandsof one political interest-largeenergy users that threatenedto leavethe stateunlesselectricity priceswerereducedand a political ideology that fit well with the then-governor'sambitions for nationaloffice. The final policy was designedto gain the supportof

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many other interests:the utilities, consumergroups, small businesses, environmentalgroups,andsoforth. All weredazzledby the marketpromise of cheaperelectricity ratesall aroundand choice of electricity provider. When the marketfailed to deliver on this promise,the impactson statepolitical leaders,especiallythe governor,were severe.s Only then did policymakersrecognizethe importanceof the otherinterestsat stake in energypolicy. A projected$10 billion state budget surplus was used to purchase electricity. This, along with a faltering stateeconomy,resultedin budget cuts for stateprogramssuchas education,transportation,and so forth. The stateeconomy,alreadysufferingfrom the collapseof the dot-corns, washit againas the costof doing businessin the stateescalatedbecause of energycosts.Energypricesare not isolatedto individuals but spread throughoutthe fabric of the economy.Higher businesscostsget passed on to consumersandotherbusinesses so that the impactof price hikes is magnified. Higher governmentand nonprofit operatingcosts take resourcesaway from programsand strain governmentbudgets.Higher energy prices reduceconsumers'spendingon other products, further contributingto economicdecline. The interestsof the statearethus compromisedby the interestsof the market. Where the state has an interestin equitableprices for all consumers,rich andpoor alike, the marketis interestedonly in maximizing profits, whetherby selling more at lower prices where demandis increasingor selling less at higher prices wheredemandis steadyor declining. Where the statehas an interestin protectingthe environment, for reasonsof public healthand aestheticvalue, the marketis interested only in reducingproductioncostsby externalizingwastes(pollution) as much as possible.Where the statehas an interestin strengtheningthe economywithin its borders,the marketdoesnot care wherecustomers operateso long as they keep buying the product. Theseare the fundamentalconflicts betweenthe marketand the state. The risks inherentin marketdynamicsare preciselythe reasonthat governmentsshouldexaminecarefully the prosandconsof privatization and deregulation.It is not purely a political issue,althoughthe electricity crisis surely threatenedGovernor Gray Davis's political fortunes, but it is an issue of market failure. A market failure occurs when the marketeithercannotor will not providea productthat the public needs. Governmentthen stepsin to offer servicesthat areperceivedto be in the public interest. 110

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The California electricity crisis was not a marketfailure, but, rather, a hugemarketsuccess.The marketoperateson one principle: the profit imperative.As long ascompaniescanmakea profit, the marketis working. And the higherthe profits, the betterit works. Damageto the public interest is of no concernto the market, for it will chargewhatevera consumeris desperateenoughto pay. Throughoutthe winter of 2001,the front pagesand editorial sections of Californianewspapers printedhand-wringingarticleseveryday about the power crisis. Back in the businesssectionsof these samepapers were reportsgleefully heraldingthe huge increasesin profits garnered by Enron, Duke Energy, and the other energybrokers,including California-basedcompanies,PG&E Corporationand Calpine.The companies haveno interestin selling the productat an affordablerate so long as there is a customerwho will pay more, as residentsof Washington Stateand British Columbiadiscovered. If California were to go dark becauseits utilities are bankrupt,then that would just be the fallout of a free marketfreely operating.The public interest is of no value to the market, although one might question whetherit is good businesspracticeto bankrupta statethat ranksas the fifth largesteconomyin the world. Conclusion The fallout from the winter of 2001 had not been settled almost two yearslater. At the endof June2003, the statewas still trying to recover billions of dollars in overchargesfrom energycompaniesthrough the FederalEnergy Regulatory Commission(FederalEnergy Regulatory Commission2003). Other statesadvertiseto entice California companies to relocatewhere electricity is cheaperand supply more reliable. Retail customersin California now face electricity prices that are 40 percentor more higher than theywere beforederegulation,and thereis no belief that they will comedown any time soon. In September2001, the California Public Utility Commissioneliminatedretail customerchoice in order to ensurethat the utilities would have enoughratepayersat the new higher rates to payoff their debts. Earlier in the summer,however, when wholesaleprices fell, the large users signedcontractswith energyprovidersto escapethe higher rates of investor-ownedutilities. This effectively passeson the majority of the costsof the deregulationdebacleto residentialand small business 111

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ratepayers.Nettie Hoge, executivedirectorof the Utility ReformNetwork of San Franciscosaid, "Big businesswantedderegulation,but when it resulted in skyrocketing prices, they were the first to bail. Now, they want to give it anothershot-atour expense."(Mitchell 2001: Business-5). In the end, California'sexperiencestruck a major blow againstthe ideaof electricity deregulationitself. Statesthat werein the processof restructuringbeganto put safeguardsin place and other statesbegan to rethink the whole idea of deregulation.It is unlikely that the old vertical industry will be resurrected-therewere problems with the regulatedindustry as well. What is certain,in my view, is that governmentat all levels will haveto examinemore carefully the public interest(andpolitical interests)beforeturning essentialpublic servicesover to a volatile, greedy marketplace.In the next chapter,we consider whetherit is possibleto achievea balancebetweenthe interestsof the marketand the states.

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9 Balancing the Interests of the States and the Market

Deregulationas public policy is a powerful idea that is not going away any time soon.Given the conflict betweenthe market'sinterestsand the public's interests,however,deregulationwithout governmentoversight seemsimprudent.This chapterexamineswhetherit is possibleto develop a balancedpolicy that can enablethe marketto work effectively while achievingnonmarketpublic policy interests.I try to proposesuch a balancethat matchesthe strengthsof the marketwith the public policy interestsof the state.I raisemore questionsthan I can provide answers to. Perhapsthat is just as well, as good public policy derivesfrom the interactionsof many interestsin the political arenanot just the ideasof one analystor one theory. What Is Good About Regulation? Regulationbeganin the United Statesin the 1880sasa reactionto predatory market practicesof the railroads.The InterstateCommerceCommission, the first regulatory agency, was establishedprimarily to overcomemarket abusesand establisha level playing field for both companiesandcustomers.The purposeof regulationsincethen, seenin suchagenciesas the Food and Drug Administration,the Securitiesand ExchangeCommission,and the FederalCommunicationsCommission, has been to overcomeexcessesin the market and to compensatefor marketfailure. As we haveseen,the pioneersof the electricity industry believedthat it should be regulatedas a natural monopoly. During the New Deal era,the industry was vertically integratedso that single companiesprovidedall electricalservices,from generationto transmission 113

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to retail distribution.With statesproviding oversightof companieswithin their borders,the industry thrived. California'scompanieswere among the bestin the country for both consumersand shareholders.They collaboratedwell with state regulatorsto meet the demandsof a diverse and growing stateeconomy.

Was DeregulationNecessary? Daniel Fessler,chair of the California Public Utility Commission,proposedderegulationpolicy in California in responseto the demandsof the big electricity users.It was not immediatelyembracedby most sectors in the state,and, in fact, was initially opposedby the utilities themselves.To most citizens, even today, it is not clear that the electricity industry in California was in need of fixing. The rush to develop deregulationpolicy to meeta theoreticalideal-freemarketefficiencywas clearly a seriousmistake,at leastas the policy was written. Today's retail customersare much worse off than they would have been had regulation continuedas it was in 1996. So, from the viewpoint of the majority of customers-residential, commercial,and small businessderegulationprobably was not necessary.Up to now, in any case,they have gained no benefit and, in fact, have suffered losses.Electricity costshaverisen by 40 percent,small customershave nochoiceof provider, and the retail electricity companiesthemselveshave declinedin market value. Among the biggestlosersof deregulationwere the thousandsofPG&E shareholdersand retireeswho lost their nesteggswhen the companyfiled for bankruptcy. On the otherhand, vertical integrationof the industry doesseemlike an anachronismwhen electroniccommunicationsystemshavemadeit possibleto buy and sell electronsat greatdistances.The productionof electricity can be separatedfrom transmissionand retail distribution. Why, then, should it not be freely traded the way other commodities are?Why should the statedictate how the businessoperatesany more thanit governshow pork belliesaretraded.If CompanyX in Kansashas excessgeneratingcapacityto sell to CompanyZ in Arizona, why should this transactionnot be made like any other market transactionwithout governmentintervention? If selling electricity itself can be done by the market, what of the remainderof the vertical industry, transmissionand retail distribution? Transmissiondoes seemto fit the model of a natural monopoly. It is 114

BALANCING INTERESTS OF STATES AND MARKET

difficult to envision in this segmentof the industry competition that would not involve multiple wires andtransmissiontowerscrisscrossing the countryside.This would be enormouslyexpensiveand inefficient as well as aestheticallyugly and probably dangerous.In addition, maintaining and managingthe transmissiongrid requirescoordinationthat would not be possiblein a competitivemarket. Continuing monopolyownershipof transmissionsystemsseemsto be the bestoption for the marketas well as the pUblic. What is not clear, however,is whetherthat ownershipshouldbe private orpublic. Thereis an argumentto be madefor state ownershipof the transmissiongrid, perhapswith managementof the systemcontractedout to private companies.Governmentownershipwould ensurethat all private companies retain accessto the grid and avoid the possibility of monopoly power beingexertedby the utilities to excludecertainproviders.The government would also be able to identify critical developmentneedsfor electricity transmissionand to strategicallyplan the growth and expansionof the system.Becausethe transmissionsystemmust be open to all competitors,there seemsto be no persuasiveargumentfor it being owned by the independentlyowned utilities (IOUs). Government ownershipmay better facilitate the workings of the market, especially if the systemwere establishedas a public authority with its own budgetingand bonding capability. That leavesretail distribution as the remainingsegmentof the regulated industry. Becausethis segmentincludesmaintenanceof the wires that carry electricity to individual locations,this would seemto be the most likely candidatefor continuedownershipby the 10Us.They have the equipmentand organizationalinfrastructureto continueto operate thesesystemsefficiently. They would continueto be regulatedmonopolies to preventprice gouging.On the otherhand,thereis no reasonthat this function could not also becomea public enterprise,following the exampleof successfulpublic electricity providerslike Los AngelesWater & Powerand the SacramentoMunicipal Utility District (SMUD). During the crisis, customersof theselocal government-ownedcorporations sawno price increasesandno blackouts.Municipally ownedcompanies havetraditionally providedpowerfor their people,respondingto public demandto protectregional interests,as well. In the 1990s,SMUD decommissioneda nucleargeneratorfollowing a citizen referendumin which voters approveda rate hike in order to cover the generator's strandedcosts. 115

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Local governmentsall over the stateof California beganto consider public poweroptionsfollowing the crisis. Somestudiedthe possibility of developinga municipal utility district that would generateits own power. Others consideredbecomingexempt wholesalegeneratorsto contractwith providersfor wholesaleelectricity that they would then sell at retail to their own citizens. The citizens of San Francisconarrowly defeatedan initiative in 2001 that would haveallowed the city to take over the PG&E systemthrougheminentdomain.EastBay Municipal Utility District in Oakland,which provideswater to a large population, held public meetingsto discussthe possibility of becoming an electricity utility as well. The greatestirony to come out of electricity deregulationcould be local governmentsenteringthe marketthat they had previously stayedout of becausethe regulatedindustry provided reliable serviceat an affordableprice. What Is GoodAbout Deregulation? Regulationseemslike an anachronismin an advancedglobal economy. As competitionexpandswith companiesoutsidethe bordersof the state and the nation, regulationseemsto be increasinglyrestrictive.Deregulation promisesthe opportunityfor innovation,new products,and technologicalchange.Regulation,on the otherhand,supportsthe statusquo and can reward companiesfor what would be considered badinvestmentdecisionsin a free market.So the supportersof deregulationpoint out that regulatedelectricity utilities investedin expensivenucleargeneration facilities only becausethey were guaranteeda return on their investmentthat might not havebeenpossiblein a competitivesituation. Theseinvestmentsdrove up the price of electricity while the companies amortizedtheir costs. In a free market, companiesthat make poor investmentswould falter in the face of competitorswho kept their operating costslow so they could offer consumerslower prices,too. That is the theory, at least. The evidenceto supportit is not always convincing. Regulatedcompaniesin the past had solid reputationsas efficient and innovativeoperations.Bell Laboratories,for example,was amongthe most creativeand innovative researchcentersin the world when it was part of the regulatedAT&T. Today as LucentTechnologies, it has founderedand is dangerouslycloseto going out of businessaltogether.The regulatedpublic utilities were solid, reliable investmentsin the portfolios of many retirees,pensionplans,and other mutual funds. 116

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Eventhoughthey wereregulated,they returneddependableprofits. They wereableto managetheir businesses in sucha way that they provideda reliable product at an acceptableprice and still provideddividendsfor their shareholders.Partof the fallout from the California electricity crisis was the loss of the pensionand retirementincome of thousandsof PG&E employeesand ordinary investors,many of them seniorcitizens who saw their retirementincomedecline.Thesewere long-terminvestors in the original companythat was spunoff underderegulationasthe retail distribution arm. It was this segmentof the companythat filed for bankruptcy.The parentcompaniesthat are now exemptwholesalegeneratorsmadehugeprofits while their operatingsubsidiarieswere going bankrupt.The new companiesrepresenta riskier investment,however, becauseprofits are linked to the volatile electricity-tradingmarketthat did not exist beforederegulation. The marketcan offer consumerschoicesthat the regulatedmonopolies did not, and it can sendsignalsaboutconsumerinterestsand willingnessto pay for products.Consumerscan createmarketsfor "green" electricity and non-nuclearelectricity if given the opportunity to contract directly with companiesthat supply electricity madefrom renewable resources.In California, the "green" provider Green Mountain EnergyCompanyattractedsignificantnumbersof customerswho were willing to pay slightly higher prices for environmentallybenign electricity. No other provider had the successin the California marketthat GreenMountain did. In reality, California residentsdid not havemany choices,and most customerschoseto stay with their IOU. This may indicatethat they were generally satisfiedwith the servicesoffered by the IOUs--demonstrating againthat residentialcustomerswerenot convinced that the systemwas brokenbeforederegulation. SinceCaliforniapolicyrnakersdecidedagainstretail wheeling,in order to gain the political support of the utilities, provider choice may not have been seenas a true choice by most consumers.Customersstill receivedtheir bills from the old companyso choice may have seemed overly complex. Thosewho did choosean alternateprovider received two bills eachmonth, one from the provider for the electricity and one from the utility for distribution costs.Table 9.1 showsthe actual January 2001 electricity bills for our householdfrom GreenMountain Energy and PG&E. They demonstrateamong other things why PG&E was forced into bankruptcy.The GreenMountain bill is succinct-kilowatthours used 117

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Table 9.1

Household Electricity Bills for January 2001

a. Green Mountain Energy KWh used Price per KWh Charge Service charge Total bill

519 $0.2718960 $141.10 6.95 $148.15

b. Pacific Gas and Electric

Transmission Distribution Public purpose programs Nuclear decommissioning Competition transition charge (CTC) Trust transfer amount (ITA)

$2.99 20.00 1.85 0.26 115.105.30

Summary Total charges Legislated 10 percent reduction Direct access energy credit Net charges Price per KWh Baseline usage Over baseline usage

$0.27187/Kwh

$62.58 6.26141.10$84.78-

379.5@ $0.11589 139.5@ 0.13321

(519) and the ratecharged(27 cents)plus a monthly servicecharge.Total charge:$148.15.The PG&E bill, however,is complex.It, too, hasa charge for electricity ($62.58),representingthe controlledrate that PG&E was allowed to charge,minus the mandated10 percentreduction, plus the distribution chargeand the Competition Transition Charge(CTC) that was designedto payoff PG&E's strandedassets.The CTC was envisionedasan addedchargethat PG&E could chargeuntil all of its stranded costswere amortized.In this case,however,the CTC is a negativecharge that reflectsthe differencein the marketprice and the regulatedprice. Becausethe maximumallowableprice was lessthan the marketprice, PG&E owedus $84.78that month. Even now, I do not understandthesebills. This kind of complex accountingmight well lead the averageconsumerto questionthe benefitsof providerchoice.Indeed,evidencefrom New York and California indicatesthat consumersmay not really want asmuchchoiceaseconomistsbelievethey should.Deregulationrequires peopleto make decisionsabout purchasesthat were previously simple transactionsthat were reasonablypriced and did not have to be negotiated. Choice brings anxiety and uncertaintyalong with freedom. In a truly competitivemarket,one canneverbe certainthat one hasobtained 118

BALANCING INTERESTS OF STATES AND MARKET

the lowestprice, whetheroneis buying a car or choosinga long distance provider.Somesocialcritics now arequestioningwhetherendlesschoice is even good psychologicallyand suggestthat peoplemay not want to be botheredmaking choicesfor every commodity (Johnson2000). Ultimately, consumersmay begin to questionwhetherderegulation actually delivers on its promises.Are pricesreally lower in a free market? Are choices really better?Airline deregulationinitially brought genuinecompetitionas new companiesenteredthe marketand offered low prices on travel that the large airlines could not. The large companieseventuallyboughtup mostof theseupstartsandthe numberof major airlines is smallertoday than beforethe industry was deregulated.The hub-city systemthat airlines usetoday gives themvirtual monopoliesat those locations, and the residentsof those areastypically pay higher fares than do travelersmaking a connectionthere. Cabletelevisionprovidesanotherexample.The cableindustry began in the 1970sas a regulatedmonopoly. Cities acceptedbids from cable serviceprovidersthat thenbuilt the systeminfrastructurein return for a monopolyto provideservicewithin the community.Deregulationof the cable television industry in the early 1990s was supposedto open the market to multiple providers, provide choice, and bring prices down. What has happenedin many regionsis that one provider has captured the market although, in theory, other companiescan enter the market. The only real competitionis from wirelesscompaniesthat use satellite technologyinsteadof cable.Pricesare much higher. In a competitivemarket,it is rationalbehaviorfor companiesto work to reducethe numberof competitors,as MancurOlson demonstratedin his classicThe Logic ofCollectiveAction (Olson 1965).Too many competitorsin a marketmakeit difficult for anyonecompanyto maximize its profits. Companieshave to gamble on the amountof market share that they can gain, and, consequently,either overproduceor underproduce.If they underproduce,they lose marketsharethey might havehad. If they overproduce,supply will exceeddemand,which lowers pricesand reduceseveryone'sprofits. This is easily seenin agricultural marketswhere a good year that producesbumpercrops leads to lower pricesper busheland thus lower profits for all producers. Olsonarguesthat marketstendto becomeoligopoliesin which a few largeproducersdominateandcanbettercontrol their own marketshare. Again, the airline industry is a goodexampleof this phenomenon.After deregulation,the presenceof many small airlines, offering no frills air 119

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travel at very low prices,cut into the marketshareof largecarriers.The large carriersthen cut their own prices,while continuingto offer superior service, until they had recoveredsufficient market share.Because they had better services,consumersnaturally choseto fly the bigger airline for the sameprice. Eventually the smallercompaniesfolded or wereboughtout by the big airlines andthe numberof carriersshrank.In an industry with high costsof operation,it makessenseto reducecompetition whereverpossibleso that profits for the surviving companies will be maximized.Thereare far fewer airlines today than in 1980and fewer large airlines as well. How free is a marketwherethereareonly a few providers?The California electricity market,in reality, wasnot truly competitive.The number of providers was limited at both the wholesaleand retail levels, offering an openinvitation to the kind of price manipUlationthat developed.What actually happenedin California may havebeenthe trading of a regulatedmonopolyfor a real one or, at best,an oligopoly. This shouldnot havecomeasa surprise.Electricity is not a commodity that canbe loadedonto a truck anddriven somewhere.The practicalreality is that electricity transmissionmust be done in a limited region becauseof transmissionlossesover longer distances.For statesthat are locatedon the edgeof the continent,as California is, accessto electronsis limited to those generatedin the immediateregion. California imports electricity from its neighboringstates,Mexico and Canada.Statesin the middle of the country, on the other hand,havemany more options.

Market Failures and Political Failures There were failures on both sides. Although the market did indeed work for the benefit of the wholesaleelectricity companies,it clearly failed to meet the needsof retail customers.Policymakers designed the mechanismsthat enabledthe companiesto gain huge profits, but failed to achieve the promisesof deregulation.Whether this was a market failure, as economistsbrand marketsthat do not operateefficiently, is anotherquestion. Several energy companiesmade huge amountsof profit which is the measureof successin the market.Even if thosecompaniesare eventuallyforced to return someof their profits, they are still likely to havebenefitedhandsomelyat the expenseof captive customersin California. It was clearly a policy failure in that deregulationfailed to servethe 120

BALANCING INTERESTS OF STATES AND MARKET

generalpublic interest.Policymakersbelievedthat deregulationwould reduceelectricity pricesthroughchoiceso that all consumersin the state would benefit.While someof the elementsof the policy were certainly flawed-the Power Exchangefor a notable example-choicedid not develop in the California market nor have many statesattractedmultiple providers,as we have seen.Ultimately in California, deregulation itself was a victim as the statemovedto protectthe energypolicy intereststhat deregulationdid not. The stateis now more involved in the electricity marketthan it ever was underregulation.It is purchasingelectricity, promotingand subsidizing conservation,and approving new generatingcapacity, some of which will be peakers-plants that will provide powerduring peakusage times or during maintenanceclosuresin the state.As the state expands its role and ensuresthat in-state generationincreases,it is questionablewhetherthe marketoutsidethe statewill everplayamajor role again. It is doubtful that any future governor, at least in the near term, could get the political supportneededto return to a marketthat so badly failed to meetthe public's interests. At the sametime, deregulationhasunalterablychangedthe electricity industry in California and most of the country. The regulatedutilities no longer exist as they were in many states,and they cannoteasily be put backtogether.The parentcompaniesaremaking higherprofits than were possibleunder regulation.Many of their generatingplants were sold to othercompaniesso that it would be difficult, if not impossible,to restructure the industry again.The companiesnow haveto operatewithin a deregulatedmarketwith considerablestatecontrol over their activities. The remainingissuethen is how it might be possibleto designpublic policy that would balanceboth public and private interests.Can the state protectits fundamentalenergypolicy interestswhile still enablingcompanies to makea reasonableprofit? If the stategetstoo involved in the market, will the companiesabandonthe statefor greenerpastures,statesthat allow them to make a higher profit? If the state withdraws from market control, will the companiesfmd new ways to generateextraordinaryprofits?Whatcanthe statedo to ensurethat the companiesbehavethemselves?

The New Role of the State The most importantroles for the stateare, first, as plannerand coordinator, working with the industry to develop generationfacilities in 121

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environmentallyfriendly ways,and, second,aspromoterof energyefficiency and conservationto reduceelectricity demandwithin the state. The marketcannotbe countedon to do eitherbecauseeachcompanyis interestedonly in maximizing its own profits and not in increasingproduction until demandhasappeared,becauseto do so would temporarily createexcesscapacitythat would lower prices.Companiesgenerallydo not urgecustomersto uselessof their productso we cannotexpectthem to promoteconservation. Under regulation,the public utilities usedto anticipatedemandand wereableto build facilities in anticipationof demandbecausethey were guaranteeda return on investmenteven for idle capacity. Companies werealsogiven incentivesto promoteenergyefficiency or demand-side managementin the form of a steadyprofit stream.No companyin a free marketcan afford to operatethis way, so it falls to the stateto identify growing demandand developplans for meetingit through either generationor efficiency. The statesalso haveto identify needsfor new capacity so that electricity remains available and affordable for all consumersin the state.The California exampleand othersdemonstrate that statescannotdependon the marketto maintain an affordablesupply of electricity. The statemust alsocontinueto developpoliciesthat encouragecitizens to adopt energy efficiency as a lifestyle. This is difficult for at least two reasons:market enticementsthat increasedemandand cultural biasesthat favor consumption.The market dependsupon continually increasingdemandand profits. Thereare no regulatorylimits on the developmentof new energy-usingproductsand no mechanism for evaluatingthe cumulativeenergydemandthat new productsrepresent. As Figure 9.1 shows, U.S. economicgrowth for the past thirty yearshas beenaccompaniedby growth in electricity use. The explosion of electronicsgadgetsbeginningin the 1980sis largely responsible for the exponentialgrowth of electricity demandduring the 1990s. During the sameperiod, housing developersbegan building bigger and biggerhousesthat include more electricity-drivenappliances,further stimulatingdemand.The pressureon consumersis always to use more with no considerationfor the true costs of their consumption. Consumersthen assumethat the commodity, electricity, will always be availablein sufficient quantity and at a price they can afford to pay. I leaveit to you to decidewhetherthis representsconsumerdemandor market manipulation. 122

BALANCING INTERESTS OF STATES AND MARKET

Figure 9.1

U.S. Economic Growth as Compared with Electricity Usage 200

Index 1980=100

190

1980=100

180 170

1980=100

160

150 140 130 120

1980=1001980=100

100

1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980 1980

110 100

Source:EdisonElectronicInstitute: www.eei.org.Reprintedwith the pennission of the EdisonElectric Institute.

Consumptionin the United Statesalsohasa cultural base.As a highly advancedmaterialisticsociety,we are measuredin someway individually by the amount of stuff we accumulate,and the bigger and more expensivethe stuff the better.The growth in salesof SUVs is indicative of this phenomenon.In the SanFranciscoregion and the areasaround large cities nationwide,peoplemove to distant suburbsto live in large new housesequippedwith the latest electronic gadgetrybecausethey are priced lower than similar housingcloseto the city. They then spend up to two hours eachway driving their SUVs to work in the city or in Silicon Valley or anotheremploymentcenter. By traditional GDP measures,they havea high standardof livingall of thosehigh-pricedthings add up to a substantialdollar value. By humanmeasures,I am not so sure.The time spentcommutingtakesan emotionaltoll in termsof stressand lost time with the children who are the putative beneficiariesof this wealth. Theseparentshave to work evenharderto support thestuff just to keep up the grandlifestyle. During the height of the electricity crisis, someof thesehomeownershad bills as high as $600 per month for the use of multiple electricity ports for computers,entertainmentsuites forbig screentelevisions,hometheaters,and stereoequipment. Obviously,demandexistsor the marketwould not offer this expensive 123

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stuff. The underlying philosophyin America is that if I can afford it, I can have it, regardlessof the social or environmentalcostsor whether my excessiveuse drives up the price for all others in the market. To paraphraseLeona Helmsley'scomment about taxes, "Only the little peopleconserveenergy." When it comesto conservation,however,the market does sendthe right signal throughpricing. When pricesare high, conservationmakes sensefor almosteveryone.Unquestionably,the conservationefforts that Californiansundertookin the springand summerof 2001 playeda substantialrole in bringing down demandand market prices. Californians know how to reducedemand.During the fifteen years precedingderegulation, demand-sidemanagement(DSM) programsof the major utilities reducedthe growth of demandto,suchan extentthat the actual demandin 1995was about15 percentlessthan it would havebeenwithout DSM. Unfortunately,pricing to encourageconservationis problematicfor at least three reasons.First, pricing perpetuatesthe basic inequitiesof all free market systems.It is, in essence,forced conservationfor the poor who may also be victims of circumstancesas energyconsumers becausethey cannotafford to pay for energyand they lack the capital resourcesto investin conservationprojectsthat would lower their bills. They must do without rather than investing in ways to do better with less. Ironically, it is the rich who can afford to pay higherenergyprices who alsohavethe capitalto makeenergy-savingchangesin their habits. The price hasto rise to significant levels to makeit worth their while to install energysavingdevices,andthat makesit evenharderfor the poor. Second,conservationby pricing is a short-termmechanismthat does not lead to permanentreductionsin consumptionbecauseit does not leadto any basicchangesin attitudeaboutenergyuse.During the 1970s and 1980s,whenoil priceshit all time highs,Americansboughtsmaller, more efficient cars. The automobilemanufacturerswere required, by governmentpolicy, to steadily increasethe fuel economyof their vehicles, excluding trucks. After 1982, the price of gasolinedid not rise with inflation, however,so by the 1990s,the real price of a gallon was about the sameas the price in 1973 when adjustedfor inflation. Consumersthen beganto buy larger vehicles that use more gasolineand automobilemanufacturersbeganto developSUVs for the averageconsumermarket.Categorizedas light trucks, thesebig and heavyvehicles usesignificantly more fuel thanthe small carsthat they replace.Drivers 124

BALANCING INTERESTS OF STATES AND MARKET

love them becausethey are roomy and saferin a crash.So long as the price of gasolinestaysrelatively low, thereis no reasonfor consumers to worry about theamountof oil that they demand.As the numberof SUVs grows-theyare now 50 percentof new vehicle salesper yearso will the pressureon governmentto keepoil pricesdown. In contrastto consumersin othercountriesthat heavily tax gasoline, U.S. consumersenjoy low prices. With the currentvisceral opposition to taxationin this country,it is unlikely that gasolinetaxeswill increase substantiallyanytimesoon.In addition,the ownersof SUVs will constitute a significantpolitical force againstgasolineprice increasesthat might provide the incentive for conservationthat would also reducethe demandfor SUVs. The third problem with conservationby pricing is that energyprice hikes, even if temporary,are inflationary. Becauseour productionand transportationsystemsareenergyintensive,any increasein fuel or electricity pricesleadsto a chain reactionof increasesin the price of virtually everyproductand servicefrom breakfastcerealto plasticgewgaws. Operatingcostsincreasefor businesses that then passthesecostsalong to consumers.Governmentoperatingcostsalsoincreaseleadingto budget cuts or tax increasesas governmentbudgetsstretch to reallocate resourcesto energy.Ultimately, as we seein the California case,price hikes resultin a massiveshift of wealthfrom averagecitizensto a handful of large energycorporations.Using pricing to promoteenergyconservation,while effective, is costly in other ways and unlikely to be successfulin the longer term. The stateof California shouldalso continueto promotethe development of alternativeenergy systemsthat use the state'smost abundant energyresource-sunshine. During the electricity crisis, the stateimplementeda programto subsidizesolarelectricity systemsfor homeowners and commercialbusinesses,the latter with lobbying by actor Clint Eastwood,who ownsa restaurant-hotelcomplexin Carmel.New policy shouldbe developedto establishself-generatingstandardsfor any new industrial building. As an example,a serverfarm, covering aboutfour acres,wasproposedto be built in Hayward.Thesefacilities requiresubstantial amountsof electricity. Its flat roof could be equippedwith a photovoltaicsystemsothatit could generateits own electricity andprobably sell some back to the grid or to nearby buildings. Staterequirements and subsidiesfor solar installationswould greatly increasethe numberof theseinstallations. 125

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The stateshould also continueto promoteconservationbecausethe market cannot.It is obvious that the market alone cannotpromoteenergy efficiency, conservation,or alternativeenergy systems.It is truly not in the interestsof energycompaniesto do so, as their primary interestis in promotingmoreconsumption.Even "green"energycompanies havethis bias. While they can promotethe use of renewableresources to generateelectricity, they cannotcompeteeffectively in the marketthat is, generateprofits-by encouragingtheir customersto use less electricity. Thus, it falls to governmentto developpolicies and incentives that meetthe collective interestsof the public while energycompaniesproducewhat is neededto meetwhateverdemandthereis. For the statesto protect their energy policy interestsin a deregulated market, they must take a role in balancingthe interestsof both electricity providersand customers.Ironically, the stateshavea stronger role to play in a deregulatedmarketto ensurethat the marketactually works as it is supposedto. To avoid the developmentof a real monopoly, the statesmust provide incentivesfor competitorsto enter the market. This is the only way to ensurethat consumershave real choicesamongproviders.This could meanthat the stateswill haveto becomeelectricity providers themselvesif the market does not produce enoughcompetition. So statesmust guard againstthe possibility of market manipulation by designingderegulationpolicy that recognizesthe weaknesses of the marketmodel as well as its strengthsand taking an active role in making sure it works the way it is advertisedto do. Electricity is not pork bellies after all. It is a necessityof modemlife that few, exceptthe odd hermit, canchooseto do without. The consequences of marketmanipulation do arguefor someregulatoryinterventionin this marketplace. Conclusion

It is clearly difficult to developan evenbalanceof the interestsof both the market and the states.The market wants ever-higherprofits while the stateswant to managecostsand protect the poor and the environment.The free marketenvisionedby economistscannotmeetthe states' multiple policy interests.Nor can the statesupportthe excessesof the marketand still meetthe public's interests. I havearguedherethat electricity policy must be designedin sucha way that the statescan achievethe public interest while enablingthe 126

BALANCING INTERESTS OF STATES AND MARKET

marketto do what it doesbest-providea quality product.The deregulation policy that California adoptedin 1996 did not achieveeither of thesegoals. The state sacrificedall of its energy policy intereststo a policy basedon free markettheory that servesindividual but not collective interests.In the end,the companies'greeddamagedtheir own longterm interestsin California, leaving them with little credibility with the public or the government.The state has now developedorganization structuresand policies to guard againstfuture market manipulations. Proposalsto re-regulateare in the legislativeworks. The greatestirony of all is that the experimentin free marketelectricity has resultedin a greaterrole for governmentat both the state and local levels in California than was everconsideredin the first 100 years of the electricity industry. In 2001, California establishednew agencies to do the planningand demand-sidemanagementthat usedto be the job of the regulatedindustry.Local governmentsin California andelsewhere are looking into developingmunicipal electricity utilities and forming large buying cooperativesin order to negotiatebetterelectricity prices. Theseare further evidencethat the statesput their other energypolicy interestsaheadof the market'spromisesfor cheapelectricity-promisesthat havefailed to materializealmosteverywhere. To achievea balancebetweenmarket interestsand the state'sinterests, policymakersmust finally recognizethe deficienciesof market theory when it comesto achievingpublic policy goals.This caseclearly demonstrates that marketscanproducewealthandevenchoicefor some, but only governmentcan guaranteethat benefits will be availablefor everyonein the state.

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10 The future of Electricity Deregulation

The crisisin California hada significantimpacton otherstates'restructuring activity. By February2003, only eighteenstateshad completely deregulated,five had delayed restructuring,and one, California, had suspendedderegulation.Therewas no active restructuringin morethan half the states.Deregulationhas ground to a screechinghalt in all but those statesthat had been far along in the processbefore 2001. The statesthat are not active as of this writing include all of those in the Southeastand many in the GreatPlains (seemap in chapter6). This hasled to a marketthat is more than half-regulatedand only partially opento the market.Energycompanies,on the otherhand,haverestructuredandwill continueto pressurethe statesin the interestsof creating a national marketthat is completelyderegulated.This chapterconsiders the aftermathof the California crisis as the truth about the companies' market manipulationunfolded, the impact of the "crisis in confidence" that developedin light of Enron'scollapse,and the assurances that states will requirebeforederegulationcanagainbecomea viable policy. I argue that the role of the FederalEnergyRegulatoryCommission(FERC)in the deregulatedmarketplacehaschangedwith deregulationandthat theFERC hasbecomethedominantagencyto protectthe public'sinterests,not those of the industry. The future of the market and the states'policy needsin this market,whetheror not the statehasderegulated,are also discussed.

Aftermath of the Crisis Before the end of the year 2001, Enron Corporation,the leading promoter of electricity restructuring, collapsedamid revelations of 129

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accountingpracticesthat overstatedcompanyearnings.In the unfolding of Enron'sstory, there also cameto light a seriesof memoranda that outlined trading schemesto manipulatethe price of electricity on the California market.This was the smokinggun that lent credenceto California's claims that market manipulation droveup the price of electricity during the winter of 2001. More evidenceemergedthat other electricity companieshad withheld electricity from the market at the time to further reducethe supply and drive up prices.El PasoCorporation, a natural gas transmissioncompany, also withheld gas from California further increasingthe price of both gasandelectricity (Oppel 2002). By early 2003, the FERC had found evidencethat Enron and morethan thirty othercompanieshadmanipulatedpricesduring 20002001 and ruled that the state was entitled to refunds of $3.3 billion (Oppel 2003).The samereportfound that "Enron'sonline trading platform was 'a key enabler'of gas price manipulation." The politics of these events has high significance. Kenneth Lay, Enron's former CEO, was in many ways the father of electricity deregulation.He was instrumentalin persuadingCongressand the first Bushadministrationto inserta clausein the EnergyPolicy Act of 1992 that allowedthe developmentof exemptwholesalegenerators(EWGs) that could generateand sell electric powerat wholesalewithout being subjectto any regulatoryrestrictionsat the nationalor statelevel. These entitiesdid not exist at the time, but in ~ short while, Ken Lay refashioned Enron so that it would becomethe largestenergytrading company in the country, an EWG that did not generateelectricity itself but tradedit, using emergingcomputertechnologyto buy excesselectricity from one sourceand sell it to another.Lay thus developedthe initial infrastructurethat madeelectricity deregulationpossible. Lay then beganto work to convincestatelegislatorsto restructure their electricity systems.He sought the support of then-Governor GeorgeW. Bush of Texas as he lobbied governorsin other statesto supportderegulatingtheir own utilities. When GovernorBushbecame PresidentBush, Lay and otherenergycompanyCEOs gainedunprecedentedaccessto the White House,especiallybecausevice president Dick Cheney had been CEO of the Halliburton Company.The Vice Presidentchaireda task force in the spring of 2001 to developa new national energypolicy. The task force's proceedingswere kept secret from the public, butseverallarge energycompanies,including Enron, admittedto having had significant input into the proposedpolicy. No 130

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environmentalgroups were given the opportunity to sit on the task force. The draft energypolicy that emergedwas heavily biasedtoward energydevelopmentwith little considerationof conservationas a national policy, a completereversalof the energypolicies of the 1970s and the 1992 policy. This proposedpolicy that favored market approachesto providing energysufficiency for America wasjuxtaposed with the marketfocus of the FederalEnergy RegulatoryCommission at the sametime. While Californians suffered blackoutsbecauseof market manipulation,the Republicanmajority in the federal government continued to argue that market forces alone would meet the nation'senergyneeds.As of February2004,the energypolicy had still not beenadoptedby Congress,despiteRepublicanmajorities in both housesof Congress. The politics of the energy companies in the shadowof the California crisis may have led many statesto approachderegulationmore cautiously. Once it becamemore and more apparentthat the companies had manipulatedthe California market,statesslowedthe process of restructuringuntil they could be assuredthat theirotherenergypolicy interestscould be protected.In a deregulatedmarket, the only assurancethat statescanhaveto protecttheir residentsfrom predatorymarket practicesmust comefrom the nationalregulator,the FERC. The 1992EnergyPolicy Act elevatedthe role of federal watchdogs over stateregulatorsas the move to restructureelectricity in the states accelerated.Electricity deregulationor restructuringnot only dismantlesthe statelegal framework, which had developedover almost 100 years, but also limits the state'sability to protect other energy policy interests thatare intertwinedwith regulation.Becausestateregulators in a free marketlose their powerto protectthe public's multiple interests,federalregulatorsalonebecomeresponsiblefor ensuringthat the market works fairly and efficiently. The breakdownof the traditional federal-stateregulatory ship left California'scitizensunprotectedfrom predatorymarketpractices that led to the highestretail electricity prices in the nation and drove a major public utility into bankruptcy.The caseprovides an exampleof the complexinstitutional impactsinvolved in implementing major new policy. It also raisesquestionsabout the federal role in regulating againstbad policy designin the statesand providesan illustration of the interplay of economicsand politics within our federal system.

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The FederalEnergyRegulatoryCommission'sNew Role! Through the winter of 2001, while California scrambledto get control of the electricity market,this mostimportantfederalactorsatquietly on the sidelines.The PERChadbeengrantedauthority by the 1992Energy Policy Act to ensurethat wholesaleelectricity prices are "just and reasonable."Yet, evenas wholesaleelectricity pricesroseto unprecedented heightsand the utilities were threatenedwith bankruptcy,the PERCrefusedto intervenein the California market.Had thePERCactedearly to constrainwholesaleprices,the statemight havemanagedthe crisis better with fewer political and economicconsequences. Market manipulationcaneasilyoccurin a marketwherethe physical infrastructureof the industry limits the entranceof sellersinto the marketplace.The fewer the suppliersin a market,the more powereachwill haveto control how muchproductis madeavailableon a daily basisand how high or low the price will be. We also know now that poor public policy can establishconditionsthat make market manipulationeasier. In the political arenain which policy is developed,powerful industry voices often have the ability to designpolicies to maximize their own benefits,as happenedin California. For thesereasons,it seemsimperativethat regulatorsat the stateand federal levels maintain traditional regulatory roles that guard against predatorybusinesspracticesthat can distort the market'soperations.In the caseof electricity this includesthe expectationthat the PERC will stepin to cap wholesalepriceswhen they areclearly out of control. Had the PERCbeenwilling to intervenein the California marketin January 2001,the crisis might well havedissipatedthen.Whenthe PERCfinally did capwholesalepricesin late May, the marketsettleddown andprices fell to more normal levels, even at the beginning of the summer,the period of peakelectricity demand. Throughoutthe winter and spring of 2000-2001,the stateof California implored the PERCto placea cap on wholesaleelectricity pricesin the western states.The PERC chairman,Curtis Hebert, with support from the GeorgeW. Bush administration,arguedthat capping prices would only reducethe supply of electricity availableto the California market. The market was the solution not the problem, arguedHebert, despitethe crippling effects of sky-high wholesaleelectricity prices on the state'sresidentsand economy. The crisis in California continuedthroughoutthe spring; stateenergy 132

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regulatorspredictedrolling blackoutsall summerlong; and the state's electricity deregulationprogram was suspended.Then, in May 2001, PresidentBushreplacedHebertaschair of thePERCwith PatrickWood III, a former Texaspublic utility commissioner.Within weeksof Wood's appointment,thePERCfinally imposeda temporarypricecapon wholesaleelectricity pricesin the westernstatesandorderedall westerngenerators to sell their uncommittedpowerin the market.Contraryto economic theory,suppliersdid not desertthe market.By the end of June,wholesale electricity was selling for $100per megawatt,down from $750per megawatt the year before. Only later was it learnedthat without regulatory intervention, companieshad deliberately withheld electricity from the California marketin orderto boostpricesand their own profits.

The FederalEnergyRegulatoryCommission'sRole in National EnergyPolicy The FederalEnergy RegulatoryCommissionwas establishedin 1977 throughthe Public Utilities RegulatoryPolicy Act (PURPA) to regulate and overseethe interstatetransmissionand interstatewholesalesalesof natural gas and electricity. It replacedthe FederalPowerCommission, retaining the responsibility for regulating wholesaleenergy prices in interstatecommerce.One of its initial roles was to ensurethat public utilities would acceptelectricity from small generatorsor qualifying facilities (QFs). Most oftheseQFs generatedelectricity throughcogenerationor usedotherrenewableresources.The PERCwasalsoto ensure that wholesaleprices of gas and electricity would be just and reasonable. A primary responsibility for the PERC at the time was to make surethat public utilities acceptedelectricity from QFs and to encourage them to think more seriouslyabout generatingelectricity by using re2 newableresources. When deregulationof electricity becamea reality with the passageof the 1992EnergyPolicy Act, the PERCwas designatedas the coordinator for the EWGsto assistthemin gainingaccessto utility-owned transmission lines. The FERC was also granted the power to determine reasonablepricesfor transmissionservices(Kreith andBurmeister1993: 356). Thus, the agencythat was designedin the 1970sto pressureutilities to acceptelectricity generatedfrom renewableresourceswithin the traditional regulatory structurebecamethe protectorof free market interestsdesigned todismantlethe regulatorystructure.

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When statesrestructuredtheir utilities and openedup their electricity markets,the determinationof just and reasonablepricesbecamea critical responsibility for the FERC. Under regulation, prices were developedusing a "cost plus" methodwhere the monopoly companieswere grantedthe recoveryof their productioncostsplus a reasonableprofit. In a deregulatedfree market,economictheory assumesthat priceswill be determinedthrough the dynamics of competition, supply, and demand. Just and reasonableprices, in theory, should be determinedby whateverprice the market will bear. In 2001, under ChairmanHebert, the FERC was committed to the principle of free electricity markets,as were many leadersin the Bush administration,and opposedto price caps.Ratherthan steppingin to set prices, they supportedthe belief that, in time, the market itself would determinejust andreasonableprices.According to SeverenBorenstein, director of the University of California's Energy Institute in Berkeley, the FERCsmarketanalysisat that time "amountedto religious faith in markets" (Lochhead2002). Thus, the agency'sunwillingness to step into the market might be seenas protecting the long-term interestsof the stateas it madethe transitionaway from regulationin the shortterm if the marketworks the way it is supposedto. Unfortunately, this may have encouragedthe companies'predatory behavior.When the FERC finally did intervenein late spring, pricesfell immediately.By sendinga signal to the marketthat it was taking a strongerregulatoryrole, the FERCwasableto rein in thecompanies'excesses. The aftermathof the California experiencewith electricity deregulation andthe revelationsof marketmanipulationunderscorethe essential role of the federal governmentto moderatethe free marketand protect states'interests.This role was not contemplatedwhen the FERC'sresponsibilitieswere expandedin 1992. A June 2002 study of FERC by the U.S. GeneralAccounting Office (GAO) found that the agencywas still not equippedto regulateand overseeenergymarkets. The GAO found that the FERC did not have the authority to levy meaningfulcivil penaltiesandthuscould not "posea crediblethreatand deteranticompetitivebehavioror violations of marketrules by market participants"(U.S. GeneralAccountingOffice 2002: 5). The agencydid not havean effective regulatoryand oversightapproachthroughwhich to determineif interstatewholesaleprices are just and reasonable.It also lacked sufficient staff knowledgeableabout competitive energy markets.After PatrickWood took over asFERC chair in May 2001, the 134

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agencybeganworking toward developinga strongerrole as regulator. At the crucial time for California, how'ever,the agencywas largely unable to perform thekind of critical analysisneededto intervenein the market.The GAO documentedthat the FERC'sstrategicgoals and objectives throughoutthe 1990s had focused more on market development than on marketoversight.After Wood's arrival in the summerof 2001,the agencybeganto developstrategiesto detectandregulateabuses of marketpower (U.S. GAO 2002: 36). A major lessonfrom this case is that the FERC must now play a major role in ensuringthat energy marketsare working properly. The FERC's early inability to recognizethe distortions in the California market damagedthe credibility of the agencyas well as public confidencein electricity restructuringas soundpublic policy. Wood agreed with the findings of the GAO report and revealedreorganizationplans to detectmarketmanipulationand"toughenenforcementas it continues to encouragea moreopen,but orderly, energymarket"(Lochhead2002). Restoring the Federal-StatePartnership During the 1970s,the statesand the federal governmentdevelopeda partnershipin energypolicy that rested ona baseof energyefficiency and conservation.That partnershipwas largely abandonedduring the 1990ssurgetowardderegulation.The California casestrongly suggests that statesneedfederal partnershipsupportto make deregulatedmarkets work properly. When and under what circumstancesthe FERC should act are questionsthat go to the heartof intergovernmentalrelations in electricity policy. ShouldtheFERCbe expectedto bail out states becauseof poorpolicy design?How quickly shouldthe FERCintervene in a marketthat could balanceitself out over time?At what point should nationalpolicy interestssupersedemarketinterests?The FERC'smission is both to promotecompetitionin the electricity industry and to provide oversightin the public interestto guard againstanticompetitiveactions. The GAO found that the agencyhasbeenmore successfulin developing the marketthan in establishingeffectiveoversight(US. GAO 2002: 35). Electricity restructuringis still in the experimentalstagesat the state level. California policymakersdesignedthe law undera set of assumptions that later provedto be flawed. During the crisis, the statewas berated by pundits and electricity providersfor the way its deregulation policy was designed.The PowerExchange(PX) was set up to buy the 135

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most expensiveelectricity on the market eachday, which in itself encouraged"gaming" by the companies.This policy was designedto protect the interestsof the state'sutilities, which had lobbiedfor protection againsttoo low prices in the market.Policymakersneverimaginedthat this samemechanismwould be an incentiveto providersto raiseprices to unprecedented levels. In the end, the PX provedto be the worst idea of all, a mechanismthat enabledprice gougingandencouraged the worst type of free marketbehavior. The result of California'spolicy designwas a distortedstatemarket that also had nationaland internationalrepercussions.Residentsof Oregon,Washington,and British Columbiaalso facedprice hikes as companiesin thoseareasdivertedelectricity to the morelucrativeCalifornia market. Companiesin thosestatespaid farmersto reducetheir acreage of cropsthat useirrigation so that more electricity, generatedby hydro, could be producedto sell to the market to the south. The attraction of windfall profits createdshortagesin thesestates,andthis drove up their pricesas well, althoughnowherein the rangeof the pricesin California. The PERC'saction to cap wholesaleprices was essentialin bringing stability back to the westernmarkets.Its inaction in January,ostensibly to allow the market to work as it is supposedto in theory actually encouragedthe worst predatorymarketbehavior. With deregulation,electricity is now becominga nationalmarket,no longer limited by state regulators.The national interest, therefore, is better servedby ensuringthat staterestructuringpolicies are designed to enhancethe effectivenessof the national market.A strongerPERC, focusedon the public interestas well asthe industry's,would work with the statesto help design legislation that avoids the market distortions thatoccurredin California.The federal-statepartnershipin energypolicy must be restoredthrougha strongerPERCthat provideseffective oversight as well as promotesmarketdevelopmentand works with the states to designeffective policy. Suchpolicy should include a mix of energy efficiency incentivesas well as increasedin-statesupply to ensurethat a stateis not left to the merciesof a predatorymarket.

The Statesand the Futureof the Market While the PERCcan becomea strongforce in ensuringthat electricity marketswork properly, no federal agencycan meetthe other stateinterestslinked to energy policy. The stateplanning that characterized 136

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electricity regulationas a naturalmonopolywasdiscardedwith deregulation. Statesthat havederegulatedare now lessable to ensurethat they will have a reliable supply of electricity at reasonableand predictable prices.All statesnow needto developmorecomprehensive energypoliciesto guardagainstthe predictableforces of the market.Suchpolicies must include incentivesand regulationsto increaseconservationand efficiency andthe useof renewable,indigenousresourcesto generateelectricity. Stateenergypolicies should also encouragethe developmentof publicly owned electricity districts that are governedby the users-the citizens-whocan determinewhat fuels are most desirableand acceptable3 and can help keep market prices down. The vauntedsimplicity of the markethasintroducednew complexity into stateenergyplanning. Can the Market Really Work to Protect the Public Interest?

The free marketerscontinueto promoteenergyderegulationas a longterm policy to supply the American demandfor energyand to support domesticeconomicgrowth. At the sametime, consumerproductcompaniescontinueto supply the market with more new productsthat require energy to operateand thus drive up the demandfor electricity. Americans'demandfor energyincreaseswith the market'sproduction of energy-usingitems. The state'spolitical needfor low-priced energy is in conflict with the market'sneedfor continualgrowth in that unlimited demandand limited supply will inevitably force pricesto rise. The only way the statescan avoid this reality is by developingpolicies that promote conservation,energy efficiency, and the use of renewable sourcesof energy. Stateshave to develop an understandingof how the market really works and decide whetherit is the best way to achievepublic policy goals. Statesrestructuredtheir electricity markets becausethey were convincedby economistsand lobbyists representinglarge companies thatcompetitionwould bring consumersproviderchoiceandthatchoice would automatically lowerprices. But in any market, it is fair to ask who getsthe real choice. In the caseof electricity, it is pretty clearthat hotels,andshoppingmalls-getthe bestchoices. largeusers-factories, They are able to contractdirectly with providersand negotiatethe best prices. They were the strongestsupportersof deregulationas a state policy in California and are the largestbeneficiariesof the policy. 137

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Retail and commercialcustomersdo not get a real choicein the electricity market.While theremay be choices,providersare still interested in maintainingat leasta minimum price level and will abandonthe market when that price level cannotbe attained.This happenedin Pennsylvania, where companiesbailed out after the policy was implemented, and in Virginia, wherethey did not evenenterthe marketbecauseprices were alreadytoo low. Even when small customersdo makea choiceof supplier,they haveno leverageoverthe marketthat determines monthly prices.They haveno mechanismby which they can individually signal the marketthat the price is too high. They also have no pricing mechanism that gives them incentivesto use energy at different times of the day when demandis greateror lower. Small customersare truly at the mercy of the market.Protectingtheir interestswas one of the rationales for regulatingutilities in the first place. Big userscan signal the market more easily by lesseningdemandto which the marketrespondsby reducingsupply. When demandpicks up again,supply will naturally lag behindbecauseit is no simple matterto drill new gas wells or restartan electricity generator.The "simple" law of supplyanddemandbecomesproblematicwhenproducersreduceproduction in orderto assurea high enoughprice to covertheir costsand a reasonableprofit. In energyproduction,the supplylagsthatleadto higher pricescan causeripples throughoutthe economythat can lead to inflation in a hot economyor slowerrecoveryin a weakeconomy.Regulated energymarketshad the capacityto evenout economiccycles and pricing so that businessesand residential customersdid not face widely varying prices of an essentialcommodity.Freemarketpricing of these goodsprohibits businesses, families, governments,and nonprofit organizationsfrom budgetingfor energycostswith confidence.Low-income usersin a market that divergeswidely can be faced with hard choices betweenbuying energyand otheressentials.Stateenergypolicy has to considerhow to protectlow-income usersfrom "unreasonable"energy prices. The state has to define what unreasonablemeansbecausethe marketconsidersthat the only unreasonable price is the one that buyers will not pay. Where thereare at leastenoughbuyersto achieveenergy producers'earningsgoals,thenpricescanbe definedasreasonable,even if 49 percentof the userscannotafford to pay. The free marketersalso promotederegulationas a meansto spur innovation by unlocking the creative talents of unregulatedcompanies. They assume,as a matterof dogma,that regulatedcompanieshave no incentiveto be innovativebecausethey are guaranteeda return on their 138

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investments.Yet if we examineelectricity deregulationclosely, it is difficult to seewherethe innovationis. It is certainly not in the production of electricity, which continuesto be dependenton fossil fuels for most generation.Natural gas is the primary fuel for new power plants at the moment.The nuclearpowerindustry is alsotrying to makea comeback, despitethe lingering political dilemmaof nuclearwastedisposalin this country and new fears of terrorist attackson nuclearpowerplants. Regulatedcompanieswere slow in adopting renewablesourcesas fuels for electricity generation,and their decisionsto build nuclearpoweredgeneratorsraised the price of electricity as the cost of constructing and operatingthe plants rose. The regulatedutilities were grantedthe authority to chargehigherpricesfor this electricity and the amortizationof thesefacilities is now a major issuefor statederegulation policy. At the time theseplants were constructed,however, the nuclearpower industry was growing in prominenceall over the world. France,for example,producesa high percentageof its electricity through nuclearpower.In the United States,nuclearpowerhasbeencontroversial sinceits origins, and its opponentshavepicked up new supportsincethe terroristsattacksof September11, 2001, makingit difficult to predictany shift away from naturalgasto nuclearpowerin the short term. Regulatedcompanieswere innovative,despitethe assertionsof market theorists. Companiesknew that their requestsfor price increases would be whittled down to gain public support,so they lookedfor ways to reducetheir operatingcosts.Many regulatedutilities adopteddemandsidemanagement programsfor their customersandthemselvesprecisely becausethey profited from lowering demand.They had to developnew technologiesto improve their own operatingefficiency. The argument that regulatedmonopolieswill not innovate does not stand up in the face of the evidence. The major innovationfrom deregulationso far doesnot appearto be in creatingnew productsto improve efficiencyof electricity generation and transmission.It has beenonly in the buying and selling of electricity by addinga middlemanand complexity to a relatively simpleindustry that worked pretty well for most consumers.It remainsto be seen whetherthe unregulatedmarket will produceinnovation in electricity generationon its own. It is clear that the only way this can happenis if the companiesare guaranteeda sufficient marketshareso that they can recouptheir developmentcosts and make a profit. This is unlikely to happenin a truly unfetteredopen market for electricity. It is far more likely for it to happenin an oligopoly where companiescan guarantee 139

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their market sharethe way that regulatedcompaniescan. Prices will then be higher than they would be with more competition. Pricing in the marketis more complexthan is typically presentedby markettheorists.The expectationthatcompetitionalonewill drive down prices is overriddenby the reality of an industry with high costs for development,both for the constructionof powerplants and the extraction of fuels, transmission,and distribution. The price of natural gas, which hasbeenderegulatedsincethe early 1980s,is determinedby supply and demand.When the price of natural gas falls becauseof ample supply, however,companiesstop drilling for new suppliesbecausethe market priceis not high enoughto assurethem of cost recovery and a profit. As demandgrows, then, prices must rise in order to provide the drillers with sufficient incentivesto increasesupply. Most new electricity generatingplantstoday arefueled by naturalgas. Most new homesbuilt in this country are fueled by either natural gas or electricity. Natural gas is desirablebecauseit bums more cleanly than otherfossil fuels, reducingthe pollution. It doesnot take an expert,however,to predictthat the demandfor naturalgaswill rise in the foreseeable future, particularly when the u.s. economyrecoversfrom the presentrecession.When that happens,the price of gaswill inevitably rise and with it the price of electricity. Statesthat deregulatedfor the promiseof lower priceswill find their priceshigher and their residentsand industriessubject to the whims of a marketthat is interestedonly in its own profits to the detrimentof the states'otherenergypolicy interests. The samemarketdynamicappliesto powerplant construction.California wascriticizedfor not building new powerplantsduring the 1990s. Yet, in the early years of the decade,the statewas in the throes of an economicrecessionand demandfor electriciiy was flat. When the deregulationlegislationwas enactedin 1996,there was a surplusof electricity in the westernstatesand, thus, no demandfor new powerplants. At the height of the crisis, the stateapprovedlegislation to streamline the applicationprocessfor new powerplants(SenateBill 28X). At least ten new power plants that were proposedin the summerof 2001 have now beendelayedor put on hold becauseof the marketslowdown(California EnergyCommission2003).The fact is that in a free market,companiesdo not invest in expensivegeneratorsin anticipationof market demand.That would only produce oversupply in an economic slowdown and further depressprices for their product. It takes a sustained economicboom with increasingdemandto provide the incentivesfor companiesto build new capacity. 140

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u.s. policymakersat all levels should also reflect on the possible effectsof increasinginternationalenergydemandfrom developingcountries. Anyone who hastraveledaroundthe world, especiallyto developing countrieslike China,is struckby thedesireof peoplein thesecountries to be like Americans.U.S. productsand companiescan be found everywhere.KentuckyFried Chicken(KFC) hasa storeon the groundsof the SummerPalacein Beijing. I was told therethat KFC is the mostpopular restaurantin the city. McDonald'sdoesa roaring businessin Moscow; in Sydney it sells McCapuccino.All over the developing world, billboards advertiseAmerican companies'products and the American lifestyle. School children in China are taught to speakEnglish in the primary grades. As the adoptionof anAmericanlifestyle growsthroughoutthe world, so will the demandfor the energyneededto supportit. Logically, one has to concludethat the limited supply of fossil fuels on the planetwill not be enoughto go around. Can Americansassumethat developing countriesthat currently havesurplusenergyresourcesupplieswill continue to sell them to us insteadof keeping them for their own use or selling themto anotherbuyer?If pricesrise to the point whereonly the rich canafford to buy, will therebe political ramificationsfor the United States,both domesticand international? The free market is in theory divorced from such political considerations. It is simply a mechanismby which products and servicesare exchangedfor money accordingto supply and demand.It doesnot consider the moral or political questionsof who benefitsand who losesin thesetransactionsand how one chooseswithout having equality of incomes.In a social and political world, where thesequestionsmatter, economictheoryfalls shortandpolicymakersmustconsiderhow to protect the higher public policy values. Statesnow havea strongincentiveto focus their efforts on encouraging efficiency andconservationin the shortterm and developingcomprehensiveenergypoliciesfor the longerterm. To protecttheir energypolicy interests,including reasonableprices for all users, statesmust identify their indigenoussourcesof renewableenergyand provide incentivesfor the developmentof innovativetechnology.They shouldsubsidizethe use of solarandothertechnologiesto encouragethe developmentof personal electricity production.They shouldrewrite building codesto provide incentivesfor "green" constructionand sustainabledevelopment.They shouldbe wary of exposingtheir residentsto the whims of the marketand developpolicies that provide protectionsto overcomemarketdynamics. 141

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California adoptedits new Energy Action Plan on May 8,2003.Its statedgoal is to: Ensurethat adequate,reliable, and reasonably-pricedelectrical power and natural gas supplies,including prudentreserves,are achievedand provided through policies, strategies,and actions thatare cost-effective and environmentallysound for California's consumersand taxpayers (Stateof California 2003: 2).

The new plan, developedin responseto the 2001 electricity crisis, outlinesthe ways that the agencieswill monitor the market, assureadequatesuppliesof energy, "protect the public's health and safety and ensureour quality of life." It also emphasizesprotecting low-income populationsfrom "disproportionateadverseimpactsfrom the developmentof new energysystems"(Stateof California 2003: 3). The plan has six sets of actions: (1) Optimize Energy Conservationand Resource Efficiency; (2) Acceleratethe State'sGoal for RenewableGeneration; (3) EnsureReliable, Affordable Electricity Generation;(4) Upgrade and Expandthe Electricity Transmissionand Distribution Infrastructure; (5) PromoteCustomerand Utility Owned Distributed Generation; and (6) EnsureReliableSupplyof ReasonablyPricedNaturalGas. The statewill finance up to 300 megawattsof peakingcapacityin critical areasto ensurelocal reliability and it will "implement a voluntary dynamic pricing systemto reducepeakdemandby as much as 1,500to 2,000 megawattsby 2007" (Stateof California 2003: 5). The statehas also acceleratedthe dateby which renewablegenerationwill constitute 20 percentofin-statecapacityfrom 2017 to 2010. California developedthis plan in responseto a crisis brought on by overrelianceon a marketthat doesnot work underthe sameset of values that statesdo. This plan could have beendevelopedearlierhad the stateunderstoodthe potentialdamagesthat could arisefrom enactinga deregulationpolicy that placedthe state'senergyconsumerscompletely at the mercy of the market.Otherstatescan learnfrom California'smisfortunesand from what they now know aboutthe market.The lessonis simple: protect your energypolicy intereststhat are not sharedby the energyindustry. The marketcannotdeliver thosepolicy interests.

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The lessonsfrom this caseraise seriousquestionsabout whether the marketis an effectivemechanismfor deliveringpublic policy. Sincethe late 1970s,economistshavearguedthatgovernmentinefficiencieshamper the effectivenessof the marketeconomy.Regulationhas beenportrayedas the deadhandof governmenton the creativity and innovation of a free marketfreely operating. This ideology has increasingly dominatedpolitical thinking about public policy and even about democracyand what it meansto be an American. Libertarianpolitics put forth by various right-wing political think tanks(e.g., the Cato Institute) demandderegulationof the federal governmentand devolutionof policymakingto the lowest governmental levels. The anarchyof the free market economyis portrayedas the ideal model for the political system,promoting individuality and eschewingboth collectivedecisionmakingand true public interest.In this ideology,the ability of individuals to take careof themselvesby getting what they can at the expenseof their neighborsis the only public interest.That this translatesinto political anarchyinsteadof democraticcollective policymaking seemsnot to disturb the ideologues. The society that it createsis certainly not the one envisionedby the founders, even though they themselveswere elites. What Alexis de Tocqueville1 found in earlyAmericawasa societybasedon "self-interest rightly understood,"that is, understandingthat individuals can be free only insofar as all othersin the society are free. Public policy that results in underminingthis conceptdoes so at the expenseof the very foundationsof Americandemocracy. The great philosophersof economics,especiallyAdam Smith, saw economicsas a systemthat could improvethe lives of all peopleandthe society.He mistrustedbig government,but he alsomistrustedbig business 143

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andfelt thatgovernmentshouldmoderatebusinessactivities so thatthey did not reducecompetition(seeViner 1927). Smith wrote his thesisin eighteenth-centuryLondon, where the neighborhoodsto this day are dottedwith many small businesses that servethe needsand demandsof their local customers.A market with lots of small businessescan meet individual needsthat large businessesdo not. Smith's thesisof perfect competitioncannotbe fulfilled in a marketof giantsthat control essential information and manipulateconsumerdemandthroughadvertising. Not even the Internet enablescustomersto have perfect information althoughit doesimprove the process. The California casedemonstratesthe real hazard for government policymakersin dependingon the marketto deliver public policyfor an essentialcommodity. Electricity is not just anothercommodity, after all, but a complex product the use of which is woven throughoutthe economyand public policy. When the price of electricity goesup, costs rise throughoutthe economy.Operatingcosts rise for businessesand governments,as well as for residentswho pay the costsof home lighting, heating,and cooling. The costsof anythingmadefrom petrochemicalsrises:plastics,fertilizers, drugs,and so forth. Costsof transportation rise, adding further to increasesin commodity prices. Energy price increasescontributed significantly to the inflation of the late 1970s. A commoditythat hassucha powerful impact on the whole economy,and one that usershave few options not to use, cannotbe equatedto most other productsin the market. Electricity productionstill has the markings of a naturalmonopoly,as SamuelInsull arguedin the early 1900s. Regulationassuredthe productionof adequatesuppliesof electricity deliveredat a price that was affordablefor all consumersand produced in a way that protecteda state'snaturalenvironment.Thesethreepublic policy valueshavebeenassociatedwith electricity policy for morethan thirty years.Deregulationalso unintentionallyderegulatestheserelated policies,asCaliforniaandotherstatesthatderegulateddiscovered.When faced with out-of-control price increasesand limited suppliesof electricity, California steppedin immediatelyto protecttheseother energy policy interestsand now has a much strongerrole in governingenergy productionanddelivery thanit did beforederegulation.Pressuresin the stateto reregulatecannot succeedbecausethe utilities have been dismantled and, like Humpty Dumpty, cannotbe put togetheragain. But the stateis taking seriousstepsto developpolicies to ensurethat it will neveragainbe placedat the mercy of a voraciousmarket. 144

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From a broaderperspective,this casealso illustratesthe challenge of making large institutional changes,especiallywhen more than one level of governmentis involved. Electricity restructuringrequires changein both state and federal institutions. This involves the creation of new setsof rules and proceduresand a changein established ways of operating.NeitherCalifornia nor the FederalEnergyRegulatory Commission(PERC) was preparedto overseea wildly out-ofcontrol market.The statehadto developwaysto intervenein the market, especiallywhen the utilities were facing bankruptcy.The PERC did not have staff with the expertiseto "monitor rapidly evolving energy markets"and to change"a dysfunctionalorganizationalstructurebesetby frequentleadershipchanges"(Lochhead2002:AI). California's new institutions,the PowerExchangeand CaliforniaIndependentSystem Operator,operatedefficiently but wereineffective,in part because of the policymakers'inability to foreseethe potential for manipulation built into the policy design and in part becauseof the PERC's inability to analyzewhat was happeningin the market. The FERC's emphasisat the time on protectingthe interestsof energyprovidersin a developingmarketunderminedits own obligation to protectthe interestsof the public as defined in the 1978 law. Deregulationinterrupts the federal-statepartnershipin energy policy that developed during the 1970sand extendedthroughthe early 1990s.Deregulation is seenas freeing the marketfrom governmentinterference,implying that no governmentalpartnershipis needed.Without that partnership, however, thepublic interestis sacrificedto the interestsof entrepreneurs whose principal focus is on improving their own bottom line. The public interestcannotbe servedwithout somegovernmentoversight of market practices.Thus, new policy initiatives can be hamperedby old institutionalarrangements that fail to adaptquickly enough to changingpolicy demands,particularly whereagenciesfail to focus on meetingthe interestsof the public as well as thoseof the industry. The Proper Role of Government and the Proper Role of the Market

Governmentsconsideringadoptingderegulationas a public policy also needto reflect on the properrole of governmentas well as the market. The governmentis a systemfor collectivedecisionmakingin the public interest.This conceptgets lost in a market systemsimply becausethe 145

CHAPTER

11

marketvaluesindividual choicemorehighly thanit doescollectivechoice or the public interest. Governmentsthat deregulateor privatize servicescan risk the loss of their capability to solve theseproblemsexceptat great cost and more dislocationof resources--opportunity costs,to usean economicsterm. Once a serviceis privatized, a political lobby is establishedto ensure that more businesswill come the market'sway. Witness,for example, the powerof the prisonindustry in stateswhereprisonshavebeenprivatized. In order to guaranteethat cells will be filled, the industry lobbies for mandatorysentencinglaws. Many stateshavelearnedthat suchlaws tie the handsof judgesand prosecutorsand overcrowdprisons,placing higherdemandson statebudgets.So privatizationdoesnot reducepublic budgetsthrough all the supposedefficiency of the private sector.It createsdemandfor strongerpoliciesandmorebudgetresourcesto guaranteemore businessand higher earnings. What is the proper role of the market in a democraticsociety?The greateconomistsof the pastsaweconomicsas a way of improving society, not merely increasingthe wealth of a few at the expenseof many. Adam Smith's"invisible hand" was conceivedas a way to achievethe maximumwelfare for the whole society,so long as perfectcompetition governedthe market's operations.Competition cannot be perfect in today'smarkets(if it everexistedoutsideof theory) nor are consumers equally qualified to participatein the market, thus it cannotbe argued that maximumsocial welfare is everreally achieved. The devotionof neoclassicaleconomiststo simple theoriesof market behaviorbecomesdogmatic in the face of the reality of the manipulation of the Californiaelectricity market.Theresponseof reputableeconomists to the crisis was to call for a more free market and more deregulation,despitethe obvious marketmanipulationthat was occurring at the time. Any examinationof energydemandduring thosemonths comparedto previousyearsshoutedthat therewas somethingvery wrong with this market.It had to be manipulation,not just lower suppliesbecauseof the drought in Washingtonor bad policy designby California lawmakers.Most economistsat the time refusedto admit publicly that therecould be anything wrong with the market. Nor would they recognize the seriousconsequences for the statefrom such high prices. The responseto theseconcernswas that new marketstake a while to stabilize, and, in the long term, prices would comedown as supply and demand stabilized. Apparently, the interim would be the government's 146

PUBLIC POLICY AND THE MARKET

problem, while its own budgetwould be batteredby higher operating costs and higher costs to subsidizesmall businessesand low-income residentsin the state. The dominantadvocatesof neoclassicaleconomicsfail to acknowledgethatthereshouldbe a balancebetweenthemarketandpublic policy. The mantrathat the private sectorcan deliver governmentservicesbetter and at lower cost than governmentis fallacious in many instances. Economistsand neoconservativepolicymakersrarely, if ever, ask who really benefitsand who really pays for public policy. Political rhetoric misleadsthe public into believing that benefits are more widespread thanthey truly are.Government-bashing hasbecomede rigueurfor politicians of both parties.The bureaucracyis seenas the problemnot the solution andthe only way to solve public problemsis to turn them over to the private sector.Yet preciouslittle evidencehas beenprovided to justify theseconclusions. Since the early days of public administration,governmentshave striven to follow private sectornorms for managementand policy development.Governmentat all levelsis arguablymorebusiness-likethan ever before.At the sametime, citizen alienationtoward governmentis also greaterthan ever before, leading someto questionwhetherthese practicesthemselves have distancedgovernmentfrom the peoplethey are supposedto be serving(King and Stivers 1998). I havetried to demonstrateherethat governmenthasa critical role to play in making our societyand our economywork. The lessonfrom the California caseis simple: When onepolicy is turnedover to the market, governmentslose control of all the other policy intereststhat are connected to it. Deregulationor privatization is not simple, then, and policymakersmust approachit with a clear understandingof all the interconnectedpolicy interestsinvolved and what they are trading off. Policymakersmust also accepttheir role to protect the public interest andrecognizethat the private sectorcannotdo this job. Deregulationof essentialcommoditiesor the achievementof public goalsabdicatesgovernmentalresponsibilityand abandonsthe public interestto an institution that simply cannotachieveit. It is now time for governmentto be governmentand let the marketbe the market. The future of electricity restructuringis murky at best. Fewer than half the stateshave deregulatedtheir marketswhile the industry itself has movedquickly to restructureunderthe provisionsof the 1992 Energy Policy Act. Given this divide betweenpublic policyinterestsin the

147

CHAPTER

11

statesandprivateinterestsin the market,we canexpectincreasingpressureon the statesto deregulateso that the marketcan work efficiently. Statesare wary now, however,and many of those that did deregulate have had secondthoughts.The trend toward increasedgovernmentinvolvementin electricity marketsshouldcontinuethrough new municipal powerproduction,incentives forrenewableresourcegenerationand personalpowergeneration,andmunicipalbuying cooperativesasin Ohio and Massachusetts. Stategovernmentsmust also read their own energypolicy mission statementsand identify ways to protect the policy intereststhat are explicitly interconnectedbefore developingany policy to deregulate electricity. The evidenceis clearthat the stateshavehad a complexof policy interestsrelated to energy acrossthirty years. California and many otherstateswerepersuadedto deregulateelectricity by the promise of low pricesto servethe interestsof their residentsandbusinesses. Thosepromiseswerenot andcould not be fulfilled and the statemoved finally to protectthe complex of policy interests.Other statesshould move carefully to deregulate,armed with an understandingof what they are giving up and how they can maintaincontrol over thoseother valuesthat matter. In the end, it is governmentthat mustservethe people'sinterestsand not the market. Governmentmay be slow to innovate and messy,but that is the way Americandemocracyis structured.Economistsemphasize efficiency as the highest value and advocateprivatization as the way to increaseefficiency in the government.Yet we ought to question whetherefficiency is the most importantvaluefor public policy when it disadvantagesthe powerlessand leads to public alienationof government. In any case,the word "efficiency" doesnot appearanywherein the U.S. Constitution, so we should concludethat the messystructure the foundersestablishedwasnot intendedto be efficient. It was intended to servethe people,all the people,and not just to protectthe interestsof a free marketeconomy,which is not mentionedin the documenteither. The fallacy of today'seconomictheory is the assumptionthat free marketsalonecanservethe interestsof all the people.This casedemonstratesthat marketsrewardthe cleverestand most powerful. Only governmentscan protectand servethe public.

148

12

Epilogue

On August 14,2003,asI wasputting the finishing toucheson this manuscript, the electricity went out throughoutmuch of the northeasternpart of the United Statesand southeasternCanada.The great blackout of 2003 was the most extensivein North American history. While reportsare still preliminary,they do indicatethat deregulation may lie at the baseof the blackout insofar as it disruptedthe management of the electricity grid that was in placeunderregulation.In Ohio, wherethe blackoutstarted,companiesin the north and southof the state areconnectedto two different independentsystemoperators(ISOs) that did not communicatewith eachotheraboutthe extentof outagesin their systems.This lack of communicationled the companiesto demandmore electricity from a grid that was alreadyoverloaded.Like dominoesfalling, eachstate'sdemandput more and more pressureon the entire grid until it shutdown everywherefrom New York to Michigan and north to Ontario and New England. Deregulationdisruptedcommunicationsamongcompetingcompanies while it also linked themall to the transmissiongrid. When onecompany neededpower,it took it from anotherpartof the interlockedgrid. Because noneof the ISOsknew the full extentof the problem,they could not react fast enoughto stopthe cascadingeffect of the failures. So Ohio pulled on powersuppliesin Michigan, which pulled on Ontario, which thenpulled on New York, and the lights went out everywherefor as long as twentyfour hoursin someplaces(Lipton, Perez-Pen a, andWald 2003). The blackoutwas also blamedon the aging transmissiongrid that is not capableof carrying the electricity demandedby the new markets. Electricity demandgrows with the economyas we havealreadyseen.It may grow at fasterrateswith deregulation,however,becausecompetition leads all companiesto encourageconsumersto use more of their 149

CHAPTER

12

product.Without regulatoryefforts to encourageenergyefficiency and conservation,demandfor electricity will grow, putting more pressure on the grid. Under the regulatedmonopoly model, the electricity providers(independentlyownedutilities) ownedthe grids andupgradedthemasdemand grew. They were required to use integratedresourceplanning and demand-sidemanagementprogramsto control growth in demandand resulting pressureon the grid. The companiesthat sold electricity also managedthe grid andhadtheincentiveto makesurethattherewasenough capacity to carry their own electricity to their customers.Deregulation removesresponsibilityfor the grid from the profit-making providersand leavesit in the handsof the local companiesthat canno longermanageit. No one has the incentive to invest in upgradingthe grid becausethe profitmakersuse any grid to get their productto the areawith the most demand.The federal governmentis now facing the prospectof investing billions to expandthe electricity grid nationwideso that private companies can sell more electricity. This crisis hasnot yet broughtAmericansto discussthe implications of ever-expandingelectricity demandon our environmentand our pocketbooks. If we continue to build more and more conventionalpower plants and bigger and bigger grids, the impact on our environmental heritagewill surely be severe.It will take a bigger crisis to convince Americansthat energyefficiency and alternativesourcesof energyare the only way to ensurethat there will be enoughto go around.Californians learnedthis lessonin 2001, although it did not last. As soon as prices stabilizedand peoplegot usedto paying more for electricity, demand startedto rise. Figure 12.1 illustrates the impact that the 2001 conservationefforts would have had on the 2002 peakdemand. The American Council for an Energy-EfficientEconomyfound that energyefficiency programsin California, New York, and New England reducedpeakdemandby more than 4,300megawattsin 2001, which is the equivalentof aboutfifteen medium-sizedpowerplants(www.aceee. org and www.eren.doe.gov). Until Americansrealize that unlimited demandfor electricity leads only to more demand,we can expectmore blackoutsand higher prices for electricity and everythingthat is relatedto it. Thereis no free lunch whenit comesto energy.While regulationwas designed to manageelectricity growth and profits, deregulationleadsto an out-of-control market that will increasedemandexponentially.Inevitably, more demand 150

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--

151

20

21

11

11

20

21

11 10

20 11

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,.

- Day Ahead Forecasl - - -Available Resources (esL)

11 15

11 17 17

11

20

21 Hour BegInning

22

23

2'

_ Demand wilh 2000 conservation

11

Source: California EnergyCommissionWeb site: www.energy.ca.gov/electricity/peak_demandl2002-07-1O_CHART.PDF. Notes: This graph comparesthe July 10,2002demandwith two alternativescenarios.The top line shows the availableelectricity generationresourceson thatday. Rolling blackoutstypically would occurwhen operatingreservesdip below 2 percent.The dottedline is the ISO'sforecastof expecteddemand,which closelyparallelsthe line that showsthe actualdemandin the ISO control area.The dashed line on the bottom illustratesthe EnergyCommission'sscenarioof what demandcould havebeenif Californianswereconservingat the samerate as the summerof 2001.The black line representswhat electricity demandwould havebeenbasedon 2000 usagepatterns.

---Actual Syslem Load - Demand w,th 2001 conservation

11

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Figure 12.1 Peak Electricity Demand in the Independent System Operator Control Area (on July 10, 2002, with available resources and alternative demand scenarios)

forecast

CHAPTER

12

meansthat priceswill rise as suppliesof naturalgas,the currentfuel of choicefor electricity generation,start to decline. The blackoutand the California electricity crisis underscorethe need for a comprehensivelook not only at energypolicy in this country but at ways that ordinary Americanscan provide more of their own energy. Given today'stechnologyand the efficiency of smallergenerators,it is time to look beyond the delivery of electricity using early twentiethcenturytechnologysuchasfossil fuel generationandtransmissiongrids. Deregulationhas createda market that is going in the wrong direction by increasingdependencyon outmodedtechnology.Statesand energy usersneed tothink more creatively about generatingsmaller amounts of electricity closer to the end users.This would reducetraffic on the grid and avoid massiveblackoutsin the future. I hope that I have demonstratedadequatelythe weaknessesof the market for delivering public policy. Both of thesecrises demonstrate the value of governmentinvolvementin a marketthat is truly a public good. Electricity is not pork bellies after all.

152

155

www.ahfc.state.ak.us/

Research and Rural Development Division Division, Alaska Housing Finance Corporation

www.energy.ca.gov/ www.state.co.us/oemc/ www.opm.state.ct.us/aboutopm.htm

Arkansas Industrial Development Commission, Arkansas Energy Office

California Energy Commission

Colorado Governor's Office of Energy Management and Conservation

Connecticut Office of Policy and Management, Policy Development and Planning-Energy

Division of Facilities Management Energy Office

Arkansas

California

Colorado

Connecticut

Delaware

www.delaware-energy.com

www.aedc.state.ar.us/energy/

Department of Commerce, Energy Office

www.azcommerce.com/energy.htm

www.aidea.org/aea.htm

(continued)

Energy office Web site http://adeca.state.al.us/adeca/pages/pages_stm/ Science_Technology_Energy_STE.stm

Community and Economic Development, Alaska Industrial Development and Export Authority, Alaska Energy Authority

State energy office Department of Economic and Community Affairs, Science, Technology and Energy Division

Arizona

Alaska

Alabama

State

State Energy Offices and Web Sites

Appendix 1

154

www.gefa.org/energy_program.html www.hawaii.gov/dbedt/ert/energy.html www.idwr.state.id.us/energy/ www.commerce.state.iI.us/aboutdcca/ www.state.in.us/doc/energy/ www.state.ia.us/dnr/energy/ www.kcc.state.ks.us/energy/index.htm

Georgia Environmental Facilities Authority, Division of Energy Resources

Department of Business, Economic Development and Tourism, Energy Resources and Technology Division

Idaho Department of Water Resources, Energy Division

Illinois Department of Commerce and Community Affairs, Bureau of Energy and Recycling

Indiana Department of Commerce, Energy Policy Division

Iowa Department of Natural Resources, Energy and Geological Resources Division, Energy Bureau

Kansas Corporation Commission, Energy Programs Section

Kentucky Division of Energy

Louisiana Department of Natural Resources, Technology Assessment Division, Energy Section

Georgia

Hawaii

Idaho

Illinois

Indiana

Iowa

Kansas

Kentucky

Louisiana

www.dnr.state.la.us/SEC/EXECDIVITECHASMT /ENERGY/lntroFrame.htm

www.nr.state.ky.us/nrepc/dnr/energy/dnrdoe.html

Energy office Web site www.dca.state.fl.us/index.htm

State energy office Florida Department of Community Affairs

State Florida

Appendix 1 (continued)

154

Massachusetts Department of Economic Development, Division of Energy Resources

Michigan Department of Consumer and Industry Services, Energy Office

Minnesota Department of Commerce, Energy Division

Mississippi Development Authority, Energy Division

Department of Natural Resources, Energy Center

Montana Department of Environmental Quality

Nebraska State Energy Office

Nevada Department of Business and Industry, State Energy Office

Governor's Office of Energy and Community Services

New Jersey Board of Public Utilities, Division of Energy www.bpu.state.nj.us/wwwrootlenergy/energy.htm

New Mexico Energy, Minerals and Natural Resources Department, Energy Conservation and Management Division

Massach usetts

Michigan

Minnesota

Mississippi

Missouri

Montana

Nebraska

Nevada

New Hampshire

New Jersey

New Mexico

www.emnrd.state.nm.us/ecmd/ (continued)

www.state.nh.us/governor/energycomm/index.html

http://energy.state.nv.us/

www.nol.org/home/NEOI

www.deq.state.mt.us/energy/

www.dnr.state.mo.us/de/homede.htm

www.decd.state.ms.us/main/energy/

www.commerce.state.mn.us/pages/EnergyMain.htm

www.cis.state.mLus/oplaierd/

www.state.ma.us/doer/

www.energy.state.md.us/

Maryland Energy Administration

Maryland

www.state.me.us/spol

Maine Department of Economic and Community Affairs Development, Energy Conservation Division

Maine

154

www.odoc.state.ok.us/index.html www.energy.state.or.us/ www.dep.state.pa.us/dep/deputate/pollprev/ pollution_prevention.html www.riseo.state.ri.us/ www.state.sc.us/energy/ www.sdgreatprofits.com/

North Carolina Department of Administration, State Energy Office

North Dakota Division of Community Services, Energy Programs

Ohio Department of Development, Office of Energy Efficiency

Oklahoma Department of Commerce, Division of Community Affairs and Development

Oregon Office of Energy

Pennsylvania Department of Environmental Protection, Office of Pollution and Compliance Assistance

Rhode Island State Energy Office

South Carolina Energy Office

South Dakota Governor's Office of Economic Development

North Carolina

North Dakota

Ohio

Oklahoma

Oregon

Pennsylvania

Rhode Island

South Carolina

South Dakota

www.odod.state.oh.us/cdd/oee/

www.state.nd.us/dcs/Energy/default.html

www.doa.state.nc.us/doa/energy/energy.htm

www.nyserda.org/

New York State Energy Research and Development Authority

New York

Energy office Web site

State energy office

State

Appendix 1 (continued)

154

www.seco.cpa.state.tx.us!

Texas Comptroller of Public Accounts, State Energy Conservation Office

Utah Energy Office

Vermont Department of Public Service, Energy Efficiency Division

Virginia Department of Mines, Minerals and Energy, Division of Energy

Washington Department of Community, Trade and Economic Development, Energy Policy Office

West Virginia Development Office, Energy Efficiency Program

Wisconsin Department of Administration, Division of Energy and Public Benefits, Energy Bureau

Wyoming Business Council, Energy Program

Texas

Utah

Vermont

Virginia

Washington

West Virginia

Wisconsin

Wyoming

www.wyomingbusiness.org/wbc/internal.cfm? arealD=1 &navDetaillD=176

www.doa.state.wi.us/depb/boe/index. asp

www.wvdo.org/community/eep.htm

www.energy.cted.wa.gov/

www.mme.state.va.us/de/

www.state.vt.us/psd/ee/ee.htm

www.dced.state.ut.us/energy/

www.state.tn.us/ecd/energy.htm

Tennessee Department of Economics and Community Development, Energy Division

Tennessee

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154

23

20

California, Idaho, Illinois, Iowa, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, MiSSissippi, Missouri, New Hampshire, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Washington, Wisconsin Alabama, Alaska, Arizona, California, Colorado, Hawaii, Indiana, Iowa, Louisiana, Maryland, Massachusetts, Michigan, MiSSissippi, Montana, Nebraska, North Carolina, Ohio, Oregon, South Carolina, Wyoming

Technical assistance and energy audits of residential and commercial buildings and schools; "institutional conservation programs"

Energy tax credits, low interest loans, grants or bonds for upgrades of residential and commercial buildings and schools

(continued)

26

29

34

Total

Alabama, California, Delaware, Georgia, Hawaii, Indiana, Iowa, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Nebraska, Nevada, New Jersey, New Mexico, North Carolina, Ohio, Oklahoma, Rhode Island, South Carolina, Tennessee, Utah

Alaska, Arizona, California, Delaware, Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Massachusetts, Michigan, Minnesota, Montana, Nevada, New Hampshire, New Jersey, New York, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Texas, Utah, Vermont, Virginia, Washington, Wisconsin

States Alabama, Alaska, Arizona, California, Colorado, Delaware, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Montana, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Oregon, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Utah, Vermont, Virginia, Washington

Transit programs (carpooling, vanpooling, ridesharing, fleets containing alternative fuel vehicles)

Consumer tips on energy efficiency including home energy and appliance rating; energy rebates

Alternative energy development (biomass, fuel cells, solar, tidal energy, ethanol, methane, wind, photovoltaic)

Priority area

Priority Areas

Appendix 2

154

16

12

9 8

8 8 7 7

Delaware, Iowa, Kentucky, Massachusetts, Mississippi, Missouri, Montana, Nebraska, New Hampshire, New Mexico, North Dakota, Oklahoma, Rhode Island, South Carolina, Texas, Utah Alaska, Arizona, Colorado, Georgia, Nebraska, New Hampshire, North Dakota, Ohio, Oregon, Rhode Island, Vermont, Wisconsin Alabama, Colorado, Connecticut, Hawaii, Illinois, Indiana, Montana, Utah, Washington Delaware, Georgia, Ohio, South Carolina, Tennessee, Texas, Utah, Wyoming California, Delaware, Georgia, Hawaii, Kentucky, Massachusetts, Minnesota, North Dakota California, Colorado, Connecticut, Florida, Louisiana, Montana, Pennsylvania, Rhode Island Alaska, California, Delaware, Hawaii, Rhode Island, Tennessee, Washington Alabama, Delaware, Georgia, Maryland, North Carolina, South Carolina, Washington

Governmental buildings/state facilities programs

Weatherization assistance for lowincome residents; fuel assistance

Recycling programs

Energy education programs to primary and secondary schools

Statistics on state energy usage

Water resources management/water quality issues

Emergency contingency planning (petroleum)

Teaming with a university to undertake a special energy project

19

Residential and commercial energy efficiency codes, standards

Total

States Alabama, Alaska, California, Colorado, Delaware, Hawaii, Illinois, Kansas, Kentucky, Louisiana, New Mexico, North Carolina, North Dakota, Oklahoma, Oregon, Pennsylvania, Rhode Island, Texas, Vermont

Priority area

Appendix 2 (continued)

154

6 6 6 6

Connecticut, Delaware, Florida, Indiana, Montana, Oklahoma California, Hawaii, Oregon, New Mexico, South Carolina, Tennessee Alaska (fishing), Florida (cruise ships), Iowa (agriculture), North Carolina (agriculture), Vermont (agriculture), Washington (glass, wood) Arizona, Hawaii, Michigan, Vermont, Virginia, Washington

Connecticut, Delaware, Hawaii, Maine, Washington Hawaii, Mississippi, Tennessee, Texas, Wyoming Alabama, California, Connecticut

Colorado, Georgia, Utah California, New York Oregon, Washington

Air resources management/air quality issues

Climate change action

Industry-specific energy efficiency programs

Software packages enabling municipalities to track energy use and costs or policy scenario analysis

Regulatory and legislative coordination around energy issues

Training energy management personnel to monitor or control energy consumption

Municipal solid waste management programs: sewer/wastewater management/groundwater issues

Sustainable development/smart growth initiatives

Powerplants and licensing

Technical assistance for businesses starting telework programs (telecommuting)

2

2

3

3

5

5

7

Connecticut, Florida, Hawaii, New York, Oregon, South Carolina, Texas

Treatment, storage, disposal of low-level radioactive waste; brownfields cleanup

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Notes

Notes to Chapter 1 1. For a history of nationalpolicy, seeNash(1968). 2. A barrelof oil is the standardmeasureusedto describequantitiesof energy regardlessof the fuel. 3. The United Statesstill lags behindthe rest of the world in public transportation. Nonetheless,severalmajor public transportationsystemswereconstructed in the 1970s, including the Washington,DC Metro and the San FranciscoBay Area Rapid Transit. 4. Stateenergypolicy has beenfocusedon electricity, natural gas, and heating oil becausestateshaveno authority over transportationfuel policy.

Notes to Chapter 2 1. A building of this vintagein the city of Pittsburghhad an HVAC systemthat was designedto operateair conditioningand steam heatingsimultaneouslythe year around.An energyaudit in 1980indicatedthatthe city could save$100,000per year for an investmentof $200,000to upgradethe system. 2. In 1980,Aramco became100 percentSaudiowned,with the dateof ownership backdatedto 1976(www.saudinf.com). 3. It is hard to remember,given the politics of the pasttwenty years,that environmentalprotectionwasa highly salientpolitical issuein the early 1970s.Environmentallegislationpassedboth housesof Congressby hugemajoritiesand virtually every candidatefor political office in the country, evenconservativeRepublicans, had a position statementfavoring environmentalprotection. 4. Gasolinepricestoday,if adjustedfor inflation, are approximatelyequivalent to 1973's pre-embargoprice of 25 centsper gallon. 5. Clinton's vice president,Al Gore, had proposed,in his book Earth in the Balance, such a tax at 50 centsto reducegasolineconsumption.During the 1992 campaign,Reform Party candidateRossPerothad educatedAmericansabout the deficit and proposeda gasolinetax to eliminateit. 6. Refinersin Californiajustify the higherpricesby the fact thatrefinerieshaveto producea specializedmix to meetCaliforniaair quality standards.Pricesvary considerably in the state,however,with the highestpricesseenin the SanFranciscoarea.

163

NOTES

7. The vice presidentclaimedexecutiveprivilegein refusingto releasethe names and proceedingsof the task force. The GeneralAccountingOffice suedthe Executive Branchfor releaseof this information.The casewas still pendingas this manuscript was completed.

Notes to Chapter 3 1. The 1977 amendmentspermittedCalifornia to imposehigher standardson carssold within the state.The manufacturersacceptedthis requirementbecauseof the large marketin California. 2. Historically, federal energy policyhas always beenlinked with national security. The first energy "crisis" occurredduring World War I when oil shortages threatenedthe war effort. The U.S. governmentestablishedwhat was later to becomethe National PetroleumInstitute (seeNash 1968). 3. The project was funded through the National Institute for Global EnvironmentalChange,MidwesternCenter,IndianaUniversity, Bloomington. 4. The mid-continentstateshaveblistering hot and humid summersas well as very cold winters. Thus, their air-conditioning demandand winter fuel needsare both high. 5. Ohio, not a respondentto the survey,was developinga stateenergypolicy at the time. The policy was unveiledin 1994. 6. The Indianalegislaturehad no energyor environmentcommittee.I was referred insteadto the chief lobbyist for the electricity industry.

Notes to Chapter 4 1. The future of nuclearpower is still uncertain.The industry continuesto tout it as cheap,safe, and nonpolluting. Since the terrorist attackson September11, 2001, however,existing nuclearpower plants are increasinglyseenas a potential targetand a major sourceof risk for residentsnearthem. 2. GreenMountain Energy moved into the California marketand quickly enrolled a sizablenumberof customers.I askedthe salesrep what they were doing to encourageconservation.He could tell me only that they were able to build new power plants using renewabIes. He also said that they do, of course, encourage peopleto conserveenergy.

Notes to Chapter 5 1. For an explanationof strandedcosts,seechapter4. 2. Becausenaturalgashadbeenderegulatedin the 1980s,residentialpricesfor gas usedfor heatingandcooking were alreadybeingpassedalong to customers. 3. In Septemberof that year, my husbandandI replacedour major kitchen appliancesandfurnace.At the time, therewere no public urgingsto buy the mostefficient units. Therewas no public reportof excessdemandfor electricity in the state. 4. Data from the California Energy Commission;available at: www.energy. ca.govlelectricity/monthly_ofU ine.html.

164

NOTES

5. In June2003, theFERC ruled that the contractsshouldstandeventhoughit found that the companiesactedto drive up prices(FERC 2(03).

Notes to Chapter 7 1. Researchfor this chapterwas performedby RachelLevine, MPA studentat California StateUniversity,Hayward.Shealsowrote a substantialpartof the chapter. 2. To be sure,electricity was not the principal reasonfor the economicdecline in 2001, but it may have been a contributing factor. Following the recession,the that moveto stateswith lower rateswill providea truer testof numberof businesses the effectsof electricity restructuring.

Notes to Chapter 8 1. In this context, Staterefers to governmentin generalas distinct from the states. 2. The InterstateCommerceCommission,establishedin 1880, was the first regulatoryagency.It was disestablishedduring the 1990s. 3. Somewill arguethat thesetwo groupsare the same.At the time this manuscript was beingprepared,the GeneralAccountingOffice had suedthe presidentto releasethe namesof taskforce membersbecausetheir work was donein secret. 4. The credit businessis very successfulamongthosewith the leastfinancial resources.Many college studentsare enticedinto taking on credit debt by companies that are permittedto solicit on campus. 5. Mishandling the energycrisis was one of the reasonsCaliforniansrecalled GovernorGray Davis in October2003.

Notes toChapter 10 1. Portionsof this sectionappearedin Timney (2002). 2. Interview with former congressman RichardOttinger,cosponsorofPURPA. 3. The SacramentoMunicipal Utilities District closed a nuclearpower plant after citizensvotedto pay higher ratesto amortizethe cots of removingthe plant.

Note to Chapter 11 1. Alexis de Toqueville was an aristocraticFrenchmanwho cameto the United Statesin 1831 to study democracyas a new form of government.His two-volume work, Democracyin America, remainsa seminal descriptionof early nineteenth centuryAmericanculture and governance.

165

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Bailey, Mary Timney. 1984."Improving EnergyManagementandAccountabilityin Municipal Operations:A Model EnergyBudgetfor Local Governments."Report of the EnergyTask Force of the Urban Consortiumfor TechnologyInitiatives. Washington,DC: Public Technology,Inc. - - - . 1993."Energy Policy Developmentin the States:Implicationsfor Global Warming Policy." Projectreport preparedfor the National Institute for Global EnvironmentalChange.Bloomington:IndianaUniversity, MidwesternCenter. Banerjee,Neela,andRichardperez-Pena.2001."A FailedEnergyPlanCatchesUp to New York." New York Times,June 1: AI, A20. "A Blinkered Strategy."2001. New York Times,May 6: 14. Brennan, TimothyJ.; KarenL. Palmer;andSalvadorA. Martinez.2002.Alternating Currents: Electricity MarketsandPublic Policy. Washington,DC: Resourcesfor the Future. Brennan,Timothy J.; Karen L. Palmer;RaymondJ. Kopp; Alan J. Krupnick; Vito Stagliano; andDallas Burtraw. 1996. A Shock to the System:Restructuring America'sElectricity Industry. Washington,DC: Resourcesfor the Future. Brower, Michael C.; Michael W. Tennis; Eric W. Denzler; and Mark M. Kaplan. 1993. Powering the Midwest: RenewableElectricity for the Economyand the Environment.Washington,DC: Union of ConcernedScientists. CaliforniaEnergyCommission.2003.EnergyFacility Status,May 21; availableat: www.ca.gov/sitingcases/all_projects.xls. Davis, David Howard. 1978. EnergyPolitics. New York: St. Martin's Press. - - - . 2001. "The EnergyCrisis of 2001." Paperpresentedat the annualconferenceof theAmericanSocietyfor Public Administration,Newark,NJ, March 11. Davis, PeterV. 1983. "Selling SavedEnergy: A New Role for the Utilities." In Uncertain Power: The Strugglefor a National Energy Policy, ed. Dorothy S. Zinberg, 182-98.Elmsford, NY: PergamonPress. Douglass,Elizabeth.2003. "EI PasoPledgesto Aid Probesof Other Firms." Los AngelesTimes,March 22: C2. EnergyInformationAdministration.2000."The Restructuringof the Electric Power Industry," January; available at: www.eia.doe.gov/cneaf/electricity/page/ restructure.htrnl. - - . 2002. Annual Energy Review; available at: www.eia.gov/emeulaer/pdf/ pages/seeS.pdf.

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168

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Meadows,DonellaH.; DennisL. Meadows;JorgenRanders;andWilliam H. Behrens III. 1972. The Limits to Growth: A Reportfor the Club ofRome'sProject on the Predicamentof Mankind. New York: Universe. Mitchell, Eve. 2001."PUC Expectedto AcceptNew Plan." HaywardDaily Review, September20: Business,1,5. Nash,GeraldD. 1968. United StatesOil Policy 1890-1964.Pittsburgh:University of PittsburghPress. Olson,MancurJr. 1965.TheLogic ofCollectiveAction: Public Goodsandthe Theory of Groups. Cambridge,MA: HarvardUniversity Press. Oppel, RichardA. Jr. 2001. "Surplusof Finger-Pointingin California Energy Crisis." New York Times,June5: AI, C2. ---.2003."PanelFindsManipulationby EnergyCompanies."NewYork Times, March 27: A14. Oppel, RichardA. Jr. with Lowell Bergman.2002. "JudgeSaysSupplierInflated GasPricesin California Crisis." New York Times,September24: AI, C2. Oppel,RichardA. Jr., andLauraM. Holson.2001."While a Utility May Be Failing, Its OwnerIs Not." New York Times,April 30: AI, A17. Piller, Dan. 2002."Confidencein DeregulationDeclining as ProblemsRise." Dallas-Fort Worth Star Telegram,June9: 1. Regens,JamesL. 1979."StateResponses to the EnergyIssue:An AnalysisofInnovation." Social ScienceQuarterly 61, no. 1: 44-57. RhodeIslandPublic Utilities Commission.2001. Reportofthe RhodeIsland Public Utilities Commissionon Electric Restructuring,February 28; available at: www.ripuc.org/energy/relegislature2001.pdf. Saudi Arabian Information Resource.[n.d.] "Oil: Historical Backgroundand Aramco;" availableat: www.saudinf.comlmainldll.htm. Savas,E.S. 1983. Privatizing the Public Sector: How to Shrink Government. Chatham,NJ: ChathamHouse. Smeloff, Ed, and PeterAsmus. 1997. ReinventingElectric Utilities: Competition, Citizen Action, and Clean Power. Washington,DC: IslandPress. Stateof California. 2003.EnergyAction Plan,May 8; availableat: www.documents. dgs.ca.gov Icpaljointl26305 .pdf. Stateof Wisconsin. 1986. Governor'sEnergy Efficiency Plan. Madison, WI: Departmentof Administration. Timney, Mary M. 2002. "Short Circuit: Federal-StateRelationsin the California EnergyCrisis." Publius: The Journal of Federalism32: 109-22. Tongren,RobertS. 2003."Consumers'CounselCalls for RegulatoryAction to Spur Electric CompetitionandProtectOhio Consumers."Ohio Consumers'Counsel. 2002End-of-YearUpdateon Ohio'sElectric Market; availableat: www.pickocc. org/ news/182003.shtml (February18,2004). U.S. Departmentof Energy. "The Budget for Fiscal Year 2003;" available at: www.energy.gov. U.S. GeneralAccountingOffice. 2002."EnergyMarkets:ConcertedActions Needed by FERC to Confront ChallengesThat ImpedeEffectiveness,"GAO-02-656, June;availableat: www.gao.gov. Vietor, RichardH.K. 1984. EnergyPolicy in AmericaSince1945:A Studyof Business-Government Relations.Cambridge:CambridgeUniversity Press.

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Viner, Jacob.1927."Adam Smith andLaissezFaire." Journal ofPolitical Economy 35, no. 2: 198-232. Weidenbaum,Murray L. 1981. Business,Government,and the Public. Englewood Cliffs, NJ: PrenticeHall. Weingroff, RichardF. 2003."Creatinga Landmark:The IntermodalSurfaceTransportation Act of 1991." FederalHighway Administration, U.S. Departmentof Transportation,April 28; availableat: www.fhwa.dot.gov/infrastructure/rw01.htm. Witherspoon,Roger.2003."ReportSaysPublic Can'tBe Protected."Journal News, WestchesterCounty, January11: AI.

170

further Reading

Bailey, Mary Timney. "An Innovative Management Systemfor Improving Energy Conservationin Municipal GovernmentOperations."Ph.D. dissertation. University of Pittsburgh,GraduateSchool of Public and International Affairs, 1984. Baumol,William J., andJ. GregorySidak.TransmissionPricing andStrandedCosts in the Electric PowerIndustry. Washington,DC: AEI Press,1995. Blair, PeterD. "U.S. Energy Policy Perspectivesfor the 1990s." In Making National EnergyPolicy, ed.HansH. Landsberg,7-40.Washington,DC: Resources for the Future, 1993. Blumstein,Carl; Betsy Krieg; Lee Schipper;and Carl York. "OvercomingSocial andInstitutional Barriersto EnergyConservation."Energy5 (1979): 355-71. Cicchetti, CharlesJ., and JohnL. Jurewitz,eds.Studiesin Electric Utility Regulation. Cambridge,MA: Ballinger, 1975. Colle, Zachary."$3.3 Billion EnergyOverchargeFERCRULING: FederalRegulators Tally Shortof Davis' Demands."SanFranciscoChronicle, March 27,2003. Available at www.sfgate.com. Eisner,Marc Allen; Jeff Worsham;and Evan J. Ringquist. ContemporaryRegulatory Policy. London: Lynne Rienner,2000. Heilbroner,RobertL. 1965.The Worldly Philosophers:The Lives, Times,andIdeas oJtheGreat EconomicThinkers. New York: Simon and Schuster,1965. Jones,Bradford S. "State Responsesto Global Climate Change."Policy Studies Journal 19, no. 2 (1991): 73-82. King, Cheryl S., andCamilla Stivers,eds.GovernmentIs Us: StrategiesJoranAntiGovernmentEra. ThousandOaks,CA: Sage,1998. Landsberg,HansH., ed. Making National EnergyPolicy. Washington,DC: Resources for the Future, 1993. Maher,Ellen. "The Dynamicsof Growth in the Electric PowerIndustry." In Values in the Electric Power Industry, ed. KennethSayre, 149-216.Notre Dame, IN: University of Notre DamePress,1977. Montgomery,W. David. "Interdependencies BetweenEnergy and Environmental Policies." In Making National Energy Policy, ed. H. Landsberg,61-94. Washington,DC: Resourcesfor the Future, 1993. Portney,PaulR., ed.Natural Resourcesandthe Environment:TheReaganApproach. Washington,DC: Urban InstitutePress,1984.

Han~

171

FURTHER READING

Sawhill, John C., ed. Energy Conservationand Public Policy. EnglewoodCliffs, NJ: Prentice-Hall,1979. Sayre,Kenneth,ed. Valuesin the Electric PowerIndustry. Notre Dame,IN: University of Notre DamePress,1977. Sclove,RichardE. "Energy Policy and DemocraticTheory." In Uncenain Power: The Strugglefor a National Energy Policy, ed. Dorothy S. Zinberg, 37-65. Elmsford,NY: PergamonPress,1983. Smith,VernonL. "Can Electric Power-A'NaturalMonopoly'-BeDeregulated?" In Making National EnergyPolicy, ed. HansH. Landsberg,l31-51.Washington, DC: Resourcesfor the Future, 1993. Sunstein,CassR. After the RightsRevolution:Reconceivingthe RegulatoryState. Cambridge,MA: HarvardUniversity Press,1990. Thayer, Frederick C. An End to Hierarchy and Competition. 2d ed. New York: Franklin Watts, 1981. Timney, Mary M. "Eco-Nomics:Toward a Theory of Value for Public Administration." AdministrativeTheory & Praxis 23 (2001): 25-28. Vietor, Richard H.K. Contrived Competition: Regulation and Deregulation in America. Cambridge,MA: BelknapPressof HarvardUniversity Press,1994. Waring, Marilyn. If WomenCounted.SanFrancisco:Harperand Row, 1988. Zinberg,Dorothy S.,ed. Uncertain Power: TheStrugglefora National EnergyPolicy. Elmsford, NY: PergamonPress,1983.

172

Index

Accelerateddepreciation,56 Acid rain, 19,26-27,52,60 Agricultural states,37 Air pollution, 19,27,34--35,38,60 Airline deregulation,7, 100, 119-120 Alaskan oil pipeline, 20, 35 Alternative energy sources,22, 43 American Council for an Energy-Efficient Economy, 150 American Electric Power, 19, 57 Arabian American Oil Company (Aramco), 17 Arctic National Wildlife Refuge,29-31 Asmus, P., 49 AT&T, 7,116 Atomic energy, 20 Atomic EnergyAct, 38 Atoms for Peaceprogram,20 Auctioning off transmissionfacilities, 56 Automobiles,S,18, 124--125 averagefuel consumption,18 efficiency standardsfor, 22 ethanolfuels, 27 manufacturersof, 35, 124 Averagefuel consumption,18 Bell Laboratories,116 Bilateral contracting,58 Biomassenergy,24, 28, 38, 50, 53 Bonneville Power, 33, 71 Borenstein,Severen,134 Brennan,T. 1., 56 Buildinglhome construction,18, 22-23, 26-27,43 Burmeister,George,42 Bush, GeorgeH. w., 27-29, 44 Bush, Georgew., 12,29-31,61,65,83,130,

California alternativeenergy sourcesin, 53, 125 CompetitionTransition Charge,68, 118 Departmentof Water Resources(DWR), 73,103 electricity deregulation,9-11, 13-15, 66-67, 78-80, 114--116 Energy Action Plan, 142 energy crisis aftermathof, 74--76, 87-88, 117, 129-131 conservationefforts, 72, 125-126 consumerdemandand, 70-72, 103, 108-109 EWGs and, 74 explanationfor, 70-74 overview of events,63...{j5 rolling blackouts,9, 31, 46, 64, 66, 73 StateThree alert, 64 independentlyowned utilities (IOUs), 63...{j4,68-70,72 municipal utility districts (MUDs), 75 Power Exchange(PX), 67,121, 135-136, 145 price caps,9-10, 65...{j6, 69 restructuring(casestudy), 63-76 California Arabian StandardOil Company,17 California ConsumerPower and ConservationFinancingAuthority, 73 California Energy Commission,89-90 California IndependentSystemOperator, 71, 145 California Large Energy Consumers Association,67 California Public Utility Commission (CPUC), 55, 63...{j4, 67...{j9, 73, III, 114 Carbondioxide, 51, 53, 60

Cable television, 119

25,40 Cheney,Dick, 30, 130

132-133

173

Carter administration,4, 7, 12, 19,22-23,

INDEX CheneyTask Force (200I), 61 ChicagoEdison, 48 China, 141 Chloroflurocarbons,26 Civil Aeronautic Board, 7 CleanAir Act, 27, 35, 38, 52, 56, 105 CleanAir Act Amendments,19,34,45 Clean WaterAct, 35 Clinton administration,29-30 Club of Rome, 22 Coal, 12, 17,20,34 Ford administration,22 pollution and, 19 Coal-burningpower plants, 19, 52 Coal mining, 52, 60 Cogeneration,24, 51 Colorado, 95 Columbia River, 33 Conservation,4---8, 25, 30--31 consumptionculture and, 123-124 energy efficiency programs,22-23 statepolicy and, 22, 35 utility companiesand, 24 ConsolidatedEdison, 57 Consumeractivists, 38 Consumerchoice, 81-82, 117-118 ConsumerProductSafety Act, 35 Consumerprotection,7, 34 Consumptionculture, 123 Contract renegotiation,56 Cost plus method,24, 57, 134 Credit penalty, 10 Credit ratings, 64

Deregulation(continued) as necessary,114---116 in other states,77-81 political failures and, 120--121 positive elementsof, 116-120 prices and demand,86 public interestsand, 102 as public policy, 113,147 qualifying facilities (QFs) and, 24 stateenergyoffices and, 92 statepolicy for, 33 state-to-stateprice variations, 84---86 statusof activity, 83 strandedcostsand recovery,56-57 technologyrevolution and, 54---55 Title VII of PUHCA, 28 Direct purchasing,67 Duke Energy, 8, 31, 67, 78,111

Davis, Gray, 64, 72, 110 Demand-sidemanagement(DSM), 54---55, 61 in California, 5, 72 energyefficiency and, 28, 65, 124 stategovernmentsand, 38, 45, 96 Departmentof Energy (DOE), 8, 22, 25, 28-30,40,54,97 Departmentof Interior, 22 Deregulation,5, 7-11, 13,23,50,110 benefits from, 87-88 California's experience,9-10, 80--81 central fault in, 10 choice and the market, 81-86, 117-118 competitive marketplace,79 consumersand, 119 electricity restructuringissues,55-59 featuresof, 77-78 future of, 129-142 innovation from, 139 issuesin restructuring,55-59, 145 market failures and, 120--121 movementto, 54---59

174

Earle, Tony, 43 East Coastblackout (1967), 78 EasternIntertie grid, 48 Edison, Thomas,47--48 Eisenhoweradministration,20 EI PasoNatural Gas Company,74, 130 Electricity costs of, 51, 84---86, 118 demandfor, 50,86,149-151 as natural monopoly, 48--49 regulationof industry, 49 as unique commodity, 49-50, 144 Electricity deregulation.See Deregulation Electricity generation,47 environmentalimpacts of, 51-52 social costsof, 59-{5 I Electricity providers consumerchoice and, 8-9 cost plus pricing and, 24 energy efficiency and, 28 marketingof services,58 Emissionscontrol, 27 Energy brokers,9 Energy Conservationand ProductionAct of 1976, 35 Energy costs company'scompetitivenessand, 6 lower-incomecitizens, 6 Energy crisis (1970s),3--4, 17,35,39 Energy Information Administration, 81 Energy policy, 3, 22; seealso Deregulation; National energy policy; State energy policy in 1980s,26 in 1990s,29-30 acid rain and global warming, 26-27 Alaskan oil pipeline, 20

INDEX Energy policy (continued) buildingfhome constructionand, 18-19 Bush (2000) administration,30--31 cleannessas issuein, 21 demand-sidemanagementprograms,5, 28, 54-55,61,65,72,124 energy efficiency and conservation,22-23, 27-28 free marketand, 8 "Golden Gimmick" agreement,18 history of, 17-31 impact-motivatedparticipants,21 market and, 143-148 National Energy Policy Act, 27 as national security issue,3, 21, 31, 36 Northeasternblackout (2003), 149-152 nuclearpower, 20 oil embargo, 19-20 performance-motivated participants,21 politics of, 130--131 post-1973,20--23 post-WorldWar II economyand, 18 power-motivatedparticipants,21 pre-1973goal of, 17 price caps, 18 renewableenergy sources,24 statelevel, 3-4, 8 tax incentives,23-25 Energy Policy Act (EPACT), 50, 54, 97, 130--131, 133, 147 Energy Policy and ConservationAct of 1975, 5,35 Energy Researchand Development Administration (ERDA), 22 Energy Tax Act, 24 Enron Corporation,8, 14,28,30--31,65,67, 74,79,82,lll, 129-130 Environmentalprotection,5, 7, 12,27,34; see also Conservation activists, 38 costsof, 59-60, 85 electricity generation,51-52 Equity, 102 Ethanol fuels, 27, 37 Exempt wholesalegenerators(EWGs), 28, 31,46,50,54,69,74, 130 Exxon, 18 FederalCommunicationsCommission,113 FederalEnergy Administration, 4, 22 FederalEnergy RegulatoryCommission (FERC), 31, 74,82,88,III exempt wholesalegenerators,50 failures of, 14-15 goals and powersof, 25, 28 just imd reasonableprices,65-67

175

FederalEnergy RegulatoryCommission (FERC) (continued) national energy policy and, 131, 133-135, 145 new role of, 14, 132-133 FederalPowerAct, 67 FederalPower Commission,25, 48, 133 Federal-statepartnership,131, 135-136 FederalWater PowerAct, 48 Fessler,Daniel, 67, 114 Food and Drug Administration, 113 Ford administration,3-4, 12, 19-20,22,35 Foreign oil producers,35 Foreign policy energyproduction and, 21 internationalenergy demand, 141 Fossil fuels, 12, 17,21,26,36,38,51,53, 61, 141 Free market ideology, 8,11-12,15,25,29, 31,40, 100, 134, 138 California crisis and, 68, 75, 114 political considerationsof, 141 Freeman,S. David, 73 Friedman,Milton, 25 Gasolineprices, 18-19,23,26,30,124-125 Gasolinetax, 29, 125 Georgia, 80 Geothermalpower, 24, 28, 38, 53 Global warming, 26-27,41,53 "Golden Gimmick" agreement,18 Governmentoperations,6, 37 Greenenergy sources,59 Green Mountain Energy Company,117 Greenhousegas emissions,29, 53, 60 Halliburton, Inc., 30, 130 Hebert, Curtis, 65, 132-134 Hoge, Nettie, 112 Hydroelectricenergy,28, 50, 53, 71, 85 Impact-motivatedparticipants,21 Independentsystemoperators(IS0s), 58-59, 64,67,149 Independentlyowned utilities (IOUs), 63-64, 68-70,74,78,115, 117 Indian Point nuclearpower plant, 52 Indiana, 37, 46, 94 Industry associations,28 Insull, Samuel,47-48, 109, 144 IntegratedResourcePlanning,61 IntermodalSurfaceTransportationEfficiency Act of 1991, 27, 45 InterstateCommerceCommission,113 Invisible hand, 146 Iran, 19

INDEX Kahn, Alfred, 7 Kansas,53 Kash, Don E., 8,21 Kentucky, 80 Kreith, Frank, 42 Kyoto Agreement,96

National energy policy (continued) free market and, 8 government'srole and, 145-148 state funding, 39 National Energy Policy Act (NEPACn, 8, 27-29,45-46,82,90 National Energy Strategy(1991), 29 Natural gas, 17, 19,23,26,30,34,61,85, 139-140 Natural gas deregulation,7-8, 12,25 Natural Gas Policy Act (NGPA), 23 Natural monopoly, 4, 10,34,48-49,55,101, 114, 137 Nevada,80-81, 84 New Deal era, 113 New Mexico, 93, 95-96 New Power Holdings, 79 New York, 77,80-81,84-86,118 Nixon administration,20, 35 North American Electric Reliability Council (NERC),48 Northeastblackout (2003), 149 Nuclearpower, 12, 17,20,24,26,38-39, 50-53, 56, 139 Nuclearpower plants,52, 57, 85 Nuclearwaste,52, 61 Nuclear weapons,25, 40

Lay, Kenneth,28, 65, 70, 82-83, 130 Lee, Henry, 36 Libertarian politics, 143 Limits to Growth (Meadowset al.), 22 Lobbyists, 7, 18, 137 Logic of CollectiveAction, The (Olson), 119 Long Island Lighting Company,67 Loti, Trent, 65 Lucent Technologies,116 Major, John, 67 Market; seealso Free market ideology future of, 136-137 how market works, 102-104 market interests,104-105 oligopolies, 119-120 pricing in, 140 profit imperative, 106-109 public interest and, 137-142 public policy and, 143-148 regulatory policy for, 99-100 risks in, 11 role of, 145-148 social values and, 105-106 statesand, 99-112, 136-137 state vs. market interests,109-111 Market failures, 99, 113, 120-121 Market manipulation, 132 Massachusetts,80 Meadows,D. H., 22 Middle East oil, 3, 17-18,22 Minnesota,36, 38, 81 Mobil,18 Montana, 80, 86 Moody's InvestorsService,74 Municipal utility districts (MUDs), 75

°

National Associationof StateEnergy Offices, 90 National Centerfor AppropriateTechnology, 80,87 National Conferenceof StateLegislators,42 National EnergyActs, 24 National Energy ConservationAct, 24 National energypolicy, 3-4, 12 energyconservation,4, 20 energy independence,4, 20 federal-statepartnership,135-136 FERC and, 133-135

176

OccupationalSafety and Health Act, 7, 34-35,60 Ohio, 77, 79-80, 87,93,149 Ohio Consumers'Counsel(OCC), 79 Oil deregulationof, 7-8 imported oil, 7 minimum oil prices, 3 policies pre-1973,3, 34, 69 subsidy of domesticcompanies,118 Oil depletionallowance,3, 18 Oil embargo,3,17, 19 Oil shocks,21, 36 Oligopolies, 119-120, 139 Olson, Mancur, 119 Oregon, 80, 85,95-96,108 Organizationof PetroleumExporting countries(OPEC), 3, 7,12,17,19,23, 26,30, 105 Pacific Gas and Electric (PG&E), 5, 9, 24, 31, 51, 63-{j5, 67, 69, 78, 107, 111, 114, 116-117 Peakelectricity demand,lSI Pennsylvania,77-79, 85-87, 138 Performance-motivated participants,21 PersianGulf, 3, 26 Photovoltaiccells, 53

INDEX Pinchot, Gifford, 29 Pipelines,as commoncarriers, 25 Political failures, 120-121 Pooleo(pooling mechanism),58-59, 67 Power Exchange(PX), 67, 121, 135-136, 145 Power failure (1965), 48 Power failure (2003), 48 Power-motivatedparticipants,21 Power Plant and Industrial Fuel Use Act, 24 Predatorymarket practices,4, 47, 113 Price caps,9, 18,23,57,65-{j6, 69, 132 Price fixing, 50 Price shocks,21, 36 Priority areas, 159-161 Privatization, 100-101, 110, 146--147 Profit imperative, 106--109, 121 Public goods,99 Public information campaigns,35, 43 Public interest, 137-142 Public policy, economicsand, 99-102 Public Utility Holding CompanyAct (PUHCA), 28, 48 Public Utility RegulatoryPolicies Act (PURPA), 24, 50-51, 54, 133

Roosevelt,Theodore,29 Round-trip transactions,79 Rural electrification programs,60 Rycroft, Robert w., 8, 21 SacramentoMunicipal Utility District (SMUD),1I5 San Diego Gas and Electric (SDG&E), 9, 63, 74 Saudi Arabia, 17-19 Savas,E. S., 100 Schlesinger,James,22 Securitiesand ExchangeCommission(SEC), 48,113 SempraEnergy, 74 SeptemberII, 2001 attacks,31, 52, 61, 74, 139 Shorehamplant, 57 Skilling, Jeffrey, 99 Smeloff, E., 49 Smith, Adam, 15, 143-144, 146 Social equity, 102 Social equity costs,59-{j1 Social values,market and, 105-106 SoconyVacuum, 18 Solar energy, 23-24, 28, 38, 40, 50, 53, 75, 125 SouthernCalifornia Edison (SCE), 9, 31, 63, 65,73 SouthernCalifornia Gas Company,74 Spot markets,59, 63, 65, 70, 103 StandardOil Companyof California (Socal), 17-18 StandardOil of New Jersey,18 Standardand Poor's,64 State energy offices, 90-97 activities by category,95 electricity restructuringand, 92 governmentstructureand, 91-92 intergovernmentalaspectsof, 97 local colleges/universitiesgrants, 96 missionsof, 93-94 organizationallocation of, 91 policy and economicinterests,91 programsof, 94--96 state electricity programs,96--97 Web sites of, 153-157 Stateenergy policy, 3-5, II, 33-46; seealso Stateenergyoffices in 1970s,36--40, 4S in 1980s,41-46 in 2001, 89-98 agricultural/rural sates,36 conservationplans, 22, 35-36, 122 demandmanagement,38, 4S deregulationpressures,9

Qualifying facilities (QFs), 24--25, 50, 133 Radioactivewaste, 52, 61 Reagan,Ronald, 7-8, 25, 100 Reaganadministration,12-13,23,31 deregulationand, 25 environmentalissues,27 global warming, 41, 44 stateenergy policy and, 33,40-41 Rebuild America program,54, 97 Regens,JamesL., 41 Regulation;seealso National energy policy; State energy policy deregulationand, 54--59 functions of, 106 history of, 47-54 positive elementsof, 113-114, 116 Reliant Corporation,8, 31, 67 Renewableenergy sources,24, 50-51, 105 ResidentialConservationService, 24 Residentialconstruction, 18,22-23, 26-28,43 ResourceConservationand Recovery Act, 35 Retail wheeling, 55, 57-58, 67 Rhode Island, 82 Ridge, Tom, 83 Rockefeller,Nelson, 3, 20, 22 Rolling blackouts,9, 31,46,64,66,73 Roosevelt,Franklin D., 99

177

INDEX Stateenergy policy (continued) economicblackmail by corporate interests,35 energy producingstates,36-37, 39 environmentand economy,37, 45 federal funding for, 39 federal standardsand, 34-35 federal-statepartnership,135-136 goals of, 6, 34, 44 governmentoperatingcosts, 37 indigenousfuels and, 34 Lee's price shockscategories,36 low-income subsidies,6, 13,39 market interestsand, 104-105 natural gas and electricity dependent states,36, 39 oil dependentstates,36, 39 oil overchargeallotments,8, 40 policy interests,38, 40, 148 pre-I975, 33-36 primary componentsof (1991-93), 43-44 public information campaigns,36 Reaganadministration'sradical shift, 40--41 role of, 121-126 state vs. market interests,109-111 utility costs,5-{i, 34 Stock manipulation,48 Strandedcosts and recovery,55-57, 63, 68, 85, lIS Sulfur dioxide pollutants, 19,51-52,60 Synthetic Fuels Corporation,23, 25 Syntheticoil and gas (synfuels), 17,22,40 Tall stack technology,19 Tax incentives,23-25, 40 Telecommunicationderegulation,7 Tennessee,94 TennesseeValley Authority, 33, 75 Texas,37,48, 77, 79-80

Texas StateEnergy ConservationOffice (SECO),93 Thatchergovernment,100 Thermostatsettings,23 Thompson,Tommy, 43 Three Mile Island nuclearaccident,20, 38, 51,57 Tocqueville,Alexis de, 143 Transmissiongrids, 24-25, 48, 55, 58, 67, 114-115, 149 Transmissionsurcharges,56 Transportationderegulation,7 TreasuryDepartment,18 Trucking industry deregulation,7, 100 Union of ConcernedScientists,53 Utility companies,24, 28, 34 Utility Reform Network of San Francisco,112 Venezuelaoil, 3 Vertical integration, 48-49, 54, 101, 114 Virginia, 79-80, 84, 138 Wagner,Curtis L., Jr., 74 "Wash" trades,79 Water Pollution Control Act, 19 Watkins, JamesD., 29 Weatherizationand Intergovernmental Program,54 Weidenbaum,Murray, 100 West Virginia, 81 WesternIntertie grid, 48 Wholesaleenergy markets/competition, 25, 58 Wilson, Pete,9, 67 Wind energy,24, 28, 38, 53 Wisconsin, 36, 38, 43 Wood, Patrick, 66, 133-135 Zimmer plant, 57

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About the Author

Mary M. Timney is chair of the Departmentof Political Scienceat PaceUniversity. For five years,shewasprofessorof PublicAdministration at California StateUniversity, Hayward,wheresheexperiencedthe California electricity crisis firsthand. Shehasalsobeenon the faculties of the University of Cincinnati and the University of Wisconsin-Green Bay. Sheholds an AB in chemistryfrom Bryn Mawr Collegeand Master of Public Administration and Ph.D. in Public and InternationalAffairs from the University of Pittsburgh. An activist in the environmentalmovementof the 1970s in Pittsburgh, shewas environmentalresearchassociatefor the WesternPennsylvania Conservancy.Later, as executivedirector of the Allegheny County EnvironmentalCoalition, sheimplementedtwo grantsfrom the U.S. EnvironmentalProtectionAgency and developedpublic education programson transportationcontrol strategies.While completing her Ph.D. in the early 1980s,she worked as energyproject director in the city of Pittsburghmayor'soffice and designedan energyprogrambudgeting system.In 1985, the governorof Wisconsinappointedher to a specialtaskforce to developan energypolicy plan. This work servedas the basefor a fundedresearchprojectto investigatethe developmentof stateenergypolicies during the 1980sin the absenceof federal energy policy leadership. Timney'sresearchandteachinginterestsare environmentalpolicy, including environmentaljustice and sustainabledevelopment;public budgeting, public administrationtheory, and ethics;and public participation.