[The new idea is in the penultimate paragraph -- that price caps could increase the supply of power]
March 25, 2001
The Price of Power
By PAUL KRUGMAN
W elcome to the Cartel California. Last week a report by the
Independent System Operator, which runs California's power grid, made
it more or less official: the electricity crisis in the Golden State
is partly the result of market manipulation by power generators. The
report alleges that generators overcharged the state's utilities,
which distribute power to consumers, by more than $6 billion over a
10-month period.
The report is almost certain to be ignored by federal authorities. But
I'll come back to that in a minute. First, there are a couple of
things I need to make clear about the report's claims.
The I.S.O. is not alleging that power generators were part of some
vast conspiracy. Actually, I shouldn't have used the word "cartel" in
the opening sentence. The generators didn't have to conspire: the
logic of the situation made it easy, almost irresistible, for each
individual company to manipulate the market. In fact, to believe that
the generators didn't engage in market manipulation, you have to
believe that they are either saints or very bad businessmen, because
they would have been passing up an obvious opportunity to increase
their profits.
Imagine the situation: it's a hot summer, and the California
electricity market is very tight. You are one of only a handful of
major players selling wholesale electricity. Surely the thought has to
occur to you: what would happen to prices if one of my plants just
happened to go off line? And when companies act on that thought . . .
well, you get the picture.
It's also important to realize that accusations that power companies
were withholding electricity to drive up prices didn't emerge out of
nowhere when the crisis erupted; this isn't a case of politicians
suddenly looking for scapegoats. On the contrary, economists were
raising red flags about the possibility of market manipulation long
before California's woes hit the headlines. Indeed, some economists
warned about the issue before California even deregulated: there was
clear evidence that "market power" was a problem in Britain, which
began experimenting with deregulation and privatization years before
the movement came to America.
And the research evidence continues to pile up. Just before the I.S.O.
issued its report, the economists Paul Joskow and Edward Kahn
circulated a study that found strong evidence that "exercise of market
power" played a large role in raising electricity prices last summer.
The authors aren't leftists, or even opponents of deregulation. They
were merely trying to look objectively at the evidence, which points
more or less unmistakably to the conclusion that deliberate
withholding of electricity to drive up prices has been an important
factor in the California crisis.
Still, there is every reason to believe that Washington will turn a
deaf ear to this evidence. As an article in this newspaper explained
on Friday, the Federal Energy Regulatory Commission, which is supposed
to act as the nation's watchdog over the energy industry, lately seems
more like a lapdog. I was particularly struck with the report that
FERC's staff found that California's power companies "had the
potential to exercise market power," but could not conclude that they
had actually used that power. As I said, those power generators must
be saints, bad businessmen, or both.
What should the regulators be doing? I'm skeptical about proposals to
make the generators pay big fines; it's not clear that you could
figure out which company was responsible for which part of the
problem, or for that matter that the companies were doing anything
illegal. What FERC could do is impose a temporary cap on wholesale
prices. This would limit the financial damage to California the state
government is currently spending more than a billion dollars a month
to subsidize electricity purchases. And in a market where "exercise of
market power" is a major factor, a wholesale price cap might actually
increase supplies, because power companies would no longer have an
incentive to withhold electricity to drive up its price.
But it's not going to happen. Blame knee-jerk free-market ideology, or
the political influence of the power companies (many of which are
based in, yes, Texas). Whatever the reason, it is hard to imagine an
administration less likely to be sympathetic to California's plight
than the one currently in power.
And if this indifference makes Californians angry, it should.
Copyright 2001 The New York Times Company