Power Policy — Or Power Politics?

Terry Campbell

California's electricity crisis has given foes of the free market ample ammunition to fire at the concept of deregulation. In Nevada and across the nation, politicians, bureaucrats and "consumer advocates" are pushing to delay-or even scrap-their states' electricity-deregulation plans. Even lawmakers who generally support market-oriented public policy have begun to lose faith in the promise of electricity deregulation. But since California's power market was never deregulated, this concern is unwarranted. Blaming California's crisis on deregulation, as writer Chad Reichle has quipped, "is like blaming capitalism for the poverty of the North Korean people." Herewith, a look at the Golden State's flawed blueprint for consumer choice in electricity, and a description of the four key ways in which Nevada's approach to power deregulation differs from California's experiment.

1. A Mandated Marketplace?

The most important distinction between California's electricity-restructuring law and Nevada's yet-to-be-enacted electricity-deregulation plan involves the most basic activity of a free market: the exchange between buyer and seller. When the Golden State's scheme went into effect in 1998, utilities were required to obtain all their electricity from the California Power Exchange, a quasi-government agency. The exchange not only prohibited buyers and sellers from signing long-term contracts, it set the price at which all electricity was sold. (All buyers bought — and all sellers sold — power at the price offered by the highest bidder.) The California Power Exchange warped the Golden State's electricity market in a disastrous way. In order to control costs, utilities have traditionally maintained their power supplies by combining the electricity they generate with power purchased through long-term contracts with independent generation companies. When demand is particularly great (for example, during summer), utilities purchase additional electricity on the short-term "spot market," where prices are usually quite high. But since temporary purchases on the spot market are relatively rare, the cost is manageable. By ordering utilities to buy all their power on the spot market, California's restructuring law sowed the seeds of today's crisis. The Reason Public Policy Institute's Adrian Moore uses this analogy to illustrate the folly of California's mandated marketplace: "Imagine having to buy groceries through a 'grocery exchange' which required shoppers to order all their food a week in advance. The exchange would then set the prices consumers paid … and wouldn't let consumers buy groceries from another store or a roadside stand. Anyone who decided to buy something different could buy it from the exchange — but only at the price of the most expensive brand available." Yet as long as supply exceeded demand — as it did during the first year of restructuring — California's utilities purchased electricity cheap. (In fact, the utilities made something of a killing during this period.) Last year, when the state's population growth and voracious electricity demand combined with unusual weather throughout the West, the price of electricity in the region shot up. Then the inherent flaw in California's restructuring plan struck with a vengeance. Utilities began to pay much higher prices for wholesale electricity, but they were not allowed to pass those costs along. The state's price cap for customers — 6.5 cents per kilowatt hour — caused the utilities to plunge into horrendous debt. And since customers were still paying the same rate, they had no reason to conserve. Thus, demand did not fall, and rolling blackouts ensued. Far from creating consumer choice and lowering prices, the perverse incentives of California's restructuring law have nearly bankrupted the state's utilities, and in the process, driven up energy costs throughout the West. The Cato Institute's Jerry Taylor and Peter VanDoren summarize the Golden State's dire situation this way: "[T]he California power crisis is not an example of what happens when businessmen are running important industries. It's a story of what happens when politicians try to manage competition and impose their vision of a market." Many Californians are now aware of the deadly consequences of trying to manage competition in the power market, and officials there are in the process of relaxing or eliminating the state's heavy-handed transaction rules.

The Silver State's deregulation law does not create a Nevada Power Exchange where all electricity sales must take place. If the deregulation process is set in motion by Governor Guinn, power providers will not be required to purchase their electricity on the spot market. In addition, there are no restrictions on the signing of long-term contracts. Thus, the market-warping effects of California's mandatory power exchange will not exist in a deregulated Nevada market. In fact, if Sierra Pacific Resources is allowed to sell its remaining generation facilities, "buy back" clauses in the sales contacts will enable the company to purchase power at 1998 prices for the next two years. This will benefit, not harm, Nevada ratepayers.

2. Letting Plants Grow

The Golden State has made no significant additions to its generation capacity in over a decade. On a per capita basis California produces less electricity than any other state. During periods of peak demand, California can import as much as 40 percent of its power. These statistics are due in part to the extreme difficulty energy companies face when they seek to build power plants in California. Government regulations at the local, state and federal levels hamstring the plans such companies have to begin or expand operations in California. The state has a backlog of applications for plants capable of generating 11,700 megawatts of power. (If California were generating that amount of additional power today, there would be no blackouts.) In addition to regulations, the Golden State's militant green lobby — even 30 years ago, there were 200 environmental groups in the San Francisco area alone — has been an immense impediment, as has the not-in-my-backyard attitude of politicians, businesses and residents alike. "It takes five to seven years to build new power plants in California," Enron executive Steve Kean recently told Congress. "It takes us ten months in other states. The process is insane."

While it takes a long time for power plants to be approved in Nevada as well, the waiting period is not as lengthy. Happily, the state's militant greens do not yet enjoy the political muscle of their comrades to the west. And with vast tracts of land with no neighbors in sight, NIMBYism is far less of a problem. While Nevada has not seen many new generation facilities come online in the past few years, all indications are that the state's power future will be very bright. Energy companies, including several major players such as Enron and Calpine, are either building or plan to build a whopping 17 power plants in Nevada, which will generate a total of over 10,000 megawatts. (Most of these facilities will be built in Southern Nevada, but other regions are not being overlooked. In Northern Nevada, a new plant outside Reno will open in June, just in time for peak summer demand. In Elko County, a subsidiary of energy giant El Paso has plans to build a natural gas plant and pipeline-infrastructure which is badly needed for mining and industry in the area.) There's also good news on the legislative front: In Carson City, politicians from both parties have announced their support for fast-tracking the state's plant-approval process, while at the same time maintaining strict environmental standards. The federal government appears willing to help as well. The Bureau of Land Management has announced its commitment to expediting the approval process for companies seeking to build transmission lines, natural gas pipelines and water lines across federal lands.

3. Encouraging Entrants

One of the most interesting things about the Golden State's "deregulated" power market is that once they were allowed in, very few alternate electricity providers were willing to enter California's retail market. Only a tiny fraction of power customers are currently served by new companies — the remaining customers have stayed with the state's three dominant utilities. (By contrast, in Pennsylvania's truly deregulated power market, over half a million customers have switched companies, and a whopping 130 power providers have entered the market.) Why did so many companies decline to enter California's market, given the state's huge number of industrial, commercial and residential  customers, strong population growth, booming economy and technology-driven demand for ever more electricity? By now, the answer should be obvious: A bizarre, government-mandated power exchange, coupled with top-to-bottom hostility to new power facilities, made potential entrants to California's market take a pass. While national generation companies did choose to sell power to the state's utilities, they did not attempt to provide electricity directly to consumers. And since the dominant utilities faced no real competition, they had no incentive to lower their prices below the state-mandated cap.

While new suppliers have been unwilling to enter California's muddled pseudo-market, they appear downright eager to compete in Nevada. For a state with a relatively tiny population and an electricity market that isn't open to competition yet, a large number of firms plan to sell electricity to Nevadans. The Public Utilities Commission of Nevada has already licensed six power marketers, and seven additional applications are pending. While not all of these firms will offer residential service, more than half will. In addition, Shell Energy is seeking to become the "provider of last resort" for Nevadans who prefer not to choose a new power company after the end of the deregulation phase-in period. This is a very encouraging signal, since analysts have always assumed that that very few companies would want to serve as the provider of last resort.

4. Divestiture: In Nevada, a Good Thing

Many state deregulation plans — including California's — require incumbent utilities to sell their generation facilitates. The theory behind this mandate holds that selling off power plants will encourage the facilities' new owners to enter the now-competitive power market. The evidence behind this claim is flimsy at best, but in California, requiring divestiture by the state's three utilities was even more dangerous, since as noted above, the companies were unable to sign long-term agreements with the buyers in order to lock in low rates. Forced divestiture in California virtually guaranteed that power costs would one day explode.

In July 1999, Nevada's two utilities, Nevada Power and Sierra Pacific Power, merged into Sierra Pacific Resources (SPR). The new company agreed to sell its generation facilities not to comply with Nevada's deregulation law, but to win approval of the merger from securities regulators. The aforementioned buy-back agreements will allow SPR to purchase power at 1998 prices for another two years. So while divestiture was a villain in California, in Nevada it will actually ensure at least some measure of price stability for customers. (That is why the sales should be allowed to proceed, despite the objections of the lawmakers and activists who clearly do not understand Nevada's power situation. Since SPR obtains about half of the state's power from the wholesale market anyway, it's a mistake to think that stopping the sales will guarantee low electricity bills for Nevadans. Requiring the company to keep its plants would also be a dramatic policy reversal, sending a signal to other energy companies that Nevada's politicians and bureaucrats are alarmingly fickle.)


The Cato Institute's Taylor and VanDoren ask "what kind of 'deregulation' imposes rigid government dictates on how industries should organize themselves? What sort of 'deregulation' keeps fixed prices on retail providers? What kind of 'deregulation requires retailers to buy power through a state-run central exchange? And what brand of 'deregulation' forbids retailers from buying electricity more than one day ahead?" The answer, of course, is California-style "deregulation," which arguably imposed even greater government control of the power market than existed under the state's regulatory-compact system. Fortunately for Nevadans, the Silver State's blueprint for consumer choice in electricity does not resemble California's disastrous scheme. But unfortunately, many of the Silver State's politicians, bureaucrats and activists are using California's situation to stop deregulation in Nevada. They are either unable or unwilling to admit the substantial and compelling differences between legal, political and economic conditions in the two states. They ignore the four points described herein, and instead employ baseless rhetoric about "protecting" consumers from the evils of the market. (One wonders how the present regulatory system protects Nevadans — prices for electricity are skyrocketing.) The anti-deregulation lobby is also blind to the likely developments that will improve the electricity situation in the West, and thus place the entire region in a far less precarious power position. First, the nation's growing demand for natural gas will doubtless spur exploration and development efforts, which in turn will drive the price of the commodity down. Almost daily, the nation's business press reports on another natural gas company's plans to expand its exploration and infrastructure projects. Second, America's electricity-generation capacity is expected to grow substantially in the near future. By one estimate, in the next three to five years alone new plants will create enough power to outpace expected demand growth by 300 percent. Third, a new administration in Washington that appears to be realistic about energy policy — and not eager, for example, to lock up natural gas-rich federal lands as a reward to the environmental lobby — will be of great assistance. Fourth, weather patterns in the West (particularly record heat last summer, a colder-than-normal winter of 2000-2001 and years of low rainfall in the Pacific Northwest) will one day return to normal, reducing demand and increasing the output of hydroelectric facilities. And fifth, the electricity price hikes that are underway in virtually every state in the West will induce a reduction in demand in the long run, thus lowering prices.

Nevada's electricity-deregulation law is substantially different than California's. Nevada's electricity market is substantially different than California's. So why is a power-policy debacle in the Golden State a reason to put off — or give up on — deregulation in Nevada? While additional steps are needed to open Nevada's market even further to competition, (NPRI's next Issue Brief will explore several options), abandoning or continuing to delay deregulation of the Silver State's electricity market is unwise.

In the next few months, Nevada's lawmakers and energy officials must decide between two paths. One path, founded on fear and misinformation, will maintain an untenable energy status quo, deny Nevadans electric choice and fail to protect consumers from soaring power bills. Another  path, founded on sound economic sense and real-world experience, promises to spur energy innovation, give consumers more choices, lay the groundwork for lower electricity bills in the long run and even give a boost to economic diversification in Nevada. If policymakers let facts be their guide and turn a deaf ear to hysteria, the Silver State will survive, and thrive, in a world where buyers and sellers — not politicians and bureaucrats — set the price of power.