Published on Sunday, Janaury 28, 2001 in the Washington Post

Some Power Trip: Put the Deregulation Genie Back in the Bottle



by Gregory Palast



CAMBRIDGE, England -- As the lights go out over California, state politicians are in a Henny Penny panic that the two big local power companies, Southern California Edison (SCE) and Pacific Gas & Electric Co. (PG&E), will collapse into bankruptcy. Not me: I can't think of anything that would more joyously combine historical justice and good public policy.

Why justice? Because SCE and PG&E executives, eager to reap the profits of deregulation, were in the forefront of the army of industry lobbyists fighting to establish the system that got California into this mess.



And why good public policy? Because letting the utilities go bankrupt could be the first step toward returning California to the system of government price regulation that has given America some of the cheapest and most reliable electricity in the world. Regulation may be politically unfashionable, but it works.



Over the past three decades, as a consultant to 19 state governments, I've seen electricity price regulation from the inside. The U.S. process is unique in the world. In open hearings, consumer groups, competitors or anyone off the street can pore over a utility company's account books, cross-examine the company's executives and question the regulators' staff. Based on that evidence, public utility commissions set a price per kilowatt hour based on verified costs plus a small, tightly controlled profit for shareholders. It's a litigious, messy business, prone to political manipulation, just as its critics say. But that's true of any democratic process.



The so-called deregulation movement seeks to replace this open, participatory, American system -- one that's been astonishingly effective for nearly a century -- with something conceived and designed in Margaret Thatcher's England and launched there in 1990. (Sorry, California, this is one fad you didn't think of first.) A number of countries, including Brazil and Chile, mimicked the British system. And California swallowed it whole.



This is how the British system works. First, electricity businesses are split into "generators" and "distributors" -- the first owning the power plants, the second the wires transmitting the power. (During this part of the deregulation process, SCE and PG&E gleefully sold off many of their generating plants -- built with ratepayers' money -- and pocketed the proceeds.) Then something called a "power pool" is established. Every day, generators bid the price at which they will supply electricity to the pool at a certain hour of the next day, say 2 cents per kilowatt hour at 4 p.m.



In Britain, it didn't take long for the handful of power sellers and traders to learn how to "game" the pool, essentially turning the daily auction into a fixed casino. Last year, Britain's Office of Electricity and Gas Markets concluded that collusion and manipulation of the pool had become standard business practice.



So it's not surprising that in Britain -- as well as in every one of its imitators -- the public has suffered higher prices, decayed service and blackouts. In the 1990s, as America's electricity prices fell with the price of oil, Britain's stayed stratospheric, on average 70 percent higher than in the States. (Don't confuse this with the taxes that keep gasoline prices high in Britain; profits account for the higher electricity prices. U.K. utilities commonly earn five times the return on capital permitted to regulated U.S. utilities.)



And this is the system that the free-market fanatics foisted on California. Notably, three of the four biggest power generators controlling the California market -- AES, Southern and Dynergy -- and the biggest U.S. power trader, Enron, are also big players in Britain.



Manipulated or not, on a hot summer's day, when a pool needs all the juice it can find, the handful of sellers can name their price. And in California, they do. For example, this past June 29, sellers demanded 52 cents per kilowatt hour; on June 29, 1999, they had accepted 5 cents, a price better reflecting their true costs.



I first came to Britain in 1996, to help the incoming Labor government try to fix the nation's new -- but already broken -- electricity market. It didn't work. Year after year, the fixes failed, as they will fail in California and other states that think they can design a deregulated system. There is no fix: Free markets in electricity go berserk because they aren't really markets, aren't free and can't be. Electricity isn't like a dozen bagels; it can't be frozen, stored or trucked where needed. And while you can skip your daily bagel, homes and industry will not do without their daily electricity.



As a result, deregulation is never really deregulation but an unhappy mish-mash of rules belatedly chasing runaway prices generated by each week's new trading game. To salvage their imploding market, the California power pool's economists busily craft one wacky fix after another -- "Intra-zonal Congestion Management," "Price Volatility Limit Mechanisms" and more, which tumble out of their bureaucracies like circus clowns from a Volkswagen. A delicious irony is that "deregulation" has produced an explosion of shifting regulations and new bureaucracies dwarfing California's old regulatory system.



Market fundamentalists say the solution to half-baked deregulation is full deregulation, with no rules at all. That's frightening. As former World Bank economist Joe Stiglitz said to me the other day, these theorists are like medieval bloodletters. If a dose of their free-market medicine doesn't cure the patient, they call for applying more leeches.



No one in America is safe from the deregulators. One would think that, after the California debacle, states would run from deregulation. But the same self-serving lobby that blinded California to Britain's fiasco has blinkered Texas, New York and others to California's failure.



Residents of the District of Columbia, where a deregulation statute took effect this month, can sleep easy with night lights burning -- but only for the next four years. That's when the price caps bargained for by the District's people's counsel, Elizabeth Noel, will be lifted, and consumers will be at the mercy of the PJM Interconnection pool (which serves parts of Pennsylvania, New Jersey and Maryland). Even PJM, considered the nation's most stable market, is subject to the same manipulations as San Diego. On July 28, 1999, completely legal "stacking" bids by the big power companies bounced the price paid by the PJM pool to 5 per megawatt hour -- about 30 times the sellers' costs.



You didn't feel it in your bill then. But when the cap goes, look out. Even Noel, proud of the protections she wrote into the statute, echoes other consumer advocates across the nation: "If I had a Harry Potter wand, I'd put the [deregulation] genie back in the bottle," she told me last week.



If the problem is deregulation, the cure is re-regulation. Those who profit from deregulation have fostered the presumption that the process is irreversible. But re-regulate we must and can.



In California, the first step would be to guide SCE and PG&E into Chapter 11 bankruptcy. The state could then purchase their power lines and other assets. Shed no tears for these two utilities. Today, they are sinking under a billion debt to power sellers. But in the first four years after deregulation, until the market turned on them (as markets do), the two operators stuffed their accounts with billion in windfall revenues.



I've seen this return to government control work. On New York's Long Island, a local electric company arrogantly spent billions on a faulty nuclear plant, driving itself and its community toward bankruptcy. In 1980, I drafted a plan for the state to buy the company. The resulting takeover by an independent government-owned power authority, completed in 1991, slashed prices by a good 20 percent and improved service.



Once the distribution grid is in public hands, California must then return the power plants within its borders to the old profit-limited, democratically organized method of regulating price. But this rescue plan will fail unless the federal government gives up on the deregulation fantasy as well. To nudge other states into following California's scheme, the Federal Energy Regulatory Commission lifted the price controls on most interstate sales into power pools. Those controls need to be permanently restored.



Pulling out of the deregulation morass is not a technical problem but a political one. An economic ideology -- not to mention several trillion dollars of infrastructure -- are on the line. California's electricity grid may be the free marketeers' Vietnam. It is the place where the conviction that markets are superior to public control -- always, everywhere and forever -- loses its way in the dark. The only solution to the deregulation debacle is swift, honorable and complete withdrawal.

(California-born Gregory Palast is a consultant on utility regulation and a columnist with the Observer of London. His book "Regulation and Democracy" will be published this year by the U.N. International Labor Organization.)