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Hoover Institution and SIEPR host conference on the California energy crisis

Deregulation of the energy market is still a good idea for California despite last year's crisis, argued experts at a two-day conference at Stanford last week.

"We need a system in which the private sector is dominant, not the public sector," said Jim Sweeney, expressing a sentiment shared by many conference participants. Sweeney is director of the Energy, Natural Resources and the Environment Program at the Stanford Institute for Economic Policy Research (SIEPR), senior fellow at the Hoover Institution and professor of management science and engineering at Stanford.

"The state should not be in the business of producing and selling energy," agreed Milton Friedman, senior research fellow at the Hoover Institution and Nobel laureate in economics.

The conference was co-sponsored by the Hoover Institution and SIEPR. Participants from academia, politics and business discussed the causes of the California energy crisis, its impact on the economy, the relationship between politics and power production, and lessons learned from California's experience with deregulation. U.S. Secretary of Energy Spencer Abraham also spoke on the importance of energy for national security.

John Raisian, director of the Hoover Institution, and John Shoven, director of SIEPR and the Charles R. Schwab Professor of Economics at Stanford, moderated the conference.


'An absolute catastrophe'

The California energy crisis was not the result of deregulation per se, but of the way it was implemented, the panelists agreed.

"The framework legislation, in my opinion, wasn't bad," said John Bryson, chief executive officer of Edison International and member of the Stanford Board of Trustees. He noted that the original legislation, signed in 1996 by then-Gov. Pete Wilson, was not responsible for two of the "fatal flaws" that led to the energy crisis: rate caps on retail prices and the prohibition of long-term contracts between the utilities that sold power to consumers and the generators that produced it. Those were the result of later implementation decisions by the California Public Utilities Commission (CPUC).

The panelists reserved most of their criticism for Gov. Gray Davis' response to the crisis last year. They pointed to his delay in raising caps on retail energy prices as a decision motivated more by politics than economics.

"The fact of the matter is that the governor didn't want to be associated with an increase in rates," said Wilson, now a visiting fellow at the Hoover Institution. Davis, who agreed to raise rate caps in the spring of 2001, has blamed the energy crisis on the flawed 1996 legislation and federal regulations that allowed wholesale energy prices to skyrocket.

Most of the conference participants seemed to agree with George Shultz, distinguished fellow at the Hoover Institution and former U.S. Secretary of State, when he called California's experience with deregulation "an absolute catastrophe."

Nevertheless, they argued that deregulation was still the best long-term solution to California's problems. The competition spawned by deregulation could lead to higher efficiency, lower retail rates and lower levels of pollution, said Peter Cartwright, chief executive officer of Calpine.

Panelists worried, though, that California's crisis might deter other states from deregulating.

"The most important cost of the California energy disaster is that we gave deregulation a bad name," said Edward Leamer, chair of the management program at UCLA's Anderson School of Business.  

Real-time pricing

In addition to outlining the causes of California's energy problems, panelists at the conference discussed a possible solution: real-time pricing, or peak prices during peak demand.

Real-time pricing could help bring true competition to the California energy market, argued Frank Wolak, senior fellow at SIEPR, and Vernon Smith, professor at George Mason University. In August, Wolak and several others were chosen by the William and Flora Hewlett Foundation to conduct a long-term study of the California energy crisis.

"We need real-time metering to have viable retail competition," said Wolak, a professor of economics at Stanford.

Real-time pricing also could solve an endemic problem in the energy market: capacity that is determined by peak demand, not average demand.

In a traditional energy market, buyers pay the same amount for energy regardless of when they use it, so they have no incentive to avoid using power at times of peak demand. That, in turn, forces suppliers to maintain extra capacity. In California, the in-state capacity is 44,000 megawatts but the average demand is only 27,000 megawatts, Wolak said. The cost of maintaining the extra capacity is passed on to consumers in the form of high energy prices.

In contrast, buyers under a real-time pricing regime would be discouraged by high prices from using energy when demand is high. Real-time pricing would spread demand out over time and allow suppliers to reduce costs associated with extra capacity. Eventually those cost reductions would be passed along to consumers.

Bryson noted that one-third of California's power already is delivered to large-scale commercial buyers using real-time pricing. The process of extending that to the rest of the market has been slowed by the cost of real-time monitoring equipment, which Wolak estimated would be about $2 per month per consumer.


'Energy security'

At a reception for conference participants Thursday evening, Energy Secretary Abraham linked U.S. energy policy to national security. He emphasized the need for a wide range of solutions to U.S. energy demand: exploiting domestic energy reserves, such as the oil fields of the Alaskan National Wildlife Refuge; building more nuclear, gas, oil and coal-fired power plants; exploring alternative energy sources such as hydroelectric, wind and solar; promoting conservation and efficiency; and modernizing the U.S. energy infrastructure. "The need for us to think very seriously and in concrete and practical terms about energy policy could not be more pressing," Abraham said.


By Etienne Benson

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