When California's energy "deregulation" was being planned, there were the following concerns:

First, the existing regulated monopoly utilities wanted to be given gobs of money to compensate them for their "stranded costs" (crap investments) in exchange for opening them up to competition. They were.

Second, economists who were involved with designing the program were concerned with the following two basic problems:

1) They were worried that competition would never develop -- that is, that a true competitive market would never come into being. Firms had to have incentives to enter the market, otherwise it would become a relatively unregulated monopoly/oligopoly, depending on your place on the grid.

2) They were worried about the possibilities of market manipulation.



In order to cope with concern 1), the economists involved recognized that in order to encourage entry into the market and develop any degree of actual competition they needed to somehow ensure that a spot market would exist. They figured that unless steps were taken in that direction, long term contracts between the existing energy producers who had a first mover advantage and their customers (specifically, the wholesale producers and retail providers as it turned out) would deter any entry by new firms. In order to get around this, they outlawed such long term contracts so as to force a spot market into existence.

This opened up the possibility for short run market manipulation. However, it was decided that opening up this possibility was a necessary measure to ensure the longer run development of a competitive energy market.

With hindsight, obviously, this was a bad move. But, contrary to the opinion of some on the Left who think it was an industry written bill (it was somewhat of course), or those on the Right who think it was bad government bungling (it was at some level that too, of course), the basic framework of the deregulation bill was designed by a well-known (and mainstream) economist.

Also with hindsight, one thing the deregulation Bill should have included was a provision for the establishment of temporary price caps in order to fend off the kind of market manipulation caused disaster we just faced. Of course, FERC should have done its job early on and used its power to do just that.

The main thing that went wrong, aside from some basic naivete, was the underestimation of the degree to which individual power plants in effect had local monopolies due to local market conditions and imperfections in the distribution grid, so that even in the absence of collusion individual plants and firms could threaten and cause shortages by temporarily reducing production. There was a lack of competition at the very local level, a situation that was largely overlooked.

As I say over and over, those who want to throw the blame on Wilson and his legislature are welcome to. One can also blame Davis, and even the Clinton administration, for failing to see the looming disaster. But, when the crisis erupted one regulatory body had both the power and the legal authority to impose price caps and solve the problem temporarily - FERC.



Most people in Blogistan who comment on these issues seem to have a Econ 101 view of the world. A little knowledge is a dangerous thing. No one really disputes that the fact that the California dergulation plan was a bad one, so stop beating that dead horse. No one really disputes that fact that it wasn't "real deregulation", so you can stop beating that one as well.

What is disputed is this silly notion that the transition from regulated monopoly to unregulated perfectly competitive markets in this industry can happen overnight and that no transitional measures are necessary.

What is also disputed is the belief that the problem was the retail price regulation - as if there would ever be such a thing as a retail spot market - and the associated, and now very refuted, belief that market manipulation was not the problem.

And, the final thing that is/was disputed is the belief by some that price caps wouldn't have helped. The truth is that at the time the necessary and appropriate action was the imposition of (temporary) price caps on wholesale power trades.