March 5, 2001

California's No-Brainer

For months and months, we have been watching California with amazement, amusement and horror as an electric power shortage reduces it from the nation's most prosperous state to a Third World country. Specifically, our editorial eye has been focused on California's politicians, who have been moving slo-mo to deal with the situation. Now that Governor Gray Davis has trotted out his solution, we don't know whether to chuckle or shriek.

Power hungry The heart of Governor Davis's scheme is the proposal for a state takeover of the 26,000 miles of transmission lines now belonging to three utilities. The lungs of his scheme would allow the two utilities now in default to sell revenue bonds to cover their almost $13 billion of debt, with the state legislature to carve out a piece in the existing rate structure to service the bonds. The blood is to come from the parent companies of the two utilities that would give back maybe $1 billion already transferred to them. And the brains? Sorry, this scheme is altogether brainless.

It seems to us that California suffers from three basic problems:

A widespread belief that there is no problem. Governor Davis has continued to characterize months of rolling blackouts and brownouts as "a challenge, not a crisis." And he is not alone. According to a recent Los Angeles Times poll, 57% of Californians do not believe there is an actual power shortage.

A firmly held notion that if there is a problem, it's not California's. First, Governor Davis blamed the power suppliers, calling them marauders and pirates. Then he shook his finger at the federal government, demanding that the Department of Energy order suppliers to continue selling power to California. The Clinton Administration complied, but the Bush Administration -- after extending the order for two weeks -- refused and allowed the order to lapse. Oh, and lest we forget to mention that during the crisis California has been busy transferring its power shortage to its neighboring states by slurping up their electricity; this prompted Senator Gordon Smith of Oregon to complain that his state was being set up as an energy farm for California.

The misapprehension that if there is a problem, California knows how to fix it. Of course, despite what its Governor and 57% of its citizens think, California does have a problem and it's as plain as the nose on your face: Demand for electric power has been growing at a powerful pace while supply has been stagnant. Moreover, the state's bogus five-year-old deregulation has both intensified the problem and blocked solutions to it -- with wholesale rates set by the market and retail rates frozen below market rates, supply continues to be tight and demand continues to be strong. But California's idea of how to fix its problem has been misguided in the extreme. The legislature's most vigorous response was to authorize the state to buy up to $10 billion of generation and enter into long-term contracts with suppliers. In other words, the state's response has been to insert itself more squarely in the electric power industry.

So far, however, not much good has come of this strategy. The state's Department of Water Resources has spent its money only on buying power it believes is "reasonably priced," thus leaving the almost bankrupt utilities to pay for the most expensive power, and the only long-term contract negotiated has been for a tiny amount of power and even that is not due to kick in until October.

Governor Davis's plan to buy the transmission system would further push the state into the power market. Not much good can come of this ploy, either, given that the transmission system is antiquated and inadequate, requiring at least a billion bucks to upgrade. (Financially, the state -- already on the hook for $10 billion worth of bonds to buy electricity -- would commit another $4.5 billion to buy the transmission lines and another billion or so to fix those transmission lines.)

Meanwhile, California's economy is beginning to show signs of power-deprivation. In the fourth quarter of last year, California led the nation in the number of mass layoffs, and forecasters have downgraded estimates of economic growth to 1% this year from the earlier expectation of 2.5%. Agriculture -- especially dairy processing plants, flower growers and poultry farmers -- have been hard hit and some have been talking about shifting production out of California. Some manufacturers already have. More alarming, all this is happening before summer, with its higher power demands.

But neither Governor Davis nor the state legislature seem ready to do the one thing that would solve the energy problem -- free retail rates to reflect market prices. Indeed, Governor Davis admitted as much a few weeks ago, saying: ". . . believe me, if I wanted to raise rates I could have solved this problem in 20 minutes." Well, duh.

The fastest, surest, most efficient way for California to generate supply is to signal suppliers that there is a market for their output at a price that, at the very least, allows them to cover their costs. And the fastest, surest, most efficient way to do that is to unfreeze retail rates. We would say that this is a no-brainer, but Governor Davis's proposal has given new meaning to the term no-brainer.

http://interactive.wsj.com/articles/SB983745958248048584.htm

-- Martin Thompson (mthom1927@aol.com), March 05, 2001