The Woes of Privatization & The Solutions Spurned: A California Case Study

By David D. Murray

On November 3rd California voters had a golden opportunity to right the wrongs that resulted in energy market manipulation, widespread blackouts, and sky-rocketing energy prices which, in turn, plunged our state into fiscal crisis and led directly to the recall of Davis (spineless weenie that he was) and the ironic election of Schwarzenegger. Unfortunately, as is too often the case, the majority of voters still lack the framework, the context or even the slightest notion of the forces that have shaped our State’s energy policy and politics and have therefore, yet again, fallen prey to the well-funded propaganda of the Electrical Utilities (those pervasive “Vote NO on Prop 80” ads).

So what really happened here and what did “privatization” have to do with it? Well, there are two major ways a State can operate an essential industry: be it roads, water works, hospitals, schools, transportation, or in this case, electrical utilities. One way is to have the state either own and operate the industry itself or to contract with private providers, such as Edison, to provide services to consumers under strict regulation, where reliable supply is guaranteed and the product, in this case electricity, is furnished to consumers at just slightly above the cost of producing it. The other way, popularly known as “privatization” or “deregulation” is when the State backs away from its regulatory roll, auctions off any State-owned infrastructure to private companies, and allows the law of the jungle to take over, come what may. In this scenario the state essentially relinquishes its responsibility to guarantee consumers reliable, adequate supply at a low price and opens the door to the possibility, or likelihood, of irresponsible public planning, inadequate supply, price gouging and market manipulation of the sort our State recently fell victim to. In the first scenario things like schools, roads, water and electricity are viewed as necessities, in the second, they are viewed as commodities.

This whole mess we now find ourselves in began in 1996 when the state’s major utilities joined forces and lobbied California lawmakers, Republican and Democrat alike, to deregulate the State’s energy industry. Which they did, unanimously, caught up in the then pervasive euphoria of Reagan-esq free market fundamentalism, and a truckload of campaign contributions, roughly $3 million. This amounted to what Ralph Nader, at the time called, “the largest corporate rip-off in American business history,” and he’s seen a few in his time. This legislation ended up costing Californian ratepayers, in the form of “transition fees” and other surcharges, between $20 billion and $28.5 billion, which translated to roughly 30% of users monthly bills. In fact calling it deregulation was only a half-truth, for while it removed most regulatory controls from the utilities it “regulated” rate payers, forcing them to shoulder prices that where 50% higher than the national market average.

When the legislative committee the originated the bill held a public meeting on the subject of deregulation, Tom Adams, representing the Coalition of Utility Employees was one of the only voices of dissent. He argued, correctly, that the electricity surplus the state was enjoying could evaporate at any time without warning and if that happened, he prophetically claimed, “California will face high electricity prices, scarce supply, and possibly brownouts.”

In 1998, still outraged consumer groups backed a ballot initiative (Proposition 9) to nullify the portion of the law that required ratepayers to shoulder the cost of deregulation. However the utilities spent $40 million to defeat the measure including $500,000 to both Republican and Democratic parties to send out mailers urging their constituents to vote “No”. Their investment paid off and in the end the measure was defeated. Which beautifully illustrates the point Ralph Nader was making when he observed that, “When the short-term gains of politicians furthers the short-term aims of big corporations, consumers always lose in both the short and long term.”

Seeing as deregulation separated generation from distribution, suddenly no one had any obligation to assure reliability. Before deregulation, the vertically integrated utilities were responsible. After, no one was required to build new plants or even “operate the ones they owned.” Therefore, during the onset of California’s energy crisis, no new major power plants had been built in the state for 10 years. This was due to the fact that, under deregulation, there is no incentive for corporations to invest in new power generation because doing so would only increase the supply, lower prices and lower their profit margins.

So after years of virtually no public planning in the area of energy generation, California faced a particularly hot summer which dramatically increased the use of air conditioning and severely tightened supply. Prices rose and continued to rise exceeding the previous price cap of $750 a megawatt hour (that existed under regulation, representing ten times the average national market price), and ultimately exceeded 3900% of the national average. Meanwhile the profits of power producers, most of them out of state, rose by as much as 500%.

But these prices weren’t simply due to a shortage and the resulting dynamics of supply and demand. Energy producers where actively manipulating supply in order to squeeze California for extra profits. “We've had hours of true scarcity, where supply just simply isn't enough to meet demand," said Eric Hildebrandt, who monitors the electricity market for the agency that oversees transmission. "For every hour of that, there's many more hours sandwiched around that of tremendous market power.” In July the California PUC (Public Utilities Commission) reported that “sellers may have been withholding power from this market in order to drive up prices in other parallel markets.” A suspicion that was confirmed in January when the agency in charge of overseeing the state’s power grid reported that, in fact, 49 power plants that could have been operating during the periods of greatest scarcity and highest price where essentially shut off and California regulators where powerless to stop them.

The result: Companies like the North Carolina-based Duke Energy, Reliant of Texas and the Houston-based Enron, the nation's biggest natural-gas distributor made literally billions selling power at high rates to the very companies that had just sold them their generators under privatization. As a matter of fact since deregulation Duke Energy has doubled its revenues, Dynegy tripled its revenues, and Enron reported that its stock had gone up 89% in a year (this was of course before mismanagement drove them bankrupt). Meanwhile California was compelled to float roughly $10 Billion in emergency bonds in order to off-set the price of electricity for California businesses and consumers, without which the entire state would have ground to a screeching halt. In fact Federal Reserve Chairman Alan Greenspan warned that California's energy crisis could plunge the entire country into a recession. But instead California’s politicians, wisely I believe, opted for a fiscal crisis over and economic one.

But regardless of how California’s law-makers chose to take the hit, the State’s budget was severely strained, the deficit ballooned, energy prices spiked, and Californians, still largely ignorant of what had actually happened, expressed their outrage by taking aim at the most obvious symbol of our State’s government, the Governor, who was subsequently recalled and replaced by our current governor, who is ironically an even bigger friend to the very same energy corporations that robbed our state blind.

Perhaps the only positive development that has come as a result of this fiasco is that the majority of California’s Democratic legislators have seen the light and come to oppose the privatization and deregulation of California’s utilities. Many have even called for a return to state ownership of California’s energy production. Before retiring, former President Pro Tempore of the California Senate, John Burton acknowledged, “There's been no one since the days of the robber barons who've gotten away with what they've gotten away with.” And current State Treasurer and Gubernatorial hopeful, Phil Angelides, speaking about the need for re-regulation of the State’s energy industry pointed out, “We have public ownership of the highway system because we know it's fundamentally important to the state and its economy…We own the water system because it's fundamental to the state's economic health.” Meanwhile, and not surprisingly, the vast majority of the State’s Republican law-makers, including our current Governor, have stuck to their free-market-fundamentalism, arguing that what is needed isn’t less deregulation, but more. Of course they are also now collecting all the extra campaign cash that the repentant Democrats have left on the table as a result of turning their backs on the powerful energy industry.

So why the need for Proposition 80 then? Unfortunately, the Republicans and the unrepentant Democrats in the California legislature still constitute a narrow majority which has successfully blocked more meaningful attempts to re-regulate California’s energy supply put forward by more progressive law-makers. While there was enough political will among those “in the know” to get this measure placed on the ballot, the energy industry’s public relations blitz so successfully obscured the facts of this proposition that it went down to a crushing 65.7% defeat, the greatest margin of any ballot initiative this cycle.

So the moral of the story is: deregulation/privatization is often a bad idea and should be looked upon with great skepticism; when push comes to shove, big money gets what it wants; big money gets what it wants because too many voters don’t bother paying attention and are therefore easily duped by misleading advertising. Interestingly enough, public financing of elections would alleviate most of these problems.