California Electricity Scandal
The California electricity crisis of 2000 and 2001 followed a failed partial-deregulation, in 1996, of the electricity market in the state.
The deregulation was signed into law by then-Governor Pete Wilson . Part of the process, which was promoted as a means of increasing competition, involved the partial divestiture, in March, 1998 of electricity generation stations by the incumbent utilities, who were still responsible for electricity distribution and were competing with independents in the retail market.
20,164 megawatts of capacity, a total of 40% of installed capacity, were sold to what were called "independent power producers." These included Mirant, Reliant, Williams, Dynegy, and AES.
Then, in 2000, wholesale prices were deregulated, but retail prices were regulated for the incumbents as part of a deal with the regulator allowing the incumbents to recover the cost of assets that would be stranded as a result of greater competition.
However, rapid growth in demand for electricity soon ate into the excess capacity and in the summer of 2000 two events compounded the situation. These were a drought in the North West states and a large increase in the price of natural gas.
California depends on the supply of hydroelectricity from the north and gas fired generation within the state, since the 1970s decision to discontinue the development of nuclear energy.
When electricity wholesale prices exceeded retail prices, end user demand was unaffected, but the incumbent utility companies still had to purchase power, albeit at a loss.
This allowed independent producers to manipulate prices in the electricity market by withholding electricity generation at some plant, arbitraging the price between internal generation and imported (interstate) power and causing artificial transmission constraints.
This was a procedure referred to as "gaming the market." In economic terms, the incumbents who were still subject to retail price caps were faced with inelastic demand. They were unable to pass the higher prices on to consumers without approval from the public utilities commission.
The affected incumbents were Southern Califonia Edison (SoCalEd) and Pacific Gas & Electric (PG&E). Pro-privatization advocates insist the cause of the problem was that the Regulator still held too much control over the market, and true market processes were stymied -- whereas opponents of deregulation simply assert that the fully regulated system had worked perfectly well for 40 years, and that deregulation created an opportunity for unscrupulous speculators to wreck a viable system.
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