June 21, 2001 | Commentary on Energy and Environment
What do you do? Refuse and appear heartless? Or give in and make his recovery even tougher?
The Federal Energy Regulatory Commission (FERC) faced a similar situation in California. State officials there, having presided over a spectacularly inept "deregulation" scheme, were demanding the agency impose price caps on wholesale electricity prices. Likewise, some members of Congress were badgering the agency to order stringent price controls.
Now FERC has caved, approving a "price mitigation plan" for California and 10 other Western states (one that expands an earlier order for price caps only during power emergencies).
Never mind that California wouldn't be in this situation if it weren't for price caps. Specifically, caps on retail prices, or how much power companies charge their customers. Those amounts were capped in 1996, but guess what wasn't? Wholesale prices, or what electricity producers charge the power companies.
Yes, producers could charge electricity retailers whatever the market could bear -- and thanks to regulations that discouraged the construction of new power plants, that got to be quite a bit -- but retailers couldn't pass any of the price hikes on to their customers. The results were predictable: Rolling blackouts. More than $8 billion in state funds spent by the end of May to buy power. And the state's two largest utilities, Pacific Gas & Electric and Southern California Edison, bankrupt.
What went wrong? In short, state officials didn't trust the market. Demand outpaced supply because they insulated customers from the beneficial effects high prices would have had on California's electricity market.
That's right -- beneficial effects. In a free market unfettered by price caps, the utilities would have started charging their customers more. In response, producers would have begun generating more electricity, customers would have curtailed their electricity use and prices would have dropped.
The idea that prices must remain free of government controls for markets to work efficiently isn't a matter of "conservative" or "liberal" ideology -- it's economic fact. As Robert Litan of the center-left Brookings Institution recently noted, "95 percent of economists would say that price controls are always dumb or that there should be a very strong presumption against price controls. They lead to artificial scarcity and then perpetuate it."
To get an idea of how well FERC's "price mitigation plan" is likely to work, recall the nationwide price controls on oil imposed by President Richard Nixon in the 1970s. As with the current crisis, the objective was to ensure petroleum products (particularly gasoline) remained affordable.
But while this plan may have looked great on the drawing board, in practice it had a ruinous effect. The artificially low prices gave customers no incentive to cut their use of oil and gasoline, so demand kept growing. The low prices also removed all incentives for producers to increase supply to meet this demand. After all, if prices (and therefore profits) are capped, why bother investing in ways to produce more oil and do so more efficiently?
FERC contends that its regulatory scheme is different. It's purportedly a temporary solution that employs "market-oriented principles," in the words of Chairman Curt Hebert Jr. The agency just wants to ensure that wholesale electricity rates "fall within a zone of reasonableness," it says. Once they "fix dysfunctional markets," we're led to believe, officials will step back and let the markets work their magic.
That would sound a whole lot more reassuring if government meddling weren't responsible for the market being so dysfunctional in the first place. If government officials want to help consumers, the best thing to do is remove all caps and production-inhibiting regulations. That may not be the most politically expedient thing to do, but it is the right thing.
At the very least, they shouldn't imitate our alcoholic friend and try to "fix" things with another shot of the same concoction that helped create the problem. A hangover delayed is not a hangover denied.
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