California on dangerous course to economic meltdown

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NEWS ANALYSIS

Economists: Raising Rates Not Enough California on dangerous course to economic meltdown, they say

Carolyn Lochhead, Chronicle Washington Bureau Friday, February 2, 2001 2001 San Francisco Chronicle

URL: http://www.sfgate.com/cgi-bin/article.cgi?file=/chronicle/archive/2001/02/02/MN85090.DTL

Washington -- Gov. Gray Davis and state legislators reluctantly moved yesterday to clear the way for higher rates for California energy consumers, although it may be too little, too late.

Many economists say state lawmakers, who put most of the burden for potential rate hikes on businesses rather than residents, haven't gone far enough to prevent more rolling blackouts and to forestall an economic meltdown this summer, when Californians crank up their air conditioning and send electricity demand soaring.

"This summer, we're headed toward a train wreck," said Severin Borenstein, director of the Energy Institute at the University of California at Berkeley. "It is possible to drive the California economy off the cliff by not dealing with the shortage that we are potentially facing this summer."

The situation is so dire -- and the approach of California's legislators so flawed, say many economists -- that a group of regulatory experts led by David Teece, director of UC Berkeley's Institute of Management, Innovation and Organization, issued a manifesto last week bluntly stating, "We are alarmed."

"The situation does not appear to be well understood," said the analysts, including two Nobel economists. "It is important to avoid actions which will make matters worse, or simply push the problems onto taxpayers. . . . An essential element of the solution is to raise retail prices. . . . There is no other way out."

Facing a Feb. 7 cutoff of federal emergency orders forcing natural gas sales into the state, Davis and state lawmakers are crafting a complex scheme that would allow the state to buy electricity directly under long-term contracts and issue bonds to cover some $10 billion in power purchases.

While lawmakers have opened the door to higher rates -- by stipulating that any future rate increases on residential users apply only above 130 percent of basic use -- even that step almost killed the package early yesterday. Indeed, Davis continues to insist that rates will not rise.

"The governor remains committed to keeping rates where they are for the consumers of this state," said Davis spokesman Roger Salazar. "It remains his hope and expectation that we will be able to reach a solution to this challenge without rate increases."

State regulators raised rates 9 percent earlier this year, and Davis suggested last week that consumers should not pay more for a botched electricity deregulation implemented by his predecessors.

"Consumers were promised that rates would go down," Davis declared last week. "No consumer . . . begged me to deregulate their rates. This experiment has not worked, and they are not going to suffer an undue burden."

But such vows mean that Davis "has taken away from himself the one policy instrument that can fix the problem quickly and assuredly," Teece said. "It may be good politics, but it's bad public policy."

Unless the Federal Energy Regulatory Commission suddenly caps wholesale prices, which it shows no sign of doing, "There's just no question that prices at the retail level have to rise," Borenstein added. "The other option is conservation through rolling blackouts."

To be sure, many economists believe the state's partial deregulation -- which among other things unleashed wholesale prices while holding consumer rates fixed -- created ideal conditions for wholesalers to price gouge.

The state's two giant utilities, Pacific Gas and Electric Co. and Southern California Edison, were forced to buy power on the daily "spot" market rather than locking in cheaper long-term rates, which worked to their benefit until natural gas prices rose sharply last summer and dry weather reduced hydroelectric supplies.

The utilities then found themselves at the mercy of wholesalers, forced to pay any price to keep the lights on. They now face bankruptcy and find it difficult to buy any power.

"At least part of the answer to this crisis is not raising consumer rates so much as cracking down on the wholesale generators who are profiteering in this market," said Peter Navarro, an economist at the University of California at Irvine. Davis and lawmakers, he said, "are panicking and playing right into the hands of the electricity cartel."

But a big part of the electricity price increase also is a result of the soaring cost of natural gas, which California electricity plants rely on heavily. That reality, other analysts contend, must find its way onto consumer electric bills in order to begin cooling demand.

Lawmakers are already under attack for bailing out the utilities and have fiercely resisted putting the costs directly onto voters' monthly electric bills.

But that is the only place where costs can work immediately to reduce demand, economists said, at least until new power plants come on line, which is not expected before this summer.

Lifting the consumer rate cap -- which also would have improved the utilities' financial health while dampening demand -- was never seriously considered. Instead, the legislation puts the state into the electricity business, where Teece contends it "has not demonstrated a very good track record . . . and in fact to the contrary, everything it's done indicates that it's not an astute player in the energy markets. That is, I think, the wrong call. It's a step backward, not a step forward."

Having the state buy electricity does not help Californians avoid its costs.

Costs can be hidden in higher taxes to pay off bonds or fund the state's purchases, or in rolling blackouts that many believe will send the state's economy into a tailspin, costing thousands of jobs.

"There's going to be some costs incurred, and the question is, do you raise rates and try to be transparent about it, or do you try to bury it in future tax obligations to the taxpayers of the state of California?" Teece said. "That's putting at risk the state's budget and its credit, and it doesn't do anything to solve the immediate demand problem."

Even after the recent 9 percent rate increase, analysts said, Californians are paying significantly less for electricity -- about 20 percent adjusted for inflation -- than in 1994.

Another alternative is voluntary conservation, a big part of Davis' plan. But experience with efforts Davis is pinning his hopes on -- including a "media and outreach campaign" and "innovative classroom programs on conservation" -- indicates that voluntary cutbacks are seldom sustained and almost never yield anywhere near the savings that occur when high prices induce people to turn lights off.

"I am very sympathetic to the people who think that we got screwed by the generators," Borenstein said. "But help on that front had to come from FERC, and FERC has told us they aren't going to help us. And so now it's time to make the best of a very bad situation instead of allowing it to completely destroy the California economy."

E-mail Carolyn Lochhead at clochhead@sfchronicle.com.

-- Martin Thompson (mthom1927@aol.com), February 03, 2001


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