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. Things went well for the incumbents for several years due to the fact that excess generating capacity kept wholesale electricity prices lower than the capped retail rates.
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.
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. 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.
Prior to deregulation, the electricity market in California was largely in private hands. The main players were Pacific Gas & Electric, Southern California Edison and San Diego Gas and Electric. The problems arose from an inefficient deregulation of the market. Ownership of certain power stations was transferred in order to increase competition in the wholesale market. In return for divesting some of their power stations the major utilities negotiated a deal to protect them from their assets being stranded. Part of this deal involved price caps for retail customers and a prohibition on the utilities from entering into hedging arrangements. The consequence was the PG&E and SoCalEd were forced to buy from a spot market at very high prices but were unable to raise retail rates. They lost billions and were reneging on power purchase deals and limiting supply. San Diego had worked through the stranded asset provision and was in a position to increase prices to reflect the spot market. Small businesses were badly affected.
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Perhaps the heaviest point of controversy is the question of blame for the California electricity crisis. Governor Gray Davis's critics often charge that he did not respond properly to the crisis, while his defenders attribute the crisis solely to the corporate accounting scandals and say that Davis did all he could.
Signs of trouble first cropped up in the spring of 2000 when electricity bills skyrocketed for customers in San Diego, the first area of the state to deregulate. Experts warned of an impending energy crisis, but Governor Davis did little to respond until the crisis became statewide that summer. Davis would issue a state of emergency on January 17, 2001, when wholesale electricity prices hit new highs and the state began issuing rolling blackouts.
The crisis, and the subsequent government intervention and bailout of the utilities, have had political ramifications, and is regarded as one of the major contributing factors to the 2003 recall election of Governor Davis.
On November 13, 2003, shortly before leaving office, Davis officially brought the energy crisis to an end by issuing a proclamation ending the state of emergency he declared on January 17, 2001. The state of emergency allowed the state to buy electricity for the financially strapped utility companies. The emergency authority allowed Davis to order the California Energy Commission to streamline the application process for new power plants. During that time, California issued licenses to 38 new power plants, amounting to 14,365 megawatts of electricity production when completed.Handling of electricity crisis