February 5, 2001
The Wisdom Fund

Deregulation Fiasco, Red Flag for Developing Countries

California Electricity Deregulation Discards Cost Minimization, Favors Profit Maximization

by Enver Masud

Guided by the World Bank and other development agencies, countries throughout Asia and Africa are deregulating and restructuring their electric power sector, even as this prescription is causing havoc in California--the world's sixth-largest economy.

Federal regulators in the United States say that California's experiment in electricity deregulation has failed. "This version of competition was a disaster," said Federal Energy Regulatory Commission Chairman James Hoecker--head of the U.S. government agency which regulates wholesale power distribution--this past December.

High electricity costs and lack of supply have idled factories and businesses from California to the Pacific Northwest. "Businesses are being forced to choose between paying exorbitant power bills or closing their doors," reports Reuters.

Southern California Edison told state officials it might begin to ration electricity to its customers because it has no money to buy more, reported the Washington Post.

The deregulation of California's electricity market--which along with Norway, and the United Kingdom models, are recommended by the World Bank and others to developing countries--was supposed to bring cheaper electricity to the state. Instead, with wholesale electric rates 10 to a 100 times higher than a year ago, California's largest utilities face losses of over $8 billion. To avoid bankrupting the utilities, the state Public Utilities Commission in San Francisco approved emergency rate increases of between 7 and 15 percent.

Amidst fears that California utilities would be unable to pay market prices, U.S. Energy Secretary, Bill Richardson, signed an extraordinary, emergency order that would force out-of-state power producers to supply electricity to California.

California's big three utilities--Southern California Edison, Pacific Gas & Electric and San Diego Gas and Electric--serve about 27 million customers, buy their electricity through the Power Exchange from different public and private producers, such as Houston-based Enron Corporation, which critics charge are manipulating the electricty market.

Enron denies the charge, saying it is merely a matter of supply and demand.

Five investigations into possible market manipulation by electric supply companies are underway, and consumer groups are planning ballot intiatives to reverse deregulation by putting the state in charge of the power system or reregulating entirely, reports the Washington Post.

In 1996, the electricity market in California was deregulated in the hopes that market forces and competition would lead to cheaper prices. Consumers were promised that rates would remain frozen until 2002.

But instead, the "free market" has wreaked havoc. No new major power stations have been built while a booming, high-tech economy has increased electricity demand. Since the summer of 2000, the state has experienced frequent energy emergencies that required businesses to limit electricity use.

Patricia Irwin, a professional engineer and editor in chief of Electrical World magazine, in a full-page display in the Washington Post, December 31, 2000, (apparently designed to calm growing apprehension with deregulation) states that California's electric power shortages are due "first" to the fact that "Utilities there had built almost no new generating plants and very little in the way of transmission capacity for a decade."

True, but Ms Irwin's statement, while explaining the cause of California's electricity shortages, may point to a fatal flaw in California's "deregulated" electric power industry. In a free market, producers have a greater incentive to build in anticipation of supply shortages, rather than when supply surpluses are anticipated. This was not the case in California.

Until the rush to deregulation, the United States enjoyed very high reliability of supply. That is changing under the new system. In mid-December last year, the California Independent System Operator warned that the state would experience rolling blackouts.

And "deregulation" itself is a misnomer. The new system is still regulated, but in ways that provide electricity supply companies greater opportunity for profits, where previously, these companies were limited to recovering only their legitimate costs.

Energy Insight Today newsletter projects that Duke Energy's revenues for the Moss Landing power plant--owned by Pacific Gas and Electric prior to deregulation--will be $238 million for 2000, compared with $49 million for 1999.

As for state Sen. Steve Peace, who took the lead in shaping California's effort to deregulate the electricity industry, experts say his political career is all but over. "He couldn't be elected dogcatcher," said political consultant Ann Shanahan-Walsh.

During the next five years, electric power companies in the Middle East are expected to add 92 gigawatts of new electric power generation at a cost of around $60 billion. Countries such as China, India, and Indonesia are also adding large amounts of new capacity. Unable to pay for this new capacity, many of these countries have sought World Bank and other loans, which come with requirements for deregulating electricity markets, and restructuring the electric power sector.

In many developing countries, the electric sector consumes one-half to three-quarters of the non-defense budget. California's deregulation fiasco should serve as a red flag for developing countries.

[Mr. Enver Masud has 35 years of industry, state government, federal government, and international experience in the electric power sector. He managed the National Power Grid Study, and National Electric Reliability Study, while employed at the U.S. Department of Energy.]

["It accuses such power suppliers as Reliant Resources Inc., Williams Cos., Dynegy Inc., Mirant and Duke of withholding power to push up prices. It also accuses a range of companies of executing strategies to boost profits by misleading the marketplace. The strategies are similar to tactics that Enron Corp., now under bankruptcy protection, employed,"--Jonathan Peterson and Nancy Rivera Brooks, "Calif. Report Widens Blame in Energy Plot," Los Angeles Times, March 3, 2003]

Greg Palast, "Power Outage Traced to Dim Bulb in White House," August 15, 2003

Enver Masud, "To soon to call for grid overhaul," Christian Science Monitor, August 18, 2003

Katherine Stapp, "Laissez-faire legacy leaves New York in the dark," Manila Times, August 23, 2003

[. . . the state will help companies recover the cost of some of the long-term contracts if they don't work out. That runs counter to the pure market theory underlying deregulation, but at the moment it appears that the market alone will not provide for New York's energy needs.--Editorial: "Power Shortage," New York Times, March 18, 2004]

["What we need to do is to help in the cause of, ah, downfall of California," an employee is heard saying on the tapes. "You guys need to pull your megawatts out of California on a daily basis."--"More Enron Tapes, More Gloating," CBS News, June 8, 2004]

Gene Johnson, "Enron gouged Western customers for at least $1.1 billion, public utility says," Seattle Times, June 15, 2004

[Directed by Alex Gibney, this is the inside story of one of history's greatest business scandals, in which top executives of America's 7th largest company walked away with over one billion dollars while investors and employees lost everything.--VIDEO: "Enron: The Smartest Guys in the Room," Magnolia Pictures, April 22, 2005]

Steven Mufson, "Energy Deregulation Comes Home to Roost," Washington Post, April 25, 2006

[On July 14, 2005, Roosevelt's Public Utility Holding Company Act, bulwark of consumer protection, was repealed by a Congress fattened with utility industry cash.--Greg Palast, "Lay lights way for power predators," Seattle Post-Intelligencer, May 24, 2006]

[. . . even after the Sept. 11, 2001, attacks, when India's cooperation in the "war on terror" was crucial, the Bush administration kept up its full-court press to get India to pay Enron for a white-elephant power plant that the company had built in Dabhol, India.

The pressure on India went up the chain of command to Vice President Dick Cheney, who personally pushed Enron's case, and to Bush himself, who planned to lodge a complaint with India's prime minister. Post-9/11, one senior U.S. bureaucrat warned India that failure to give in to Enron's demands would put into doubt the future functioning of American agencies in India.

The NSC-led Dabhol campaign didn't end until Nov. 8, 2001, when the Securities and Exchange Commission raided Enron's offices - and protection of Lay's interests stopped being politically tenable. That afternoon, Bush was sent an e-mail advising him not to raise his planned Dabhol protest with India's prime minister who was visiting Washington. . . .

Bush personally joined the fight against imposing caps on the soaring price of electricity in California at a time when Enron was artificially driving up the price of electricity by manipulating supply. Bush's resistance to price caps bought Enron extra time to gouge hundreds of millions of dollars from California's consumers.

Bush granted Lay broad influence over the development of the administration's energy policies, including the choice of key regulators to oversee Enron's businesses. The chairman of the Federal Energy Regulatory Commission was replaced in 2001 after he began to delve into Enron's complex derivative-financing schemes.

Bush had his NSC staff organize that administration-wide task force to pressure India to accommodate Enron's interests in selling the Dabhol generating plant for as much as $2.3 billion.--Robert Parry, "Bush's Enron Lies," Consortium News, May 26, 2006]

[In the 1980s, he led a he led a team of U.S. military advisers to assist the government of El Salvador in its campaign against Marxist guerrillas. . . . Paul Wolfowitz, an old friend, called him up and asked him to serve as the senior adviser to Iraq's electricity Ministry.--Rajiv Chandrasekaran, "Imperial Life in the Emerald City: Inside Iraq's Green Zone," Knopf (September 19, 2006), p88]

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