Is lack of competition leading to costly electricity glut?

SACRAMENTO – A top California utility official once quipped that he was one of the few executives in the country who earned a profit merely by remodeling his office. He was referring to the way the state’s regulated utility system is designed. Companies are granted an electricity monopoly for a particular region, then are guaranteed a hefty rate of return for the infrastructure investments they make.

This price system, critics say, results in unforeseen consequences. A recent investigative report found that California’s utility companies have been involved in a power-plant building spree, even though Californians have significantly cut their electricity usage over the same time period. In three years, the state is projected to be producing 21 percent more electricity than it needs, without counting the growth in rooftop-solar applications, reported the Los Angeles Times.

Last year, the California Independent System Operator had 24 percent in actual reserves – far above the targeted 15 percent goal. Even that 15 percent goal is 50 percent higher than what’s necessary to protect the system from disaster and blackouts, according to some experts.

As the Times’ report put it, “California has a big – and growing – glut of power.” It’s a matter of incentives. Because utilities are guaranteed a 10.5 percent rate of return on each new plant they build, regardless of whether customers actually need it, they can make more money building new plants than they could buying power from existing competing plants.

In an open marketplace, gluts of products or services lead firms to slash their prices dramatically. If, say, car manufacturers produce too many vehicles, they will provide rebates or be stuck with lots full of unsold inventory. With California’s regulated utility system, by contrast, gluts in electricity actually raise prices for consumers because of the way utilities are paid for their investments. They need only get the approval from the Public Utilities Commission to build new plants and pass on costs to ratepayers.

The regulated utility model, which dates back to the 19th century, puts government regulators in charge of looking after consumers’ best interests. But a fairly recent California utility scandal has illustrated the dangers of what Nobel Prize laureate George Stigler refers to as “regulatory capture,” when the oversight agencies are dominated by the industries they regulate.

As the Mercury News reported in 2015 regarding the investigation of a deadly 2010 explosion of a PG&E natural-gas pipeline in San Bruno:

“Additional evidence of the close relationship between PG&E officials and leaders of the agency that regulates the utility emerged late Friday in a new batch of emails long sought by the city of San Bruno … .”

Some say the current system also crushes the emergence of a functioning electricity market. The Times article tells the story of an energy company that built a $300 million privately funded facility in Sutter County:

“Independents like Calpine don’t have a captive audience of residential customers like regulated utilities do. Instead, they sell their electricity under contract or into the electricity market, and make money only if they can find customers for their power.”

But soon after the construction of that plant, the California Public Utilities Commission approved PG&E’s application to build its own power plant. PG&E gets paid no matter the consumer demand, so it was hard for a true private enterprise to compete with that subsidized model. Calpine shuttered its facility halfway into its useful life.

“A monopoly franchise removes the incentive to innovate to increase market share,” explains my R Street Institute colleague Devin Hartman, in an August study of the nation’s electricity markets. “Guaranteed cost recovery for ‘prudently incurred’ expenses diminishes the incentive to control costs. The regulated model also insulates utilities from market risks and most policy risks, such as changes in fuel prices or government subsidies.” This provides a safe place for investors, he added, but gives them little incentive to manage risks or control costs.

These analyses also highlight a point that might seem counterintuitive to many environmentalists: competitive markets often lead to better air-quality outcomes. Here, we see utilities overbuilding natural-gas-fired power plants even as consumer demand suggests the plants aren’t necessary. Because of the utilities’ rate-of-return-based payment, they can stick with older technologies and avoid looking at alternative-energy models that might trim their costs.

The current distorted market is, to some degree, a reaction to the botched energy deregulation plan former Gov. Pete Wilson signed into law in 1996, which provoked a statewide crisis in 2000. The state deregulated the price of wholesale energy, but capped its retail price. The population had been growing and regulators had not approved the construction of new power plants for years. After a hot summer and market manipulations by energy companies gaming the new system, the state’s wholesale prices soared above those retail caps.

The end result: Rolling electricity blackouts, a statewide crisis that led to the bankruptcy of PG&E, and the recall of Gov. Gray Davis. Though Wilson signed the legislation, Davis was blamed for indecision as parts of the state went dark. Since then, state officials have avoided anything smacking of deregulation or market competition and have been cranking up supply even if it’s not necessary. Other states, such as Texas, deregulated their electricity markets and have watched electricity prices go down as California’s have increased.

The Times only touches on another issue of long-term importance: solar energy and the utility companies’ fear of a “death spiral.” California law allows for net energy metering. “Customers who install small solar, wind, biogas and fuel cell generation facilities … to serve all or a portion of onsite electricity needs are eligible for the state’s net metering program,” explains the Public Utilities Commission. “NEM allows a customer-generator to receive a financial credit for power generated by their onsite system and fed back to the utility.”

Utilities must buy back the electricity at market rates, but they still have this vast – and growing – infrastructure of power plants and utility lines to finance and maintain. The more the utilities raise their rates to pay for these “stranded costs,” the more consumers opt out and install solar panels. That raises the per-capita costs of maintaining that infrastructure, which raises electricity prices – and leads to more people opting out of the system. Advances in battery storage could further diminish the need for power plants that are financed 30 or 40 years into the future.

Steven Greenhut is Western region director for the R Street Institute. Write to him at sgreenhut@rstreet.org.     

6 comments

Write a comment
  1. jewels
    jewels 7 February, 2017, 05:47

    I read your posts every day and find it interesting; however, I have a question. I work at a public state agency, Caltrans (Department of Transportation). This particular agency in San Bernardino, CA is corrupt. Management fires those who complain about the illegal activities that is going on. There is discrimination, sexual and physical assaults, and now time sheet fraud. No one within Caltrans will help as they are so scared of retaliation. Last week an employee voiced his concerns very loud so everyone can hear him. In the particular area where I work, there are probably 100 people or more. Anyway, he shouted how he is being harassed by management including being discriminated against. He yelled he is going to fight back with every breath in his body. I personally am very scared as it has gotten so bad. I know I am assuming, but I have read how employees shoot people in the workplace. There are other employees trying to voice their concerns but again it goes on deaf ears. We are all scared. Health and Safety, EEOP, all within Caltrans will not help us. How can I get my concerns publized so people are aware that this is real and does happen. Pls. Advise. Thank you

    Reply this comment
    • Tom
      Tom 7 February, 2017, 09:59

      Contact CalHR

      Reply this comment
    • Jay
      Jay 7 February, 2017, 16:11

      Have you tried contacting your State Assemblyman or Senator? Their job is to represent the interests of their constituents in front of agencies like Caltrans. You’d be amazed what they can accomplish.

      Reply this comment
  2. Spurwing Plover
    Spurwing Plover 7 February, 2017, 06:40

    If we could harness all that Hot Aor then Sacramento,San Francisco,Los Angles and the Serra Club would be very useful

    Reply this comment
  3. Russell
    Russell 7 February, 2017, 17:47

    The rate of return is not guaranteed. Utilities will earn far more on infrastructure to facilitate alternative energy. NEM is only a death spiral if the NEM customer costs are shifted to other customers.

    I love your work and would love to help you plug a few holes in your understanding.

    Reply this comment
  4. Mike
    Mike 7 February, 2017, 18:36

    Jewels, Contact a labor attorney directly. Don t trust your employer or another state agency without a lawyer. Caltrans won t dare retaliate against you with the lawyer.

    Reply this comment

Write a Comment

Your e-mail address will not be published.
Required fields are marked*



Steven Greenhut

Steven Greenhut

Steven Greenhut is CalWatchdog’s contributing editor. Greenhut was deputy editor and columnist for The Orange County Register for 11 years. He is author of the new book, “Plunder! How Public Employee Unions are Raiding Treasuries, Controlling Our Lives and Bankrupting the Nation.”

Related Articles

Look for 5 Things in May Revise

MAY 13, 20211 By JOHN SEILER Next Monday, Gov. Jerry Brown will release his “May Revise” to his January budget

Experts warn of new easy-money hazard

COSTA MESA — Federal regulators are repeating the same easy-money mistakes that led to the Great Recession. So warned five

Pro sports nonprofits seek special exemption from state raffle rules

Professional sports franchises have a track record of securing special exemptions from environmental regulations, landing sweetheart bond financing deals and