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The Independent Institute
Commentary

Raising Electricity Prices Will Save Money


The latest UCLA Anderson Forecast for California warns that Governor Davis's current approach to the power crisis will unnecessarily slow California's economy for years to come. Rather than taking the necessary but perhaps politically inexpedient steps of ending retail price controls and beginning real-time pricing, Davis has tried to insulate consumers and delay the day of reckoning. In doing so, Davis has greatly increased the total costs of the crisis.

At first glance, retail price controls on electricity seem like a boon to consumers but in reality the reprieve brought about by retail price controls is only temporary. The true electricity bill has not yet come due. The difference between the wholesale and retail price of electricity is currently being paid by the state of California. Thus, what electricity consumers save in electricity costs today they must pay for in higher taxes tomorrow.

State Controller Kathleen Connell correctly points out that the Governor's plan is "indebting future generations of Californians to ease the potential pain a portion of people might feel over the summer of 2001."

Swapping lower prices today for higher taxes tomorrow is not a good trade. Future taxpayers will pay higher taxes whether or not they conserve electricity today. Future taxes create costs in the future but they do not have any offsetting benefits on electricity consumption today. If instead we raise prices today, we not only reduce our taxes tomorrow but we also create incentives to reduce our total electricity bill.

Reducing the demand for electricity will save consumers and taxpayers money. We will consume less at higher prices and a reduction in demand will reduce electricity prices. One reason prices have risen so high is that on many hot days California is pushed to the brink where total available supply meets demand. Squeezing the last watt of electricity out of generators pushed to the maximum is much more expensive than producing the average watt.

Moreover, when only a few firms have excess power to sell, and the system is nearing blackout status, those firms with power to sell exploit the situation and demand much higher prices. If you can help it, don't buy an umbrella when it's raining.

Governor Davis is fond of threatening power producers who raise their prices when blackouts threaten. But rather than fulminate at "merchant generators," a better approach is to raise retail prices and introduce real-time pricing for the largest electricity users as soon as possible. This action would reduce demand, especially peak demand, and create a situation where we are never again at the mercy of a handful of producers. When demand is reduced and made more responsive to real-time supply, we will be able to pick and choose from among many suppliers rather than getting gamed by an energy oligopoly.

Governor Davis's decision to maintain retail price controls forced Pacific Gas & Electric and Southern California Edison to buy high and sell low. As a consequence, PG&E is now bankrupt and Edison is not far behind. A further consequence has been the entry of the state into the electricity buying business.

But the state has shown itself not to be a savvy buyer. Uncensored versions of the state's electricity contracts reveal that the state has overpaid. According to State Controller Connell the state's $43 billion dollars worth of contracts were negotiated at the worst possible times, yielding unnecessarily high prices for long terms.

We have already traveled too far down a bad path. If we stay on this path we are likely to enter into foolish schemes to socialize power generation and the transmission grid. Who knows what the long-term costs of such policies could be? (It's not encouraging to recall that Lenin defined communism as socialism plus electricity.) Instead we must reverse course and end retail price controls. If we had done this earlier our problems today would not be anywhere near this severe.

If you are sick it doesn't help to deny that you are sick and put off taking needed medicine. We would be wise to take our medicine today, bitter as it may be, rather than wait for later when it will be even more expensive to return to health.


Alexander Tabarrok is Senior Fellow at The Independent Institute, Assistant Editor of The Independent Review, and Associate Professor of Economics at George Mason University. He received his Ph.D. in economics from George Mason University, and he has taught at the University of Virginia and Ball State University. Dr. Tabarrok is the editor of The Independent Institute books, Entrepreneurial Economics (Oxford University Press), The Voluntary City (with David Beito and Peter Gordon, University of Michigan Press), and Changing the Guard: Private Prisons and the Control of Crime.

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