estate was a bust, and more people were moving out of the state than were moving in. Spending for defense, one of the state’s main industries, had been cut back sharply with the end of the Cold War, and Sacramento was running big deficits. High electricity prices were partly blamed for the state’s economic slump. Manufacturing companies were fleeing California, in part because of high energy costs, taking jobs with them. Meanwhile people did not worry much about increases in electricity demand. After all, in 1993 demand hadn’t grown at all.
Competition, it was thought, would bring down the price of power, helping to revive the state’s fortunes. California’s brand of deregulation was fashioned out of a complex negotiation and a great compromise, involving stakeholder democracy, although the stakeholders varied much in terms of their understanding of how power markets worked. Politically, the great compromise worked brilliantly; the deregulation bill sailed through the state legislature in 1996 with not a single dissenting vote and was signed into law by Republican Governor Pete Wilson.5
Under California’s restructuring, consumer advocates got lower prices; big industrial customers would get access to cheaper power. But in a deregulated market traditional utilities would be stuck with legacy costs of their contracts for PURPA power and the cost overruns on building other new plants—such as the Diablo Canyon nuclear facility on the central California coast that was caught in a regulatory morass and had ended up costing about $11.5 billion. These costs would prevent them from being competitive. The legislation gave the investor-owned utilities the relief they needed—various ways to extricate themselves from the burden of what was called “stranded costs.” They too embraced restructuring. As for the new entrants, the merchant generators, there were two great prizes. One was the ability to sell power into the large California market; and the other, the opportunity to buy the power plants that the state was strongly “encouraging” the utilities to sell. “Every major group got what they wanted most,” said Mason Willrich, who later became chairman of the California grid operator. “But no one connected the dots.”
This restructuring was an extraordinary edifice in terms of political support. The entire California congressional delegation signed a letter urging the Federal Energy Regulatory Commission not to use federal authority to interfere with the plan. The political forces were so finely balanced that any alteration could cause the whole edifice to come tumbling down.
The objective was to dismantle the traditional natural monopoly in electric power. The new system, in the words of economist Paul Joskow, was “the most complicated set of wholesale market institutions ever created on earth and with which there was no real world experience.” It yoked together a deregulated market with a regulated market. Some compared it to having a bridge designed by consensus. The subsequent collapse of this particular bridge would demonstrate the hard-earned lessons of power markets.6
THE IRON CURTAIN
Wholesale markets were deregulated—along with the markets in which the generators that operate the power plants that sold power to utilities that distributed it to customers. Prices in those markets would be free to fluctuate, in response to supply and demand. But the traditional retail markets—those between the utilities and their customers (home owners, factories, offices, and others)—were not deregulated. This meant that these consumers were to be protected—insulated—from rising prices. They, after all, were the ones who cast votes for governors and state legislators.
The result was to build an economic iron curtain between the wholesale and retail markets. The ultimate consequences would be devastating. Changes in wholesale markets, which would reflect those changes in supply and demand, would not flow as price signals into the retail markets—that is, to consumers. Thus consumers would have no incentive, no wake-up call, to make adjustments that would normally happen in response to rising prices (buying a more efficient air conditioner, putting a little more insulation in their walls). They would not get the message because it would not be transmitted to them.
In order to make the wholesale system function like a competitive market, the state’s utilities were ordered to shear themselves of a substantial number of their in-state power plants and sell them to other companies, which would operate them and in turn sell electricity into the open market. Here was the dissolution of the formerly vertically integrated utility—the kind of utility invented by Samuel Insull, which traditionally combined generation, transmission, and distribution within the borders of a single company. Many of these new merchant generators were out-of-state companies, a number of