In August of 2000 California was urged to curb energy use. Federal and state government agencies located within the state limited their power use as much as possible. The California Independent System Operator (Cal-ISO) warned the state of the possibility of rotating blackouts. Consumers, wanting to avoid the crisis of rolling blackouts, limited their energy use.

Cal-ISO is the agency responsible for managing the flow of electricity along the high-voltage power lines across the state. It is this system that transmits California's energy. Cal-ISO controls the power grid, meaning it can turn the power on or off for different portions of the state. Turning off sections of the grid at one time creates a blackout. These blackouts are rotated in different parts of the grid and often referred to as rolling blackouts. Usually rolling blackouts take out blocks of the grid at a time for 60 to 90 minutes. And then "roll" on to another set of blocks. Cal-ISO also monitors the market to ensure that market competition is fair.

The formal request to limit energy use was prompted by the extremely low capacity of the state's energy resources. Two electricity generators were experiencing mechanical failure. There was an increased use of air conditioners due to hot weather. These conditions affect both the supply and the demand of energy. Yet they hardly seem like enough to create a near energy crisis in a state as big as California. Perhaps, there are more factors below the surface?

CS Question #1: Apply your understanding of scarcity to the energy concerns in California?

The California energy problem did not go away. In fact, it escalated. The first official rolling blackouts came on January 17, 2001. They affected areas in Central and Northern California. These were the first blackouts in California since World War II. Cal-ISO ordered the blackouts because the power reserves went below 1 percent. Hospitals and airports are excluded from the blackouts. But schools, businesses and homes were all affected. Governor Gray Davis declared a state of emergency. There are proposed bailout plans to mandate buying power from wholesalers and providing it to the utilities.

Cal-ISO has been in a stage 3 warning since January 17, 2001. A stage 3 warning means that the operating reserves of energy drop below 1 and ½ percent. There have been rolling blackouts during three of the five days that the stage 3 warning has been in effect.

California is the world's sixth largest economy. The high-tech industry and film industry are both centered in Southern California. In fact, Silicone Valley, located in Southern California, is the heart of the information technology industry. If blackouts occur in Silicone Valley, Internet users around the world would be affected. So far, Southern California has not had to endure blackouts. The energy crisis and threat of blackouts has promoted discussion of relocation among Silicone Valley technology business.

Certainly the supply of energy is an issue for more states than just California. So, why is it they are experiencing such an extreme crisis when the rest of the nation isn't? There is of course, more than one factor causing this situation. One contributing factor is California's dependence on imported power. Neighbor-state, Oregon provides hydroelectric power to California. This is energy that is created by the force of water through a dam system. However, Oregon's snow and rainfall has been below average, meaning a decrease in supply. Another factor is the incredible growth of the high-tech industry in California. High-tech businesses rely heavily on energy, creating an increase in its demand. Further, California is the nation's most populous state, which means there is a consistently increasing demand for energy.

CS Question #2: Which of the factors affecting the supply of California's electricity are supply shifters and which are demand shifters? Why or why not?

Deregulation is the most significant factor of the energy crisis in California. A 1996 California deregulation law forced investor-owned utility monopolies to sell off their power generating assets and purchase electricity on the open market. Power generating assets include dams and power plants. The goal was to decrease the price to the consumer through a competitive market structure. However, the cost of wholesale power skyrocketed. Currently, out-of-state power suppliers are charging up to 10 times more than they did last year.

San Diego Gas and Electric was the first company to completely deregulate. As such, the company passed these costs on to the consumer. Customer's bills were twice and three times as much as before. Upset customers prompted a federal investigation.

Meanwhile, other electric companies, notably Pacific Gas and Electric (PG&E) and Southern California Edison (SoCal Edison) had not fully deregulated when wholesale prices rose. They were forced to seek permission to raise prices from state regulators and federal courts, which was not granted. Regulators called for a price cap on all electricity.

The inability to pass the cost onto consumers has caused great financial trouble for PG&E and SoCal Edison. Collectively they have gone $12 billion in to debt and are in danger of bankruptcy if their power suppliers demand payment in full on their debts. If these businesses file bankruptcy, they would be among the largest business to fail in U.S. history.

SoCal Edison claims it will run out of cash on February 2, 2001. SoCal Edison currently has $596 million in bills due that it cannot pay. PG&E has $500 million in cash and $1 billion in bills due in February. PG&E has 4.5 million customers, SoCal Edison has 4.2 million customers. Considering "in-between" suppliers and large accounts, these businesses provide electricity to 25 million people. PG&E borrows $1 million per hour to pay for electricity for its 4.5 million customers. There is threat of lawsuits against both PG&E and SoCal Edison. Most likely, the lawsuits will come from power suppliers and site failure to honor contractual obligations.

SoCal Edison attempted to sell its 56 percent share in a power plant along the Colorado River. California regulators disallowed the sale. Their fear was that, if privatized, this power source would turn around and charge higher prices to utilities. The refusal to allow the sale is a complete contradiction of deregulation.

CS Question #3: What was the goal of deregulating the electricity industry in California? Why didn't it work in this case? Why did it work with the long-distance carriers in the telephone industry?

Strict environmental laws coupled with deregulation issues have severely limited the growth of the energy industry in California. In fact, it takes twice as long to build a power plant in California than it does in the rest of the nation. Only eight new plants have been licensed since 1998. These plants will be operable by the summer of 2002 at the earliest. The growth of the rest of the state has not been matched by the electricity industry.

In the last decade, energy use in the United States has increased over 30 percent. Think about how many things you use every day that require electricity or some kind of fuel to operate. Alarm clocks, televisions, computers, microwaves, cars, lights, heat, radios-the list is endless. The importance of energy and how it should be exchanged in the market is an important issue.

California is the first state to deregulate the electrical industry. The famous deregulation of the phone companies led to more options and better prices for consumers. Many states have been or are considering deregulation of the electrical industry. It is quite certain that the lessons being learned in California will be closely watched.

Deregulation has proved to be a failure in California. But remember that price caps other limitations are still being enforced by California regulators. By not allowing the market to operate freely they are not making it impossible for an equilibrium price to be achieved. There is still debate about deregulation. Many argue that the failure of deregulation in California is due to the troublesome and contradictory approach that was used. The crisis in California does not mean deregulation cannot be effective.

CS Question #4: The basic economic challenge is determining the most efficient and effective way to use, or allocate, scarce resources. How does this relate to regulation and deregulation of electricity?

Further Thought:

1. How do you think the energy crisis in California will impact economic growth?
2. What are the marginal costs of keeping a cap on energy prices? (Hint: think about business relocation, retail losses, government bailouts, etc.)
3. Go to either of the following news web sites: http://www.bbc.co.uk/ or http://www.msnbc.com/news/default.asp. Locate one or two new facts about the energy situation in California. Write them down and explain their economic impact.

*Information sources: msnbc.com and bbc.com