Don't Write Off Davis Energy Plan

By Alan Blinder, Professor of economics at Princeton University and former vice chairman of the Federal Reserve from 1994-96.

Might Californians finally be seeing a dim light at the end of the energy tunnel? This spring and summer will be difficult times unless everything breaks just right. But Gov. Gray Davis' recently announced energy plan offers at least short-run management of the crisis--and a hope for a long-run solution. And that's about all anyone should ask the government to do.

Ignoring the history and some mind-numbingly complex details, the electricity problem comes down to this: Demand now outstrips supply by a wide margin even on a normal day, and by much more on days of peak demand. With the utilities no longer credit-worthy, the state must fill the gap by buying on the wholesale market. These days, that means buying high and selling low.

Any comprehensive attack on this problem must have three components: mechanisms for reducing demand, mechanisms for increasing supply and a pile of money to cover the bills while the medicine works. The governor's plan, while not perfect, has the three elements. It also avoids the wackier suggestions from both the right and the left.

Let's work backward through the three components. First, the state needs money to keep the lights on. One naive remedy would be to raise taxes to pay all the bills. No danger that any politician will ever latch onto that one. But a related bad idea--raising retail electricity rates to cover all the costs--does have a following. Why is that a bad idea? Because the utilities are saddled with debt from the past. And things almost certainly will be brighter (pun intended) in the future.

Like a family, when a government is faced with a huge, one-time expense--say, to build a highway--it generally borrows most of the money. That's sound financial practice because it spreads what otherwise would be a ruinously high cost over time. Davis wants to spread the cost of the current crisis by issuing bonds worth about $12 billion to $13 billion, secured by future payments for electricity. I do not know whether this is exactly the right number. But the principle is clear, and it's too bad the Legislature delayed the bond issue.

Next comes supply. Wishful thinkers on the right have a simple solution: Just let retail prices rise, and more supply will come. The trouble is that it won't, at least not in the short run. Over years, greater supply is the only lasting solution. But to expect much supply response in the short run is dreaming.

The left has its own favorite silly idea: The state should seize control of power plants and take over the business of supplying electricity. Seize? How much good would that do to California's business climate? And does anyone really believe that the state can, over the long run, generate and supply electricity better than private business? There are, in fact, traces of public ownership in the Davis plan: The state is buying transmission lines, and a new public authority would build power plants if private industry fails to do so. But the governor sees public ownership as a last, not a first, resort.

Finally, we come to the demand side, where true believers offer the same remedy: Just let the retail price rise enough to cut demand back to the available supply. Sound harsh? It is. Higher electricity prices must be part of the solution, at least in the short run. But relying exclusively on higher rates would be foolhardy and perhaps even ruinous to California's economy, because titanic price hikes would be needed to cut demand by enough in short order. So we would wind up inflicting pain on consumers without calling forth greater generating or transmission capacity.

The governor at first resisted the conclusion that consumer prices had to rise. But he has now embraced it. His package includes not just price hikes for big energy users, but also financial incentives for those who reduce consumption. More can be done in this regard, but he is at least on the right track.

Will these conservation measures get California through the next few months? I wouldn't bet on it. But unless the federal government truly caps wholesale electricity prices temporarily, demand management is about the only short-run game in town.

Pray for a cool summer and for a lot more rain behind the dams in the Pacific Northwest.

Alan Blinder also served on the President's Council of Economics Advisors from 1993-1994 and currently is a senior advisor to Saber Partners, which is advising Gov. Gray Davis on financial policy.