In the News: Recent Developments

Wednesday, May 30, 2001

Price Caps Have Questionable Record

By Martha McNeil Hamilton and Greg Schneider Washington Post Staff Writers

Even if California Gets Controls on Electric Costs, They May Not Help

As California Gov. Gray Davis and President Bush clash over energy policy, their major dispute has revolved around price caps.

Davis has argued that the best and quickest solution to California’s energy crisis would be for the federal government to rein in wholesale electricity costs through price caps.

Bush has responded that caps will do nothing to lessen demand or increase the supply of electricity.

This is not the first time that the government has been pressured to put a lid on prices in the face of economic problems and public outcry. Past efforts have had mixed results and illustrate how difficult price caps can be to administer properly.

President Richard Nixon, with a reelection campaign in the offing in 1971, imposed wage and price controls to help keep inflation at bay. While hailed as politically expedient, the system got low marks from many economists. Federal price controls on oil resulting from the 1973 Arab embargo and controls on natural gas were also eventually deemed ineffective and scrapped.

Economists say that price caps make the most sense when markets are not working properly — when a shortage of sellers, for instance, means there is no real competition. Indeed, in a market dominated by a limited number of sellers, governments often have acted to regulate prices. That’s how it worked in the old world of regulated utilities. The utilities had to convince regulators that price hikes were justified.

Davis says California is struggling with a similar situation of too few sellers, and caps are needed as an emergency measure until new power plants are completed. Ten economists, including Alfred Kahn, the father of airline deregulation, have backed California in a letter to Bush and Republican congressional leaders.

“Creating a well-functioning electricity market in California as soon as possible is the best way to ensure that competition in wholesale electricity will spread through the U.S. and provide the greatest possible benefits to consumers,” the letter reads.

The economists argued for temporary price caps and said that if the caps were set high enough, they would not discourage competition. They warned that the crisis in California, unless abated, could set back the cause of deregulation.

Joseph Fichera, the chief executive of Saber Partners, a New York-based consulting firm that has been advising Davis on the energy situation, argues that Bush has misunderstood California’s predicament.

“He’s talking supply and we’re talking economic impact, and there’s a disconnect,” Fichera said.

Fichera agrees that price caps have historically tended to limit the supply of a product, but new power plants are currently under construction. The price caps are needed to keep the state from having to borrow billions of dollars to pay for energy until those plants come on line.

“Right now we’re in a shortage, and just like in war or any time there’s a shortage, you have to manage that through select government intervention,” Fichera said.

With no help forthcoming from the president, Davis is pursuing a lawsuit designed to force federal regulators to impose limits on wholesale prices. Earlier this week the Federal Energy Regulatory Commission took a small step in that direction, telling some wholesalers to hold down prices during shortages severe enough to be declared state emergencies. But most out-of-state suppliers and municipal systems, including the one in Los Angeles, aren’t covered by the directive.

In California, when deregulation came, retail prices — what residential and small-business consumers play for electricity — were reduced, and frozen for several years.

From mid-1998 until the middle of last December, California’s Independent System Operator — the power-grid manager the state set up to oversee the flow of electricity on the state’s deregulated market — imposed a price cap on wholesale electricity.

The rates varied at first but eventually settled at $250 per megawatt. The Independent Systems Operator then asked FERC to remove the caps in an effort to encourage more supply to flow to California.

“In a span of three days, prices went from $250 a megawatt to $1,500,” said Steve Maviglio, a Davis spokesman. “It put the foot to the gas pedal in terms of accelerating bankruptcy and putting the state in a crisis situation.”

When wholesale prices soared, utilities ran out of money.

Some proponents of price caps argue that FERC is obligated under the law to step in.

“There’s a law on the books now, the Federal Power Act, which requires the FERC to maintain just and resonable wholesale prices,” said Linda Stuntz of Stuntz, Davis & Staffier, a law firm whose clients include Southern California Edison.

As long as FERC is reviewing this issue, the courts are unlikely to intervene to help Davis, according to Stuntz and others.

Some major consumers of electricity argue that even if FERC does act, it would not solve their energy problems in California.

John Anderson of the Electricity Consumers Resource Council, which represents major power consumers including California-based Intel Corp. and Chevron Corp., said a price cap wouldn’t cover municipal power companies or cooperatives, or such major out-of-state suppliers as Canadian power sellers.

“Governor Davis speaks as if FERC could wave a wand and cap all prices,” said Anderson. California should take other steps, including raising residential and small-business rates, to encourage more conservation, he said.

Lynn Church, head of the Electric Power Supply Association, which represents independent power producers and marketers — the companies Davis largely blames for the crisis — also opposes caps.

“By putting an artificial cap on the process, you discourage new development by not sending the proper message that there is a shortage and that people need to build and get into the market,” she said. “Secondly, it dampens the price signal to consumers” to use less power.

Staff researcher Richard Drezen contributed to this report.

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