Amid the frenzied finger-pointing taking place because of California’s electric power problems, everyone apparently has forgotten an important economic principle known as the First Law of Holes. Simply stated, when you have dug yourself into a hole, stop digging.
Deciding what went wrong in California and who’s to blame will go on for years. And it’s safe to say there never will be explanations that satisfy everyone. In the meantime, the state wrestles with daily power shortages that are damaging to the state’s economy and hazardous to the health and safety of its citizens.
The problem, simply, is that supply and demand is out of whack. A substantial portion of the state’s generating capacity is out of service for maintenance, and no new plants have been built in a decade. Reservoir levels are low at hydroelectric plants in the Pacific Northwest that normally send power to California. Meanwhile, electricity consumption has steadily grown over the years as the population and economy have grown.
If increasing supply is hard in the short run, can anything be done to lower demand? Yes, there are several measures that would curb demand using pricing tools that would cause less economic damage than other alternatives. These include simply raising electricity prices, plus other measures that buy off the least productive demand or encourage conservation at times of peak usage.
Any economist will tell you that whenever there is a shortage—that is, whenever people want to buy more of a product than is available at a given price—the price is too low. Increase the price and consumers will find ways to use less.
But suggest raising prices and consumer advocates will immediately scream that consumers didn’t cause the problem and it’s unfair to force them to pay for it. Such anger is understandable. California’s deregulation scheme was to have capped Californian’s electric rates for years, but as John F. Kennedy famously observed: Life is unfair.
Consumers are going pay in any case. The question is whether they will all pay relatively small amounts in the form of higher rates, or whether arbitrarily selected individuals will pay the damages caused by rolling blackouts or by being laid off as the regional economy sours.
Economic history demonstrates that the overall loss to society will be less if every electricity user faces somewhat higher prices than if other rationing schemes are used.
In recent weeks, utilities have rationed power by rolling blackouts. They generally have not given any notice of when, or where, they’ll pull the plug, citing the danger of attracting looters. They also avoid shutting off hospitals and other critical facilities. This often means that other customers served by the same substation as the hospital also are exempt from shutoffs.
Shutting off the power without warning to traffic signals on busy streets, to factories where electromagnetic cranes hold steel in midair, to bakeries where food is half-baked or to office computer networks where hundreds of files are open, cause much more damage than planned shutdowns.
The cost is high and is scattered arbitrarily among users rather than borne by all.
Raising prices to consumers will reduce consumption at the least overall cost to society. There are no ifs, ands or buts about it. If citizens have great concerns about the fairness of blanket increases in rates, there are ways to address that.
The state could impose such increases in the form of an emergency tax with funds going to the state treasury. Some of the receipts could be rebated to those who can least afford higher bills. The money need not go to the electric companies, but for the good of California society as a whole.
There are other market-oriented actions that can be implemented in the short- and medium-run.
A small minority of heavy users accounts for the bulk of electrical consumption. Many of these already have undergone cutoffs under interruptible service contracts that give lower-cost power in return for the utility’s maintaining the right to shut down service when overloads occur. Such contracts typically limit interruptions to 100 hours per year, and most are reaching that limit.
There is nothing, however, to prevent power distributors or the state from offering such industrial users cash payments for shutting down. Setting up an Internet-based auction for voluntary shutoffs might reduce power usage at a lower cost than what utilities are paying for peak power in the spot market. Large users might negotiate weeklong periods where major machinery is shut off during peak hours but minor service is maintained so workers can clean and do maintenance.
In the medium term, managing peak loads can do a great deal to ease the crunch. If every California family shut off their water heater and refrigerator upon leaving the house in the morning and did not turn them back on till evening, many of the rolling blackouts could be avoided. The technology to do this has existed for years. The problem is installing hundreds of thousands of them in a hurry.
Similarly, there are electric meters than can record quantities used by time of day rather than just cumulative quantity, as in the meters that most of us have. With these more sophisticated meters, it’s possible to charge higher rates for peak periods, when the system is stretched, and lower rates for off-peak periods. With appropriate price differentials, consumers generally find ways to cut back substantially during peak use times.
But the state and utility firms could put on a real blitz. Just as utility companies help each other out across state lines when there is a major ice storm, California utilities could call on crews from other states to come in and help out. Large electrical contracting firms could also be enlisted, both to replace meters and to make the wiring changes within homes to put water heater, refrigeration and heating and cooling systems on utility-controlled switches.
In short, there are no immediate panaceas for California’s power woes. But working with market forces instead of against them can ease the overall pain a great deal.
© 2001 Edward Lotterman
Chanarambie Consulting, Inc.