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Summary

For nearly 100 years electricity was a regulated industry in the United States. Privately held utility companies exchanged the right to operate under a monopoly for government regulation that capped their guaranteed profits. While the regulated market was a lucrative business for California's utilities, they saw an opportunity to make even larger profits by expanding their business into other areas, such as energy trading and operating plants in other parts of the country.

By the early 1990s, energy rates were 50 percent higher on average in California than elsewhere in the country. Large industrial power consumers such as steelmakers and cement plants were warning that high electricity prices would drive them out of the state. These businesses believed that independent power producers could offer power at much cheaper prices. They began to call for the right to buy their electricity from companies other than San Diego Gas & Electric, Pacific Gas & Electric, and Southern California Edison, the three big private utilities regulated out of San Francisco by the California Public Utilities Commission (CPUC). The utility companies themselves also fought to change the system. Millions of dollars flowed to lobbying efforts and political campaigns pushing deregulation, most of it from the utility companies.

Under deregulation, the utility companies would be forced to sell their power generating plants and act solely as energy providers. As part of the deal, consumer rates would be frozen until the utilities sold their assets and paid off some of the debt incurred when they built large and expensive energy plants, like the Diablo Canyon nuclear power plant. Once the assets were sold, consumer prices could fluctuate at the market price.

Wholesale prices, meaning the price for power that the utilities pay the actual manufacturers of power, would go up and down based on the free market. Essentially, they were trading their regulated, guaranteed prices for the opportunity to expand their businesses and take their chances in the free marketplace. They saw this as an opportunity to increase their profits, based not only on their traditional business activity in California, but also on their expansion efforts into new businesses.

Consumers, especially the large industrial consumers, saw a chance to pay less in energy bills once the market opened up to competition from many energy suppliers. The prevailing belief was that deregulation fosters competition and that competition would be good for everyone.

Declaring the energy regulation system "fragmented, outdated, arcane, and unjustifiably complex," the CPUC voted in December 1995 to open the state's electricity industry to competition. After passing unanimously in both houses of the California legislature, with votes in favor from the most liberal to the most conservative members, the final legislation was signed into law in 1996 by Republican Governor Pete Wilson, making California the first state to deregulate electricity.

At the outset, deregulation in California worked well. Wholesale prices were low, consumer rates were steady and the new structure appeared to be working. But then, in the spring and summer of 2000, a kind of "perfect storm" hit the energy market in California.

A heat wave sent demand soaring, and the combination of a lack of new power plants built over the last 10 years, a drought that cut back the amount of hydroelectric power available to the state, and the inability of outside power generators to supply enough power to the state caused wholesale prices to skyrocket.

As wholesale prices continued to rise, Pacific Gas & Electric and Southern California Edison were forced to pay market prices for electricity -- but they could not pass on the increased costs to consumers because their rates were still frozen. Electricity supplies to the state were tight and, as a result, rolling blackouts hit in January 2001 for two straight days. Huge debt for the utilities piled up, and as a result, Pacific Gas & Electric was forced to file for bankruptcy in April.

Now, five years after the legislation was signed into law, with the very utilities that lobbied for deregulation filing for bankruptcy and consumers paying almost twice what they did before, the current Governor of California, Gray Davis, is fighting for his political life. Deregulation in California backfired, and today the question everyone asks is: What went wrong?

Some would argue that nothing went wrong, that California is experiencing growing pains and eventually deregulation will prove to be the panacea everyone counted on. Others argue that the legislation was rushed through without properly evaluating the growing demand for electricity ushered in with the internet boom and a lack of adequate infrastructure. And, some say the plan implemented in California wasn't really deregulation at all, but a strange hybrid destined to fail. What is left is a new and broken system with cries of price fixing and bankruptcy and charges that a new, more harmful economic scheme has replaced the old government-regulated one.

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