A recent survey¹ of public-utility commissioners in the United States showed that nearly 75 percent intended to halt their deregulation efforts as a result of the ongoing energy debacle in California. Governments around the world are also rethinking their plans to deregulate. A reasonable reaction, given the severity of California’s crisis? Yes, except that California’s energy "deregulation" was anything but. In an Orwellian irony, it actually increased the amount of regulation and enlarged the regulatory complex. Since the passage of legislation that supposedly deregulated California’s energy markets in 1996, the crew of regulatory bodies that oversee the state’s energy markets and the state legislature have imposed an average of one regulatory change every three weeks. And these were no minor alterations; many involved adjustments to retail and wholesale pricing or to environmental requirements. Each one changed the return that power suppliers could expect on an investment in energy generation facilities. Small wonder that no new power plants have been built in the state in the past decade, even as demand was steadily rising.

California’s energy markets now actually have more than a dozen regulatory bodies watching over them, including the California Public Utilities Commission, the California Energy Commission (CEC), and numerous Air Quality Management Districts. No single organization is ultimately in charge and held accountable. For example, the CEC, which oversees the permitting process for energy companies that want to build large power plants in California, follows a very basic roadmap, but many smaller state and local authorities have the ability to drag out or block the process. Local officials, all too easily swayed by activist single-interest citizens’ groups focusing, for example, on the environment, endangered species, or the quality of life, frequently move to block projects. Yet they do not bear responsibility for the consequences of their actions—in this case, a fundamental shortage of supply.

Consider what happened in San Diego last summer. From the time local retail prices started running up—one of the first clear signs of the crisis to come—the utility industry was bombarded by 16 legislative bills, 35 legislative amendments, and a torrent of regulatory changes. The result has been an atmosphere of great uncertainty compounded by the fact that utility commissions cannot bind themselves in the future, so a deal is never really a deal. Another consequence is the fact that obtaining a permit to construct an energy production facility in California takes more than twice as long as it does in many other US states and costs far more. Indeed, the total cost of going through the process in California can be 20 times higher than in Texas (and 50 times higher than in Brazil). Some deregulation.

Finding the right regulatory focus

Through our work for the Bay Area Economic Forum, a partnership of local governments and businesses in San Francisco and Silicon Valley, we have come to believe that an arduous permitting process and greater oversight are not necessary to protect California’s sensitive environment. Other markets have standards that are as strict or stricter, but the companies and regulators within these markets can move more swiftly and with greater certainty. Take Canada, a country that has tougher environmental standards, on the whole, than most parts of the United States but still plays host to natural-resource-based industries, including chemicals, mining, oil and gas, power, and pulp and paper. Although these industries are major contributors to air and water pollution, they have shown that they can adapt to tougher regulation and are willing to make large investments to comply with stringent standards because they know that the rules are not going to change days after they invest millions.

Moreover, energy production and transmission is a regional business and needs to be managed as one, for both practical and economic reasons. Energy—and, more specifically, electric power—cannot be stored and must be transported where and when it is needed. Yet energy resources, such as hydropower, do not always lie close to populated areas or to other places that need the energy.

In addition, the weather, seasonal patterns of energy use, and available power resources vary considerably in different parts of the western United States. Hydroelectric power is abundant in the Pacific Northwest, for example, particularly in spring, when the snow melts. Much of this energy is used farther south to supply summer air-conditioning loads. Then, in the winter, when many rivers are frozen or have greatly reduced flow, power is sent north. Managing the supply of energy on a regional basis thus allows for a more efficient allocation of resources. Regulatory regimes that do not reflect the importance and impact of regional flows will exacerbate supply-and-demand imbalances. This is a particular problem in the United States, where regulatory responsibility is divvied up among federal, state, and even local authorities.

Welcome the Feds?

The fact that no entity is responsible for ensuring a regional reserve of power supply is evidence that California’s current energy regulatory structure has failed. Without question, it must be streamlined and simplified. Consolidating all the regulatory roles under a single body—with a clear and consistent policy direction, energy expertise, and a mandate to coordinate policies throughout the entire West—would simplify problem solving and help to prevent power crises in the future.

Attention should also be paid to the expansion and clarification of the federal government’s jurisdictional authority, a step that would probably require congressional action. In the United States, the Federal Energy Regulatory Commission (FERC) has ultimate authority over the country’s transmission system and wholesale-energy transactions because both may cross state lines. It thus reviews most state regulatory actions; in practice, however, the state government’s jurisdiction over retail rates and desire to satisfy constituents often lead to conflicts with the FERC. The fuzziness of the jurisdictional boundaries allows Californians to blame the Feds for inaction and the Feds to claim that they can do nothing more.

The situation would improve greatly if jurisdictional lines were made clearer and the FERC were explicitly recognized as the sole body regulating wholesale markets (sales between suppliers of power and utilities), no matter where they were. This arrangement would help the FERC foster competitive markets operating on a regional basis—something that is impossible today, with state officials making decisions that suit their own political agendas or their constituents’ needs. Reed Hundt, a McKinsey adviser and former chairman of the US Federal Communications Commission, has observed, "Why should it be that the federal government has elected to exercise regulatory authority over electrons transmitting voice or data, but when these same electrons transmit energy, they [the federal government] choose not to do so? It really makes no sense."

An extension of federal authority might be opposed by many states but makes sense because intraregional transfers are crucial for this commodity, and regulatory flaws in one state, such as California, can easily have adverse effects on an entire region. Although the FERC could not standardize and simplify the permitting process for new plants state by state, it could at least standardize wholesale pricing and transmission rules across the country. In California, state regulation prevented utilities from entering into long-term contracts for power, and prices within the state were sometimes capped, encouraging suppliers to sell outside it for higher prices. These kinds of problems would diminish with consistent FERC regulation.

And so the California mess doesn’t show that deregulation is bad. Instead it teaches the far more sophisticated and important lesson that regulation, once in place, is like an obstinate lawn weed that grows back no matter how often you pull it out. Deregulation has to attack the old regulatory regime at the root. If it doesn’t result in less and simpler regulation, it is no deregulation at all.