The deregulation of the California energy market was supported by a unanimous vote from both parties in the California legislature and signed into law by then-Governor Pete Wilson in 1996. Then-state senator Steve Peace was the chair of the energy committee and the author of the bill that caused deregulation, and is often credited as "the father of deregulation". Wilson admitted publicly that defects in the deregulation system would need fixing by "the next governor".
Part of California's deregulation process, which was promoted as a means of increasing competition, involved the partial divestiture in March 1998 of electricity generation stations by the incumbent utilities, who were still responsible for electricity distribution and were competing with independents in the retail market. A total of 40% of installed capacity - 20,164 megawatts - was sold to what were called "independent power producers." These included Mirant, Reliant, Williams, Dynegy, and AES.
Then, in 2000, wholesale prices were deregulated, but retail prices were regulated for the incumbents as part of a deal with the regulator, allowing the incumbent utilities to recover the cost of assets that would be stranded as a result of greater competition, based on the expectation that "frozen" would remain higher than wholesale prices. This assumption remained true from April 1998 through May 2000.
When electricity wholesale prices exceeded retail prices, end user demand was unaffected, but the incumbent utility companies still had to purchase power, albeit at a loss. This allowed independent producers to manipulate prices in the electricity market by withholding electricity generation, arbitrating the price between internal generation and imported (interstate) power, and causing artificial transmission constraints. This was a procedure referred to as "gaming the market." In economic terms, the incumbents who were still subject to retail price caps were faced with inelastic demand (see also: Demand response). They were unable to pass the higher prices on to consumers without approval from the public utilities commission. The affected incumbents were Southern California Edison (SCE) and Pacific Gas & Electric (PG&E). Pro-privatization advocates insist the cause of the problem was that the regulator still held too much control over the market, and true market processes were stymied — whereas opponents of deregulation simply assert that the fully regulated system had worked perfectly well for 40 years, and that deregulation created an opportunity for unscrupulous speculators to wreck a viable system.
Prior to deregulation, the electricity market in California was largely in private hands, though subject to intense regulation. The main players were PG&E, SCE, and San Diego Gas and Electric (SDG&E). Those utility companies were forced to sell their generators to non-regulated private companies such as Enron and Reliant. Ownership of certain power stations was transferred in order to increase competition in the wholesale market. In return for divesting some of their power stations the major utilities negotiated a deal to protect them from their assets being stranded. Part of this deal involved price caps for retail customers.
While the selling of power plants to private companies was labeled "deregulation", in fact Steve Peace and the California legislature expected that there would be regulation from the FERC which would prevent manipulation. The FERC's job, in theory, is to regulate and enforce Federal law which would prevent market manipulation and price manipulation of energy markets. When called upon to regulate the out-of-state privateers which were clearly manipulating the California energy market, the FERC, whose chairman was appointed by President Bush, hardly reacted at all and in fact did not take serious action against Enron, Reliant, or any other privateers. FERC's resources are in fact quite spare in comparison to their entrusted task of policing the energy market.
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