The long and the short of it: California's electricity crisis

Abstract

Unexpected problems sometimes arise when governments attempt to introduce competition. The problem considered herein is market power and its exercise during the California electricity crisis of 2000-2001. In introducing competition, both transitional and long-run opportunities for firms to exercise market power may arise. California had transitional rules that severely limited participation of its utilities in forward markets and enhanced the market power of new generating entities. The transitional problems could have been avoided, but in the long-run a smaller market power issue should be expected to arise stochastically. This analysis suggests a new long-run institutional policy role: continual regulatory oversight of an industry that could be workably competitive most of the time. This explains why an agency like the Federal Energy Regulatory Commission should have a permanent Office of Market Monitoring. It also suggests why, in some electricity markets, stochastic market power events may arise before capacity gets strained.