Among the many lessons to be learned from California’s energy debacle is that restructuring has a better chance of succeeding when more of the power in a market is free to respond to price signals, according to a recent report issued by the Congressional Budget Office (CBO) examining the causes and lessons of California’s electricity crisis.

One of the key conclusions reached by CBO is that if markets rather than regulation are to determine the price of power, prices must be allowed to respond when unanticipated disturbances occur, such as last year’s very hot summer in the West. The supply and demand sides of the market together must be sufficiently robust to dampen such swings, the CBO said.

“As California attempted to restructure, regulatory constraints limited the flow of power to the state’s wholesale market from municipal utilities in California, from utilities in other states and from federal power agencies,” the report states.

The report went on to say that utilities should be free to manage the risks of adverse price movements in a competitive environment by entering into long-term contracts. “One lesson not to take from the California experience relates to the size of the reserve margin: building enough generating capacity to meet the demand for electricity under any scenario may not be cost-effective.”

The CBO said that if restructuring is to allow supply to be more responsive to prices by moving power within the market, it must also address regulatory barriers to the construction and operation of transmission systems. A restructured market that works well will probably feature an immediate increase in the demand for transmission services, as communities increasingly acquire power from new sources in new locations not envisioned by the original designers of the transmission grid. The regionwide costs of supplying electricity can drop if low-cost generators from some states in the region are able to provide more power than before, the report added.

The CBO also said that making sure that transmission capacity does not limit the responsiveness of supply may require changing how transmission services are regulated and priced and how new lines are approved. By way of example, the report pointed out that some analysts have called for charging different, market-sensitive rates for transmission in different parts of the overall system to provide greater incentives for construction to remove bottlenecks.

In addition, the CBO said that restructuring is also more likely to be successful if utilities are allowed to use standard risk-management tools. Allowing utilities to enter into long-term contracts with suppliers at fixed prices and hedge through the futures market would help protect them from the financial difficulties that have plagued California’s power distributors, the report added.

Having a large reserve of generating capacity could also ease the transition from a regulated to a competitive market structure. “Indeed, if California had implemented its plan in the early 1990s, when the state’s utilities still possessed more capacity than they needed, the market could have better handled the stresses that arose in the summer of 2000,” the CBO noted. That improved response could in turn have masked some of the faults of the restructuring plan.

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