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California’s Antitrust “Deregulation” of the Power Industry

The power crisis in California now threatens to shut down Silicon Valley–and if Silicon Valley goes, it could end up shutting down America’s economy.

To save itself — and the rest of us — what should California do? That depends on what the problem is.

Some say the problem is “deregulation,” and the solution is to go back to a government-owned, centrally planned power industry. That’s the line taken by California Gov. Gray Davis, who blames the crisis on “price-gouging” by private companies in the pursuit of “obscene profits.”

But this evades the fact that California’s 1996 “deregulation” bill, AB 1890, imposes a vast array of new regulations on power generators and distributors. These “deregulation” regulations are the real problem — and they carry a lesson that goes far beyond the immediate crisis.

Let’s start with the most obvious question: How do you sell a vast new regulatory scheme under the name of “deregulation”? The answer is that AB 1890 is based on the most dangerous faux-free-market scheme of all: the antitrust laws.

The element that unites antitrust and AB 1890 is a distorted view of what constitutes free-market “competition.” In antitrust theory, “perfect competition” is only achieved when each seller of a good is “equal” — equal in size, knowledge, resources, and everything else. That way, no competitor can gain any “market power” — any influence that gives it an advantage over other competitors.

Of course, this perfect equality between competitors can never be achieved — but what can be done is to restrict every firm so that no one can rise too far above the crowd.

That’s exactly what the antitrust laws do. In the Microsoft antitrust case, for example, the software maker has been attacked for wielding two forms of “market power.” Its first crime is “vertical integration” — which means connecting one part of the company, its operating system, with another part of the company, its web browsing software. Microsoft’s second crime is making “restrictive” contracts — long-term agreements to cooperate with other companies, such as manufacturers of computer hardware.

The folks in Silicon Valley may have thought it was a good idea to rein in the “market power” of their competitor to the North. What they didn’t know was that the same principles were being used to restructure the power industry in California.

AB 1890 was an attempt to impose “perfect competition” for power generators. Because there can’t be any “vertical integration,” the power utilities couldn’t be allowed to integrate their generation business with their distribution business. So they were forced to sell off many of their power plants. Any power they still generated on their own had to be sold on the open market at prevailing prices — with no special discounts for themselves. The result is that power distributors, like Pacific Gas and Electric and Southern California Edison, were made utterly dependent on the prices charged by independent generators. They couldn’t fall back on their own, less-expensive supply. After all, that would give them “market power.”

The second prong of this antitrust scheme was a ban on “restrictive” contracts. AB 1890 outlawed long-term contracts between distributors and suppliers. Such contracts are absolutely vital; they allow both sides to lock in a set price ahead of time, protecting them from sudden price changes. But such contracts favor the suppliers and distributors who make the best deals — which would give them “market power.”

Then there’s the jewel in this crown of thorns. Because antitrust theory says that prices under “perfect competition” will always go down, AB 1890 capped the price power distributors could charge to consumers.

All it takes to make this system fall apart is a shortage in the state’s power supply — which was provided by California’s environmentalists. (That’s the other lesson of this crisis: no nukes means no electricity.) The result: short-term prices spiked — and thanks to California’s antitrust scheme, power distributors had no way to limit their losses. They are still expected to provide continuous power on demand — but they can’t raise their rates, they can’t generate their own power, and they can’t lock in prices more than 24 hours in advance. No wonder they are going bankrupt.

The blackouts in California are a spectacular demonstration of the failure of antitrust-inspired regulations. The solution is not to nationalize the state’s power plants, or to punish out-of-state suppliers. The solution is to expose the fake capitalism offered by antitrust theory, eliminate the “deregulation” regulations, and create a genuine free market for electrical power.