March 28, 2003

Paul Krugman Congratulates Himself

Paul Krugman says "I told you so" about Richard Cheney and the California energy crisis. He's right. He told us so. Richard Cheney and company (including all the reporters who trusted them) were 100% wrong. I don't have an informed view about whether on this issue the Bush Administration was wrong through ignorance or malevolence, but wrong they were.


Delusions of Power March 28, 2003 By PAUL KRUGMAN

They considered themselves tough-minded realists, and regarded doubters as fuzzy-minded whiners. They silenced those who questioned their premises, even though the skeptics included many of the government's own analysts. They were supremely confident ? and yet with shocking speed everything they had said was proved awesomely wrong.

No, I'm not talking about the war; I'm talking about the energy task force that Dick Cheney led back in 2001. Yet there are some disturbing parallels. Right now, pundits are wondering how Mr. Cheney ? who confidently predicted that our soldiers would be "greeted as liberators" ? could have been so mistaken. But a devastating new report on the California energy crisis reminds us that Mr. Cheney has been equally confident, and equally wrong, about other issues.

In spring 2001 the lights were going out all over California. There were blackouts and brownouts, and the price of electricity was soaring. The Cheney task force was convened in the midst of that crisis. It concluded, in brief, that the energy crisis was a long-term problem caused by meddling bureaucrats and pesky environmentalists, who weren't letting big companies do what needed to be done. The solution? Scrap environmental rules, and give the energy industry multibillion-dollar subsidies.

Along the way, Mr. Cheney sneeringly dismissed energy conservation as a mere "sign of personal virtue" and scorned California officials who called for price controls and said the crisis was being exacerbated by market manipulation. To be fair, Mr. Cheney's mocking attitude on that last point was shared by almost everyone in politics and the media ? and yes, I am patting myself on the back for getting it right.

For we now know that everything Mr. Cheney said was wrong.

In fact, the California energy crisis had nothing to do with environmental restrictions, and a lot to do with market manipulation. In 2001 the evidence for manipulation was basically circumstantial. But now we have a new report from the Federal Energy Regulatory Commission, which until now has discounted claims of market manipulation. No more: the new report concludes that market manipulation was pervasive, and offers a mountain of direct evidence, including phone conversations, e-mail and memos. There's no longer any doubt: California's power shortages were largely artificial, created by energy companies to drive up prices and profits.

Oh, and what ended the crisis? Key factors included energy conservation and price controls. Meanwhile, what happened to that long-term shortage of capacity, which required scrapping environmental rules and providing lots of corporate welfare? Within months after the Cheney report's release, stock analysts were downgrading energy companies because of a looming long-term-capacity glut.

In short, Mr. Cheney and his tough-minded realists were blowing smoke: their report described a fantasy world that bore no relation to reality. How did they get it so wrong?

One answer is that Mr. Cheney made sure that his task force included only like-minded men: as far as we can tell, he didn't consult with anyone except energy executives. So the task force was subject to what military types call "incestuous amplification," defined by Jane's Defense Weekly as "a condition in warfare where one only listens to those who are already in lock-step agreement, reinforcing set beliefs and creating a situation ripe for miscalculation."

Another answer is that Mr. Cheney basically drew his advice about how to end the energy crisis from the very companies creating the crisis, for fun and profit. But was he in on the joke?

We may never know what really went on in the energy task force since the Bush administration has gone to extraordinary lengths to keep us from finding out. At first the nonpartisan General Accounting Office, which is supposed to act as an internal watchdog, seemed determined to pursue the matter. But after the midterm election, according to the newsletter The Hill, Congressional Republicans approached the agency's head and threatened to slash his budget unless he backed off.

And therein lies the broader moral. In the last two years Mr. Cheney and other top officials have gotten it wrong again and again ? on energy, on the economy, on the budget. But political muscle has insulated them from any adverse consequences. So they, and the country, don't learn from their mistakes ? and the mistakes keep getting bigger.

undefined Posted by DeLong at March 28, 2003 03:09 PM | TrackBack

Comments

Shrill. Partisan.

Posted by: zizka on March 28, 2003 03:35 PM

But accurate.

Posted by: Chuck Nolan on March 28, 2003 03:41 PM

Another take on the crisis:

http://www.cato.org/new/07-01/07-03-01r.html

In "California's Energy Crisis: What's Going On, Who's to Blame, and What to Do," Cato scholars Jerry Taylor and Peter VanDoren argue that the real cause of the price spike of power in California was not state policy. Instead the cause stems from a "perfect storm" of high regional natural gas prices, a large drop in hydroelectric power from dry weather conditions, and a demand shock due to the unseasonably warm summer of 2000. These factors were then exacerbated by air pollution regulations and retail price controls.

Taylor and VanDoren find that "the 1996 restructuring law has little to do with the run-up in wholesale power prices," although its retail price caps caused the blackouts by preventing utilities from passing on fuel costs to consumers, thereby keeping demand high. "Virtually all the increase in wholesale prices can be explained by increases in production costs and overall scarcity," they write. "Although market manipulation may be present, it is not the fundamental cause of the crisis." Environmentalists aren't either, according to Taylor and VanDoren. "Environmentalists were a relative nonfactor in generator investment decisions in the early to mid-1990s, and they scarcely played any role in blocking new capacity in the months leading up to the crisis," they argue.

Posted by: Mark Bahner on March 28, 2003 04:10 PM

CATO is funded by Koch Oil.

BTW - Koch just got the contract to supply all the oil to the Strategic Petroleum Reserve.

Is this a coincidence? Are there ANY coincidences when it comes to Bush Administration rewarding the right with cash?

Posted by: IssuesGuy on March 28, 2003 04:12 PM

Shrill and partisan? Why don't we care more as to whether it is accurate or not? Krugman's batting average is pretty good so far.

Although it is not really as impressive as it might seem. After all, can anyone point to a prediction that presumed the perfidy and/or incompetence of the Bush administration that turned out to be wrong?

Posted by: Alan on March 28, 2003 04:21 PM

I think zizka's being tongue-in-cheek.

Posted by: JeffC on March 28, 2003 04:23 PM

I wonder if Musil and Jane Galt will *finally* recognize they were wrong and never really understood what happened in the CA energy crisis. Whereas Krugman, who is a real economist, did.

I doubt it, though.

Posted by: GT on March 28, 2003 05:13 PM

If I hadn't said it, others would have said it twelve times by now. You guys all owe me.

Posted by: zizka on March 28, 2003 05:14 PM

Where does Enron fit into this?

Posted by: Fred Boness on March 28, 2003 05:21 PM

Hope you all caught his column earlier:
http://www.nytimes.com/2003/03/21/opinion/21KRUG.html
"Why is this line appealing? It seems more reasonable to blame longstanding problems for our fiscal troubles than to attribute them to just two years of bad policy decisions. Also, many pundits like to sound "balanced," pronouncing a plague on both parties' houses. To accuse the current administration of wrecking the federal budget sounds, well, shrill — and we don't want to sound shrill, do we?"

LOL

Posted by: Stoffel on March 28, 2003 05:30 PM

Shrill, partisan, and INACCURATE. Krugman fails to mention this from the report's "findings at a glance":

" Staff concludes that supply-demand
imbalance, flawed market design and
inconsistent rules made possible significant
market manipulation as delineated in final
investigation report. Without underlying
market dysfunction, attempts to manipulate
the market would not be successful."

Especially that last sentence. But the really stupid trick is blaming all this on Cheney. If one wanted to blame a FEDERAL player, it logically would be the Clinton Administration, since this mostly happened on their watch. "Spring 2001" came only two months into the Bush Administration--and their transition was delayed almost a month thanks to the shenanigans of Al Gore's lawyers.

Posted by: Patrick R. Sullivan on March 28, 2003 05:36 PM

Krugman claims:

"...how Mr. Cheney who confidently predicted that our soldiers would be "greeted as liberators" ? could have been so mistaken...."

But we don't have to go too far,

http://www.j-bradford-delong.net/movable_type/2003_archives/001245.html

to read:

" On camera, the general feeling among the crowd was sorrow at losing Saddam. Off camera, the citizens of Umm Qasr and Basra appeared genuinely exhilarated at the prospect of a brighter future, after Saddam had been removed..."

Posted by: Patrick R. Sullivan on March 28, 2003 05:46 PM

Even if Clinton's people had been asleep at the switch, it doesn't exonerate Cheney's attempt to bury the evidence. These are totally unrelated issues.

Moreover, if prevailing market dynamics allowed for ripe for some "manipulation" (read: fraud) that doesn't excuse the firms. Someone deliberately chose to go down that path.

Posted by: Stephane on March 28, 2003 05:53 PM

I would like to know what definition of "partisan" our conservative friends use because it apparently only applied to liberals and never ever to themselves.

For the rest of us, maybe she should now spend some time re-reading Krugman's columns just to wake up to what's actually ahead of us when we dare to take down the rosy glasses. (I am obviously assuming that knowing what lies ahead is a good thing...)

Posted by: Jean-Philippe Stijns on March 28, 2003 05:53 PM

Re:
"In "California's Energy Crisis: What's Going On, Who's to Blame, and What to Do," Cato scholars Jerry Taylor and Peter VanDoren argue that the real cause of the price spike of power in California was not state policy. Instead the cause stems from a "perfect storm" of high regional natural gas prices, a large drop in hydroelectric power from dry weather conditions, and a demand shock due to the unseasonably warm summer of 2000. These factors were then exacerbated by air pollution regulations and retail price controls."

1- The 10 fold increase in natural gas prices in California was largely the result of witholding of pipeline capacity by El Paso (In this respect, electricity deregulation is not to blame, gas deregulation is),

2- Contrary to the perfect storm theory, there are reasons to believe that without deregulation no black-out at all would have happened : after the imposition of price-caps for wholesale power, avaibility of power plants increased dramatically (witholding of capacity was no longer profitable since prices were capped). The increase in plant availability between April and August 2001 (price caps were imposed in June), has had the same impact as building 15 power plants of 400 MW.

3- Krugman should not be considered as genius for having it right on this issue, it is all the others who were wrong who have been pretty dumb or dishonest, especially the so-called specialists who could not ignore that market power is major problem of electricity markets.

Posted by: fberthol on March 28, 2003 06:09 PM

Krugman, in one of his NY Times columns:

" And that's the real mystery of the California crisis: how could a $30 billion robbery take place in broad daylight? "

The FERC report press release says:

" The Federal Energy Regulatory Commission took action today that it expects will
increase the amount of refunds in connection with California's energy crisis of 2000 and
2001. ....

" The increase, yet to be calculated, is expected to be greater than the $1.8 billion total estimated by a FERC administrative law judge last December".

So, the guy patting himself on the back for being right is only off by about 28 billion dollars.

And, also from the FERC press release:

" Administrative Law Judge Bruce L. Birchman calculated that refunds from
generators and marketers should equal $1.8 billion. However, because suppliers to the
CAISO and PX were still owed $3 billion for unpaid energy, California's utilities still
owed a net $1.2 billion after the refunds period.".

Posted by: Patrick R. Sullivan on March 28, 2003 06:23 PM

" Even if Clinton's people had been asleep at the switch, it doesn't exonerate Cheney's attempt to bury the evidence."

Even Krugman doesn't make such a ridiculous charge.

Posted by: Patrick R. Sullivan on March 28, 2003 06:27 PM

I'm fascinated with the argument that the fact that the quasi-deregulation made the opening for crooks to manipualte the market, so we can't blame the crooks for being crooks?

Following this logic:

"Her outfit was too provocative, so the rape was justified."

"Not only that, the D.A. was perfectly correct in ignoring and dismissing the allegation of rape. After all the accused says he didn't do it."

"The friends of the accused rapists were also perfectly justified in hiding all evidence to help the D.A. in his decision to dismiss the charge."

And so on. Somehow this has something to do with Krugman called it accurately way in advance or not. Amazing logic, but it works just fine for the Bush partisans.

Posted by: Alan on March 28, 2003 06:29 PM

Brad claims not to know whether "the Bush Administration was wrong through ignorance or malevolence." Obviously, it must have been malevolence. There are three possibilities:

1. The Administration may have known at the time that energy firms were playing games to push prices up and chosen to cover it up for their friends.

2. The Administration could have been ignorant about what the real cause of the energy crisis was and they could have been honest about not knowing.

3. However, the Administration could not have known, as it asserted, that the cause of the crisis was due to a lack of California investment in energy capacity (because of environmental concerns or whatever).

At the time, no one knew with any certainty what the real cause was. The Bush administration ran with the third argument but we know now that that argument was incorrect. In forwarding a line of argument as truth that the Administration had in no way tried to confirm and which in fact was wrong, it was acting with considerable malevolence toward the citizens of California and other affected states.

The only honorable path for the Bush Administration would have been to accept that they did not know what was going on and investigate. I don't know whether option 1 or 3 is actually correct. But I do know the Administration was acting with malice.

Posted by: Ross on March 28, 2003 06:35 PM

"CATO is funded by Koch Oil."

That's the mentality of someone who can't debate the issues (i.e., is the Cato Institute's analysis right or wrong?). Question the motives of the analyst, rather than refute the analysis.

"Are there ANY coincidences when it comes to Bush Administration rewarding the right with cash?"

It would be pretty bizarre that the Bush Administration would reward the (libertarian) Cato Institute. For every Bush Adminstration policy you can name that the Cato Institute supports, I'll bet I could name three that the Cato Institute opposes.


Posted by: Mark Bahner on March 28, 2003 07:05 PM

Patrick Sullivan: The naive, helpless, innocent Bush team may have seen the savage Gore lawyers slow their transition by a month, but they were fully prepared!! And they hit the ground running!! What a bunch of guys!!

Posted by: zizka on March 28, 2003 07:09 PM

"1- The 10 fold increase in natural gas prices in California was largely the result of witholding of pipeline capacity by El Paso (In this respect, electricity deregulation is not to blame, gas deregulation is),"

Natural gas prices went up considerably *everywhere*. For instance, it appears prices in Canada went up by a little more than a factor of 3 (from 4 to 13 $/gigajoule):

http://www.energyshop.com/energyshop/pricearticles.cfm

And it would be reasonable to assume that the prices would rise more in the U.S. than in Canada, because the U.S. needed the gas for electrical generation (whereas electrical demand doesn't go up as much in Canada, in the summer).

"2- Contrary to the perfect storm theory, there are reasons to believe that without deregulation no black-out at all would have happened :..."

You misread the analysis. It doesn't say the *blackouts* occurred because of the "perfect storm"...it says the wholesale electrical prices went through the roof because of the "perfect storm." It says the *blackouts* were caused by failing to let electricity suppliers pass on their higher costs to customers.

"....after the imposition of price-caps for wholesale power, avaibility of power plants increased dramatically (witholding of capacity was no longer profitable since prices were capped)."

So they instituted ANOTHER restraint on the free market, to compensate for the problems caused by their ORIGINAL restraint on the free market (i.e. not allowing electrical suppliers to pass on higher costs). And everything was wonderful again. Except for the stockholders of 100-year-old PG&E, which went bankrupt. I guess that proves that governments interfering in the market is a good thing. ;-)

"The increase in plant availability between April and August 2001 (price caps were imposed in June), has had the same impact as building 15 power plants of 400 MW."

You seem to know a lot about the electrical situation in California. Tell us how much the electrical generation capacity went up in California in the 1990s, versus how much the demand went up. And then tell us how much of that increase in electrical capacity was from coal, nuclear, or renewable energy. (I already know the answer to that one...essentially zero.) My impression is that California is a huge net importer of electricity. Perhaps if California had allowed the building of 6000 MW of coal-fired or nuclear plants in the 1990s, there wouldn't have been any problem at all.

"3- Krugman should not be considered as genius for having it right on this issue, it is all the others who were wrong who have been pretty dumb or dishonest, especially the so-called specialists who could not ignore that market power is major problem of electricity markets."

You haven't made that case at all. You have explained how a problem caused by interfering in the markets (i.e., capping retail electrical prices) was "solved" by interfering in the markets again. ("Solved" is in parenthesis, because of the little PG&E bankruptcy problem.)


Posted by: Mark Bahner on March 28, 2003 07:45 PM

I thought the thing about the "perfect storm" was that it was a once-in-a-lifetime event, but Mr. Bahner's "perfect storm" is still travelling. It hit Ontario in May of this year, when the (Conservative) provincial government deregulated power. They were then forced to cap consumer prices after the price went through the roof.

Posted by: Tom Slee on March 28, 2003 08:29 PM

It did indeed.

The problem here in Ontario was that the Pickering nuclear power plant had one of its reactors shut down, and as a result there wasn't enough energy capacity in-province to supply Ontario's needs during a record hot summer.

The result was that we had to buy it on the open market, at a very high cost. We still are, it's just that the government has gone back to covering the cost out of tax revenue rather than on the market (by the way, this was the case before deregulation; Ontario Hydro had racked up a $38 billion dollar debt).

Ontario is back in a worst-case situation, with unregulated wholesale costs but capped consumer costs.

Posted by: Kevin Brennan on March 28, 2003 08:47 PM

Oh well, Patrick can't say I blame you for bewing frustrated. Everything you said turned out to be wrong! Krugman got right before anyone else how the CA crisis happened and, more importantly, how to resolve it. He was right that there was market manipulation and exercise of market power and that the best short term solution were price controls. Which, as you may recall, was rejected by Cheney and FERC (at the beginning) but the FERC finally realized that that was the solution.

If you read him carefully you might learn something next time. If you don't understand something maybe you shouldn't quote it? If after 2 years you still don't get what happened maybe you should avoid commenting? I mean you quote the "market disfunction" as if that somehow contradicts Krugamn in any way, which it doesn't, and that tells me you simply don't understand the issue.

Just a suggestion.

Posted by: GT on March 28, 2003 08:59 PM

I am a bit puzzled about other commentators blaming the Clinton administration for the problems of Californial electicity de-regulation. When I was living in San Diego, the argument that de-regulation would lead to a windfall for consumers was widely spread by those who really wanted this to happen, while most voters were basically ambivalent. Pete Wilson was publicly rooting for this, but I can't say for sure that he was very committed. The Clinton administration had nothing to do with this finally getting passed. Once the new (and flawed) system came on-line,
there were many opportunities for manipulation, and it is silly to believe that nobody would take advantage. As far as the finding of what the cost of the manipulation was, this is also not a crystal clear area. You could argue that the cost would be the minimum cost of the absolutely illegal activities, or that the cost was that plus what the market bid up the price of electricity to given the illegal activity. But the latter cost is tricky to estimate... I think it is fair to assert that the economic cost was between the $1.whatever billion that was officially recognized and the $30+ billion estimate you could get by counting the excess cost over the long term trend line (which I think was the source of the largest cost estimates). In any case, the argument that there is a large and systematic under-capacity in the California electricity market does not seem to be true given the fact that nobody is willing to loan anybody money to build new plants in the region (when last I checked).

Posted by: Jonathan King on March 28, 2003 09:59 PM

We are in the non-linear, non-zero-sum Aquarian Information age now. The fact that Koch Oil funds the Cato Institute has nothing to do with the fact that Cato advocates policies which the Koches would profit from. It's just a harmonic vortex confluence of serendipity and synergy with Neptune in the trine.

"Issues-guy"'s little comment, which relies on the discredited notion of "political interests", is entirely XX century -- if not XIX century.

Posted by: zizka on March 28, 2003 10:17 PM

zikka, you are, well, just great! :)

Posted by: Jean-Philippe Stijns on March 29, 2003 12:16 AM

"undefined"?

Posted by: Jason McCullough on March 29, 2003 06:29 AM

One year we were fine. The next year we have
constant problems. Then after that we are fine
again. Gee, i wonder...

Posted by: blacked out in ca on March 29, 2003 07:32 AM

" 'Even if Clinton's people had been asleep at the switch, it doesn't exonerate Cheney's attempt to bury the evidence.'

Even Krugman doesn't make such a ridiculous charge."

OK then - what was he implying when he notes the "incestuous amplification"?

Posted by: Stephane on March 29, 2003 07:45 AM

Time to move from shrill to shill. CATO may well not be the mouthpiece of Koch Oil but their argument tries mightily to obfuscate the issue in a way that does serve energy interests. Always placing the crux of the blame on the government not allowing consumer prices for electricity rise.

Mark Bahner writes "You (someone else) misread the analysis. It doesn't say the *blackouts* occurred because of the "perfect storm"...it says the wholesale electrical prices went through the roof because of the "perfect storm." It says the *blackouts* were caused by failing to let electricity suppliers pass on their higher costs to customers."

Yes, but the perfect storm would not have happened without the market manipulation. So it wrong to focus on the government "failing to let electricity suppliers pass on their higher costs to customers" as the actual cause of blackouts. The legislation that deregulated the California electricity market fixed retail rates for an initial period of time because that is what California's otherwise passive consumers had negotiated through their elected representatives. The law that resulted is a contract. The law may not have passed without the retail price restriction. Energy firms (suppliers, distributors, and dealers) all agreed to the terms of the contract. And California's representatives agreed to the deal on behalf of voters/consumers.

After the electricity crisis began, then the complaints that the retail electricity price protection California consumers had negotiated was wrong, an awful "government" manipulation of the market. Clearly it wasn't the wisest form of regulation. However, it was a mutually negotiated market restriction. (We are all allowed to try to protect out own interests in contracts, even consumers.) Energy firms agreed to the resulting contract and then tried to get government to renege on the deal consumers had secured. In the crisis, distributors like Edison and PG&E were caught between dealers/suppliers and consumers. But apparently, according to CATO, these distributors should have been bailed out by having government renege on the contracted price controls consumers had negotiated in the law.

In effect, CATO argues that the market should be allowed to function and the contract should not be enforced. They sure seem disappointed that an enforced contract, because of the "rule of law," got in the way of producers screwing consumers. What I can't understand is why any self-respecting "so-called" libertarian organization like CATO would claim that these "oh so weak" corporate interests should be protected by GOVERNMENT from consumers? Unless, of course, CATO is simply a shrill shill.

Posted by: Ross on March 29, 2003 08:27 AM

California's deregulation system was largely designed by the very entities that went on to exploit it - energy companies. They sold it to the votors on the basis that it would lower energy bills long-term and permanently. If anyone thinks the votors would have gone along if the argument was "Lets leave a system that promises you reliable service at a fixed price, that allows you to make economic decisions with fixed data (can I afford to air-condition the house? the kids need to know they can wear a sweatshirt and a hooded parka in July or turn up the air-conditioner - not both) and go to a market based-system, that might result in higher, lower, or rapidly varying rates for the ordinary consumer, and even leave you without electricity if a deep-pocketed customer in another state makes a better bid, but taken as a whole would mean better allocation of resources, (and no 'allocation of resources' does not mean diverting your dollars to my bottom line)" that they would have gone along? Please. It reminds me of the unlimited free-traders who argue free trade always grows the overall pie, but fail to recognize that doesn't guarantee that the vast majority may end up with a thinner slice.

Posted by: Bruce Webb on March 29, 2003 08:35 AM

I note that GT still seems not to have bothered to acquaint himself with the rules a participant in California's electricity markets had to obey. Even after I provided him with the url. I say that because he still can't answer the question I've asked him elsewhere, "How could a participant in this market avoid gaming or manipulating it?".

Again, GT cannot wish this away:

" Staff concludes that supply-demand
imbalance, flawed market design and
inconsistent rules made possible significant
market manipulation as delineated in final
investigation report. Without underlying
market dysfunction, attempts to manipulate
the market would not be successful."

And also, AGAIN, this scheme was okayed by the FERC in 1996 when Dick Cheney was a private citizen. Price controls, both wholesale and retail, were part of the scheme, and thus part of the problem. So, when Cheney did inherit the problem, he had a good point about the "temporary" price controls recommended to solve the problem.

For those of you here who have not had the opportunities GT has to inform himself, it was not possible for energy suppliers to simply offer to sell electricity at a set price. The details are in this Quan-Michaels paper:

http://www.electricity-online.com/pdf/99.pdf

Posted by: Patrick R. Sullivan on March 29, 2003 10:07 AM

“So they instituted ANOTHER restraint on the free market, to compensate for the problems caused by their ORIGINAL restraint on the free market (i.e. not allowing electrical suppliers to pass on higher costs). And everything was wonderful again.”
"You have explained how a problem caused by interfering in the markets (i.e., capping retail electrical prices) was "solved" by interfering in the markets again. "


1- There is no such thing as a "natural" electricity market - the whole process of electricity deregulation involves creating artificial rules to separate generation and supply from the management of the grid. In the real world they are part of the same technical system. Regulatory interference is necessarily a component of deregulation, the word deregulation itself being a misnomer.

2- Capping retail prices whatever the cost of wholesale power for distributor was obviously a mistake but I am not sure that raising retail prices would have been enough to avoid the crisis : The main technical constraint on an electricity grid is to constantly balance load and generation. That’s why during the same day, the price of wholesale power can vary in a factor of 1 to 100. So raising retail tariff (which apply to the total amount of power you have used during a month) in order to diminish demand is a pretty inefficient way to deal with temporary shortages of generation capacity which usually happen for a few minutes a day during weekdays.

3 - Let's not forget that the shortages in California were the result of voluntary withholding of capacity by generators and that it was more logical to oblige generators to use their plants than to double or treble prices for consumers.

Posted by: fberthol on March 29, 2003 11:48 AM

back in the day Krugman argued that the crisis resulted from market manipulation. Dick Cheney said it was a supply problem. Krugman was right. The rest is just distraction.

Posted by: Atrios on March 29, 2003 11:53 AM

“You seem to know a lot about the electrical situation in California. Tell us how much the electrical generation capacity went up in California in the 1990s, versus how much the demand went up. And then tell us how much of that increase in electrical capacity was from coal, nuclear, or renewable energy. (I already know the answer to that one...essentially zero.) My impression is that California is a huge net importer of electricity. Perhaps if California had allowed the building of 6000 MW of coal-fired or nuclear plants in the 1990s, there wouldn't have been any problem at all.”

That’s right. Hardly any new generation capacity was built after the deregulation was decided in 1994. But this is not primarily because of environmental regulation as you seem to suggest, but because investors did not think it would be profitable.


“Natural gas prices went up considerably *everywhere*. For instance, it appears prices in Canada went up by a little more than a factor of 3 (from 4 to 13 $/gigajoule): http://www.energyshop.com/energyshop/pricearticles.cfm
And it would be reasonable to assume that the prices would rise more in the U.S. than in Canada, because the U.S. needed the gas for electrical generation (whereas electrical demand doesn't go up as much in Canada, in the summer).”

Natural gas prices in California should more or less be equal to the cost of natural gas in Canada plus the cost of transport. When prices trebled in Canada, they were multiplied by ten in California. The reason why prices were so much higher in California was because a shortage of transport capacity on pipe lines. An administrative judge ruled in September that El Paso had withheld capacity in order to raise prices. (El Paso has appealed the ruling).

Posted by: fberthol on March 29, 2003 12:00 PM

I remember in 2001 how intensely partisan and political the California energy crisis was. It seems the partisan sniping continues. If we forget the politics for a moment and ask the economics 101 question, this debate over free markets versus price controls comes down to the simple question: was this market characterized by competitive behavior or the behavior of an oligopoly? If the market were competitive, price controls would have made the situation worse. If we had an oligopoly restricting production to drive up prices, price controls would actually increase the relevant marginal revenue schedules leading to more production. It would seem to me that the competitive model did not fit this situation and the oligopoly model did,

Posted by: Hal McClure on March 29, 2003 01:09 PM

I remember in 2001 how intensely partisan and political the California energy crisis was. It seems the partisan sniping continues. If we forget the politics for a moment and ask the economics 101 question, this debate over free markets versus price controls comes down to the simple question: was this market characterized by competitive behavior or the behavior of an oligopoly? If the market were competitive, price controls would have made the situation worse. If we had an oligopoly restricting production to drive up prices, price controls would actually increase the relevant marginal revenue schedules leading to more production. It would seem to me that the competitive model did not fit this situation and the oligopoly model did.

Posted by: Hal McClure on March 29, 2003 01:09 PM

Again folks there is always Richard Perle -

Shrill shrill shrill.

Posted by: bill on March 29, 2003 01:51 PM

PK is correct. The Cheney energy policy is the dead wrong prescription for the current situation. I like the term incestuous amplification. Maybe that is how Bush got most of his advisors.

BTW Bush had it wrong as well. I remember his standoff with Davis.

Some people claim that the CA energy crisis was the vindictive Bush punishing the state of CA for spurning him in the election. For whatever reason, the hit CA took was deleterious to the economy and is one of the reasons the economy is not good today- high energy prices.

Posted by: bakho on March 29, 2003 08:47 PM

"That's the mentality of someone who can't debate the issues (i.e., is the Cato Institute's analysis right or wrong?). Question the motives of the analyst, rather than refute the analysis."

Ok, how about this? The Cato analysis was made in July 2001, long before evidence of the massive price-fixing became public. Which is what Krugman says in his newest piece. And, furthermore, it's to be thanked that Enron went tits-up and revealed some of this, in part because of the lengths to which Cheney went in order to keep the records of his 'taskforce' secret.

It should be Mark Can't-Hit-A-Barn-Door, shouldn't it?

Posted by: nick sweeney on March 29, 2003 09:12 PM

Most of the arguments put forward seem to be along the lines of “____ is more guilty therefore ____ is not at fault.” It’s an expedient but inaccurate way of assigning black and white hats. From my perspective, there are plenty of black hats to go around and ANY claims to a white hat should be viewed with healthy skepticism.

Disclosure: I used to be a researcher for the electric power industry although I left well before the crisis occurred. My focus was primarily on transmission - as opposed to distribution or generation. The capacity issues that led up to the energy crisis were well known, both inside and outside of the industry. If these issues did not exist, there would not have been an energy crisis in California. I feel comfortable saying this now largely because I felt comfortable saying it more than a year before the crisis occurred. In fact, I remember being, well, shrill, on this subject months before it happened.

The electricity market has some interesting quirks: In the short term, BOTH supply and demand for electricity are fairly inelastic. Furthermore, generation (supply) was concentrated in the hands of a few large companies. This led to the situation where an individual company (if it was large enough) had pricing power without having to collude with the others: When a plant was shut off for maintenance, the ISO would be forced to buy the shortfall on the spot market. If the plant were large enough, the prices in the spot market would move due to the relatively inelastic supply. This was enough of an incentive to move maintenance or emissions-cap related shutdowns to more convenient (profitable) times.

Prior to the crisis, I did not believe that companies would actively try to game the system. Mostly for the simple reason that if such a thing occurred, FERC would step in and penalize the offenders, eliminating any ill-gotten gains. In retrospect, these assumptions were a bit naïve:

1) Untangling the effects of one, or at most a few, black hats. It would be easy to find them, determine the market distortion and come up with an appropriate penalty.
2) FERC would do its job.

To review: There were real issues with both the generation and transmission. If Bonneville and the other Pacific NW hydro producers weren’t limited by drought conditions then the ISO could have made up for any attempted manipulation with a phone call (only a slight exaggeration). Once they were out of the picture, California faced a very tight market where a few producers had pricing power without having to resort to collusion. The inelastic markets also empowered tactics that normally would have no effect on the market. Tactics that would not be immediately suspect on a cursory examination. Even without manipulation, these fundamental issues would have caused some price spikes or surges. However, this also provided a convenient alibi for the ethically challenged.

There are plenty of black hats to go around for setting the stage for the crisis. I disagree with Krugman’s belief that the crisis was “largely artificial”. With that said, the Cato report widely misses the mark as well. I am particularly amused by the contortions that they go through to ‘prove’ that long-term contracts had no effect – especially given that conservation measures and long-term contracts ultimately brought the crisis to an end. Long-term contracts had an effect precisely because the market was not functioning properly.

The substance of the article focuses on Cheney’s assessment of, and actions taken during, the crisis. There is very little to argue about but there are a few additional points to be made.

FERC has a great deal of latitude to step in when it feels that the markets are not working properly. It does not need to wait for irrefutable evidence to take action. FERC clearly should have gotten involved earlier than it did. Cheney’s comments during and after the crisis were a clear signal to FERC that he and the administration felt that no intervention or investigation was needed. They were also a clear signal to those manipulating the markets that FERC was not going to take away the punch bowl.

Second, going back to my earlier comment that this was NO surprise to a number of people in industry. I find it extremely difficult to believe that this did not come out when he gathered his energy experts together. I could see why Cheney wouldn’t want ‘we knew it was coming but rather than address the problem we decided to profit from it’ to get out to the public.

In short he clearly signaled to the regulators to back off while the market was ripe for manipulation. He glossed over the fact that the crisis was seen far enough in advance that some action could have been taken. These are not the actions of someone who is trying to contain the current crisis and prevent new ones. Yes, Krugman went overboard on some points but the essence of his critique is right on. Cheney clearly wears a black hat on this one. At the very best, he is incompetent.

Then again, maybe he’s decided to spice up the V.P,’s job with some performance art. It would certainly explain his belittling comment that conservation was sign of personal virtue.

P.S. Looking over my post I see that I have patted myself on the back about the crisis and admitted to being shrill so maybe I am not in the best position to judge Krugman ;-)

P.P.S. Sorry about the empowered pun, I couldn’t resist.

Posted by: chris_a on March 29, 2003 09:52 PM

I think part of the problem could just be there were free-market zealots without any practical experience of the market - that is, of trading. A trader would know that it is fairly easy to manipulate most markets - no matter how well constructed, and apparently California wasn't even that - if you're big enough.

Posted by: Andrew Boucher on March 30, 2003 06:57 AM

This is the best possible response to Patrick:

"back in the day Krugman argued that the crisis resulted from market manipulation. Dick Cheney said it was a supply problem. Krugman was right. The rest is just distraction."

Sums it better than I ever did.

Thanks Atrios.

Patrick, you still don't get it. The FERC does as do all the experts. But you don't.


Posted by: GT on March 30, 2003 07:27 AM

Actually it was PK who was personally responsible for the California energy crisis and caused subsequent market manipulation and price fixing by the likes of dear Enron. PK was responsible for the tax cut that barely nudged the economy and turned a needed budget surplus to what will be a most severe deficit. PK is also responsible for designing the new administration tax cut plan set to be even more damaging to the budget.

PK did it. Except, that we are in the midst of the effects of policies of compassionate conservatism and PK is decidedly not compassionate.

Posted by: bill on March 30, 2003 11:11 AM

i guess things get pretty messy here in bloglandia. there seem to be a few issues being discussed in tandem that are really severable:

1. what actually happened and why?

2. what could have been done before the crisis? or, what is the best arrangement for power supply?

3. once the crisis started, what should have been done? and who was in the position to do it?

4. who is morally blamworthy?

It is easy to excuse someone like Cheney and the FERC crew by looking at faults inherient in the system from its design. But this confuses the issues. The electricity market design was poor. There was no competitive market. Price caps were the best solution at a time where the market was not functioning (or at least better than doing nothing- opportuinity cost after all.) Cheney and FERC were wrong about what was happening during the crisis and about what needed to be done to end the crisis. This is true no matter who is to blame for the crisis' creation.

But for Cheney's behavior the crisis may have been a smaller event. But for "deregulation" the cirsis wouldn't have occured. But for immoral corporations the crisis wouldn't have occured. There are numerous "but for" causes on which everything can be blamed, but noting any one cause does not exclude the existance of others.

I might say Chris_a did a fine job making these distinctions.


Posted by: markmeyer on March 30, 2003 12:40 PM

markmeyer,

I think the general consensus of all the experts (see Frank Wolak among others) is that a flawed deregulation together with a *temporary* constrained supply, gave many energy-related companies, including producers and traders, the opportunity to a) exercise market power and b) manipulate the market. The experts can debate how much was contributed by each of these two.

What Krugman realized before almost anyone else in the mainstream media was a) what was happening and b) what should be done about it.

Krugman correctly realized that the best short-term solution was to impose price controls something the WH and the FERC resisted but finally implemented. He noted the price controls would be temporary and would fix the unique conditions and incentives that created the market manipulation and allowed the exercise
of market power.

Posters and bloggers, like our own Patrick Sullivan, seem to think that when the FERC and others say that the flawed market deregulation and the supply constrains were among the leading causes of the crisis (which they were) that it somehow contradicts what Krugman said (which it doesn't). Krugman readily accepted that there was a unique set of circumstances that led to the crisis. But what Krugamn noted, basing it on Frank Wolak's work, is that the government could provide a solution to the crisis and, for quite a while, they didn't.

Cheney and the WH kept saying it was just the free market working and the government should not intervene. Krugman realized it was not a free market working normally but rather that a flawed market and some special circumstances led to a 'perfect storm' that the government could and should address.

Cheney and the WH were wrong and Krugman was right.

btw, if you care to read the more technical aspect I recommend this.

Posted by: GT on March 30, 2003 03:56 PM

Here's the link:

http://www.wws.princeton.edu/~pkrugman/wolak.html

Posted by: GT on March 30, 2003 04:05 PM

Indeed, it seems that Bahner and Sullivan's response to an actual perfect storm would be to leave the windows open and the lawn furniture sitting out. And to insist that the weatherman be fired for shrilly warning people that one mother of a storm was going to wreak some havoc. Oh, and to excuse looters for stealing from decimated shops - after all, a post-storm shopping district is ripe for theft - er, market manipulation.

What a couple of jokers. And, indeed, thanks to Atrios for cutting through a lot of crap.

Posted by: JRoth on March 30, 2003 09:18 PM

Isn't the lesson rather simple? If you deregulate
markets where firms have the opportunity to
exploit their market power, then they will figure
out ways to cut production and raise price! You
don't get "good" results. Forcing the price taker
to be a price setter can achieve pro- society
outcomes. Interested readers can check out John
Sutton's book which I think is called Marshall's
Tendencies.

Posted by: Malcolm on March 31, 2003 09:55 AM

Oops!
Just in case anyone is still reading this, I meant
to say that forcing the price setter to be a price
taker can yield good results. It's like the argument for why unions can raise wages and employment in monopsonistic settings by making the
monopsonist act like a price taker. Sometimes a
little simple eonomics goes along way.

Posted by: Malcolm on March 31, 2003 10:02 AM

OK, pardon me, but isn't this bordering on tautology? --- "Without underlying market dysfunction, attempts to manipulate the market would not be successful." Isn't it pretty close to definitional that manipulating a perfect market is impossible? Without some level of dysfunction, manipulation is impossible? Unless I'm wrong about that, all our trading laws assume some level of dysfunction in some market. The laws are meant to be binding on market participants, nonetheless.

Posted by: K Harris on March 31, 2003 10:50 AM

Paul Krugman is bravely, very bravely, describing a radical economic agenda by a supposedly conservative administration. This agenda is directed against the interests of middle class Americans at every turn. If you think ever more tax cuts for the rich are the answer to prosperity for us all, fine. If not, I suggest we pay attention to Paul Krugman.

Funny, thing, I just got a form letter from Citigroup asking me to solicit the Senator or Representative of choice to end taxes on stock dividends. Heck no.

Posted by: jd on March 31, 2003 11:22 AM

GT,

of course. i thought that is what i said (or rather, i didn't write anything that contradicted what you wrote, and i do agree with you)

Posted by: markmeyer on March 31, 2003 07:54 PM
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