President's Message: Blackouts in California Shouldn't Cause Panic Here

July 01, 2001
By  William Poole

That time of the year is here—when it's scary to even think about your air conditioner stopping. But in California, not only are the air conditioners falling silent, but the assembly lines, the smelters, the copiers–anything powered by electricity. Five months after the first blackout, the power crisis has shut down some businesses, scared away others, driven a large utility into bankruptcy and jacked up costs for everyone.

Could the same happen here? Unlikely, say the experts. Still, energy crises played a significant role in most recessions since World War II. And whatever happens in California can ripple across the rest of the country, given the clout of the state's economy.

But the spread of the California crisis is not inevitable. Only because a string of bad decisions and bad luck converged at once–a sort of perfect storm—did this occur. As everybody knows by now, California's style of deregulation—with retail prices capped but wholesale prices not—played a big role in the meltdown. But the Northwest's drought hurt the state, too, because of its reliance on hydro power. The soaring price of natural gas—another major source of fuel for electricity generation there—was also a factor.

Here, in the Eighth Federal Reserve District, no such mix of problems exists, at least to that degree. Only one state in the District—Illinois—has deregulated, and its plan seems to have been successful. Illinois utilities were not forced to sell off their generating capacity, nor were they required to buy power on the spot market only. Illinois also offered incentives to add generating capacity, such as streamlined permitting and faster depreciation. Consequently, power companies are planning enough construction to double Illinois' generating capacity. Other District states are also building plants. In contrast, California hasn't added significant capacity in a decade.

Power providers here also have an advantage because they can heavily use some of the cheaper types of fuel that Californians dislike. Nuclear power is used by some utilities here to generate one-third of their electricity. At others, coal is still king.

One problem shared with California is "traffic jams" on transmission lines. Five years ago, the government ordered utilities to share their lines so that electricity could be traded across the country. This is both a "positive" and "negative" in the center of the country. On the one hand, our utilities have plenty of neighbors to trade with—one company is connected to 28 sources. On the other hand, all these neighbors—and other power companies across the country—need lines in the middle of the country to move their electricity.

This is just one of many problems to be worked out as the inevitable deregulation sweeps the country. In the meantime, California's woes are proving to be an economic opportunity for those in the District with power to spare. Development officials are wooing California businesses to relocate to where the supply can meet the demand.

Views expressed in Regional Economist are not necessarily those of the St. Louis Fed or Federal Reserve System.

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