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Not since the energy crisis of the 1970's has there been so dramatic a demonstration of what lurks behind attempts to control the price of energy as in the current debacle taking place in California. Blackouts are rolling through the northern part of the state as the rest of the nation looks on in amazement and silent worry. Could this be happening here?
As is common in such instances, however, the lessons are obscured. Commentators and onlookers perceive the California disaster as a consequence of deregulation rather than of regulation.
However, it is not due to problems of deregulation per se; but of deregulating in the wrong way; that is, by refusing to sufficiently deregulate.
The proximate cause of California's problems is a failure to expand capacity to meet demand. Of this, there is no doubt. Deregulation has provided greater flexibility to California’s system by enabling it to draw on power from multiple sources – this did not cause the power outages. The problem is that California’s current power generation is insufficient for a state with such an enormous appetite for electrical power.
The underlying question is why has California's power industry failed to anticipate this need and provide for it? To answer this question, one must look at the divergence of the regulatory structure in California in addressing wholesale and retail power distribution.
Deregulation has been more aggressively pushed for at the wholesale level. To understand this dichotomy, one must remember some basic economics. There are two ways for setting the price for any commodity (electricity included): (1) a competitive marketplace in which providers drop their prices in competition for buyers, who bid prices up to satisfy their demand; (2) a regulated market in which a particular entity or entities fix prices.
In the first case, the price is determined by economic factors balancing supply against demand and distributing the commodity among all bidders based on the relative value of their proposed uses to the economy as a whole. In the second case, economic efficiency is sacrificed to the particular needs of the most politically powerful who are able to influence the system to set prices either artificially high or artificially low as may serve their interests.
Attempting to avoid the same mistakes, the Public Utilities Commission of Ohio (PUCO) developed a list of the factors that contributed to California's regulatory problems. A review of this list suggests how California’s regulatory structure impeded the natural tendency of free markets to meet demand in an efficient manner.
First, complex institutional requirements in California make it difficult for buyers and sellers to negotiate direct contracts that would facilitate a determination of longer-term requirements. While investor-owned utilities buy power on a spot market, the prices they are paid by their retail customers are regulated. There is a disincentive against their meeting demand when it is high because they are guaranteed a loss – they are paying high costs for electricity that they must resell at a low price. Furthermore, there were regulatory obstacles to the implementation of price risk management tools that might have allowed them to avoid unexpected changes in the spot market.
I would suggest that we should not ignore the possibility that the regulation of retail energy prices in California might have aggravated its unexpected burst in demand. Economic actors use prices as a tool for rational calculation of their plans for the future. Relying on regulated prices, though, is a dangerous game. Told that a regulatory agency assures such-and-such a price, one may increase the planned exploitation of the regulated commodity. But such an increase in usage, which would drive the price upward and encourage an increased expansion of supply in a free market, only leads to shortages in a regulated market.
The PUCO report unambiguously concluded, "Price caps in California markets limited the incentive for generators to locate new plants." Furthermore, "The permitting process for new generation is long and costly and has caused delays in siting new generation facilities. Almost 17,000 megawatts of new supply is planned but has not been built."
It is appropriate for Muslims to understand the details of what is happening in California for a number of reasons. An obvious one is that, as in the case of the oil crisis of the 1970's, one can expect to hear – indeed, we have already heard – accusations that it is "greedy Muslim oil producers" who are responsible for California's problems.
A subtler element is that we Muslims living in America are a part of the communities that are wrestling with the issue of utility deregulation. It is in our interests as consumers to understand the issue, and to educate our neighbors that deregulation can help us to get reliable electricity at moderate costs provided that we do not allow the residual regulatory infrastructure to impair the market mechanisms that insure efficient production and rational distribution because of the greed of the politically powerful or the myth that regulators can better determine prices than the market forces created by Allah (SWT).
We would be well served to remember the Hadith of Prophet Muhammad (SAW) when some of his companions asked him to fix prices that had soared. He declined with the profound response, "Allah grants plenty or shortage; He is the sustainer and real price maker (musa`ir). I wish to go to Him having done no injustice to anyone – in blood or in property" (Islahi, 1988).
Just laws lead to prosperity and unjust laws to shortages
Sources:
Abdul Azim Islahi, 1988. Economic Concepts of Ibn Taymiyah. (Bradford-on-Aon: Islamic Foundation), p. 94.
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