Not This August


The New York Times has discovered basic economics. Sort of. In a front-page story the other day, the paper noted that gasoline and natural gas prices have dropped substantially in recent months. "In both cases," the Times reported, "high prices spurred fresh production."

The thrust of the story was that the Bush administration, having pushed for new energy policies based partly on alarmingly high fuel prices, looks pretty silly now that the alleged crisis seems to have passed. "America in the year 2001 faces the most serious energy shortage since the oil embargoes of the 1970s," the White House said last spring, when Energy Secretary Spencer Abraham was predicting that gasoline would cost $3 a gallon this summer.

Instead, gasoline prices have dropped from an average of more than $1.70 a gallon in mid-May to less than $1.50. Natural gas prices have fallen by 70 percent since December.

The Times explained these trends as the market's natural response to high prices: When prices go up, producers make more. Hence gasoline and natural gas supplies rose, and prices fell, "without federal intervention" (this seems to be Times-speak for opening up new areas to exploration and drilling).

But the rules that operate in the national markets for gasoline and natural gas somehow do not apply in California. There, according to the Times, "federal price controls" are largely responsible for a big decline in electricity prices, which hit record levels last winter.

The Bush administration apparently was wrong when it "steadfastly opposed any federal price controls for wholesale electricity markets in California, arguing that such interference would only distort the market." In the rest of America, the Times seemed to be saying, the key to reducing energy prices is allowing them to rise, thereby triggering increased supply. In California, by contrast, the key is to stop prices from rising.

The Times is right that something screwy is going on in California, but it's not because the laws of supply and demand have been suspended. It's because politicians have been trying to ignore them.

Wholesale electricity prices began shooting up in California last year mainly because of an unusually warm summer, an increase in natural gas prices, and a dry spell that reduced supplies of hydroelectric power. Electric utilities were driven to the verge of bankruptcy because the state would not allow them to pass their increased costs on to consumers.

The retail price freeze also meant that businesses and households had no incentive to cut back on their electricity use. Blackouts were the predictable result.

"Wholesale prices signaled that electricity was increasingly scarce," note Jerry Taylor and Peter VanDoren in a recent Cato Institute paper, "but retail prices told consumers that nothing had changed. Accordingly, consumers demanded more electricity than was available."

Gov. Gray Davis understood what was going on. "If I wanted to raise prices," he said in January, "I could solve this problem in 20 minutes."

But that was politically unacceptable. So instead of making Californians pay higher prices as consumers, the state is buying electricity and making them pick up the tab as taxpayers. "The problem with paying bills that way," note Taylor and VanDoren, "is that the high prices will not affect electricity demand and thus will not play their intended role in allocating scarce goods, as they would if they were simply passed on through the market."

The blackouts expected this summer have not materialized so far, partly because the weather has been unusually cool, reducing the electricity consumed by air conditioning. Lower demand, together with falling natural gas prices and new power plants, has helped bring wholesale electricity prices down. The state says it's paying an average of $133 per megawatt-hour, compared to $243 in May.

"We're not out of the woods yet," warns a spokesman for California's Department of Water Resources, the agency charged with buying electricity. "August could be raging hot."

If so, it could mean more than a little discomfort. High temperatures could disrupt millions of lives and hamper the world's 10th largest economy. How many degrees separate California from a Third World country where you can't count on power to keep your milk cold and your home lit?

California's government is not responsible for the weather. But it is responsible for a situation in which so much hinges on how hot August will be.