(More) Breaking News! California Electricity Prices are Still High!

Is it deregulation or is it just California?

An article last week in the New York Times drew new attention to the ongoing debate about the impacts of electricity deregulation, stating that “some experts blame deregulation” for high electricity prices. It argues that “states that have deregulated all or parts of their electricity systems tend to have higher rates.”   This isn’t the first time this debate has made the news.  A multipart NY Times series explored this topic in 2006-07, and in 2017 a related LA Times article inspired a blog with a very clever title.  

Can high prices be traced to deregulation?  Severin Borenstein and I have looked at this question several times, most extensively in our 2015 paper looking at the first 20 years of the deregulation period. While it’s a difficult question to answer, it turns out that you have to squint pretty hard, and have some selective definitions of deregulation, to say the answer is “yes.”  

What is Electricity Deregulation and Where Was it Implemented?

There are several factors that complicate the question “did deregulation  lower electricity rates?”  

The first complication is that there is no simple definition of “deregulation.”  In 2015 we had to devote half the paper to exploring all the ways you could define deregulation. Utilities in some states, like Virginia, joined regional markets run by Independent System Operators (ISOs) but kept their generation regulated.  Other states, like Michigan, opened up at least some retail service to competition, but changed little else. Still others, like Kansas, have slowly restructured by steadily expanding the output of non-utility generation while never really touching the existing utility structure. Of course, two states usually lead the list when it comes to discussions about electricity deregulation: Texas and California. Texas has gone the farthest down the deregulation path with extensive retail competition and market-based generation compensation.  California had its famously disastrous experience with market-based generation and retail in the early 2000’s and has largely kept the lid on retail competition ever since, with the exception of community choice aggregation.

Severin and I have largely thought the best single measure of “deregulation” centers on the degree to which generation is compensated by market-based prices rather than cost-based regulation. In 2015 we divided the U.S. into deregulated and regulated based upon that metric.  

 A second complication is that retail prices in States that deregulated were already very high. That’s a big part of why they deregulated! So any comparison of retail prices needs to be mindful of different starting points. 

 A third complication, one we emphasized in 2015, is that prices in deregulated markets more closely follow marginal generation costs, which are in turn more volatile than the long-run average costs that form the basis of prices in regulated states.  In the U.S. this means that electricity prices follow natural gas prices, the typical fuel for marginal generators, much more closely in deregulated states.  When gas is expensive, deregulation looks like a bad deal.  When gas is cheap, deregulation looks a lot better.

 

(Source: based on Energy Information Administration state level average retail price, weighted by MWh)

Many of these patterns are illustrated in the above graph, updated from the 2015 paper with data through 2021. In this version I have also adjusted for inflation (something I forgot had ever existed in 2015), so all prices are in 2021 cents/kWh.  You can see that states that eventually deregulated between 1998 and 2002 had higher prices many years before. It also shows that the price gap with regulated states grew during the mid 2000s, during which deregulated states were more impacted by rising natural gas prices. After 2008, the gap narrows when the fracking boom drives gas prices back down. After adjusting for inflation the gap between the regulated and deregulated states, while noisy, has continued to narrow and is now smaller than it was before deregulation began. 

 One last complication in studying electricity prices is that the cost of buying electricity comprises at most half the retail price in most states. The costs of transmission, distribution, which remain regulated everywhere, along with a myriad of other charges, make up half or more of the retail price. The effect of these non-generation elements can be dramatically illustrated by breaking out California from the above graph. 

(Source: based on Energy Information Administration state level average retail price, weighted by MWh)

The California Effect

When we remove California from the “deregulated” group, you can see how dramatically California’s prices have gone in the opposite direction of the other deregulated states. The sharpest climb in California electricity rates has hit in the last five years, complicating any attribution to the deregulation process in 1998.  After removing California, retail prices in all the other deregulated states have risen more slowly than those in the regulated category. The gap between those two groups, in real terms, is now about half of what it was in 1998.

So instead of “some experts blame deregulation,” a better sub-title for last week’s article would probably be “experts should blame California.” This takes us back into the long-running, many-faceted discussion about why California electricity prices are so high, and seem to be diverging more and more from the rest of the U.S. The post-2010 trend is telling here, as it coincides not with the timing of deregulation, but instead with the start of California’s aggressive commitment to reduce carbon emissions and, more recently, the rapid expansion of wildfire related costs.   

This breakdown of PG&E’s rates illustrates the sources of the increases.  All components have risen since 2013, with the largest percent increases hitting the distribution and “other” category.  This latter category includes wildfire costs, which are now approaching half a cent per kWh.  An important fact to consider is that all of these categories are absorbing the cost-shift created from rooftop solar. These costs are estimated to have added 2-3 cents/kWh to prices in PG&E’s territory in 2019, a figure that has surely increased since then as residential rates and solar PV adoption have risen.

So California’s rising prices can be traced to higher energy procurement costs, increases in transmission, and most significantly, distribution costs.  The Times article tries to make a connection between transmission spending and deregulation, arguing that “utilities in deregulated states have financial incentives to build transmission lines.”  Actually utilities in every state have a financial incentive to build transmission lines, it’s called rate-of-return regulation, and it continues in every state in the country.  

I do believe that regions with Independent System Operators have managed to build more high-voltage transmission over the last 20 years, largely because they have proven to be an effective vehicle for coordinating planning and cost recovery across multiple states and utilities.  By far the largest expected driver of transmission expenditures, however, is the need to support renewables expansion.  An expansion on which California sits on the cutting edge.

Several blog posts on this site have noted this decarbonization conundrum. On the one hand, we want more people to shift their transportation and heating uses to electricity because electricity is much cleaner (at least in California).  On the other hand, the process of decarbonizing the grid and the impacts of climate change are contributing to ever-higher electricity prices, creating significant challenges for expansion of electric vehicles and appliances.  

Managing the dual goals of decarbonizing electricity and expanding electrification requires a delicate balance of policies, as well as a power market and utility regulatory process that is more efficient and effective.  This starts with a more rigorous understanding of why electricity prices are where they are.

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Notes: (1)  In the 2015 paper we defined deregulated states as states where 40% or more of their electricity was produced by Independent (e.g. non-utility) Power Producers.  This was 16 states: CA, CT, DE, IL, MA, MD, ME, MT, NH, NJ, NY, OH, PA, RI, TX, and VT.  I exclude DC, HI, and AK from these graphs. The NY Times article states that 35 states were deregulated but does not list which ones, or exactly what definition of deregulated was used.

Since 2012, three additional states, KS, SD, and OK have increased their IPP share above 40% but I did not include them in the deregulated category.  The MacKay and Mercadal paper cited in the article considers 17 states to be deregulated, including Virginia, Michigan, and Oregon, the latter of which is highlighted in The NY Times article as an example of a regulated state.  We did not consider any of these three to be deregulated.

(2) Prices in the comparison graphs are the sales-weighted average for all electricity sales in the two groups of states.

(3) The breakdown of PG&E rates is taken from the January PG&E Bill of a representative customer.  Wholesale energy prices are the annual average cost of energy in the CAISO market, while “procured energy” is the energy component of the PG&E bill.

Keep up with Energy Institute blog posts, research, and events on Twitter @energyathaas. Suggested citation: Bushnell, James. “(More) Breaking News! California Electricity Prices are Still High!” Energy Institute Blog, UC Berkeley, January 17, 2023