Center for the Study of Energy Markets

This paper describes the lessons that should be learned about electricity market design and regulating energy markets from the California electricity crisis. A necessary first step in determining the lessons learned from the California electricity crisis is a diagnosis of its causes. This requires a clear understanding of the federal and state regulatory infrastructure that governs the US electricity supply industry. I then discuss the conditions in the western US electricity supply industry that enabled the California crisis to occur. The paper then describes the important regulatory decisions by FERC that allowed what was a very solvable problem develop into a full-fledged economic disaster during the latter part of 2000. As part of this discussion of FERC's response to the events of the summer of 2000, I will also dispel a number of the myths that circulated around this same time about the causes and consequences of the California electricity crisis. I will also discuss the actions taken at the state and federal level that ultimately stabilized the California electricity market. This is followed by a discussion of what I believe are the major lessons for electricity market design that should be learned from the California crisis. The paper concludes with recommendations for how FERC should change the way it carries out its statutory mandate to set just and reasonable wholesale prices and how state PUCs should revise their retail market policies to prevent a future California crisis. In this discussion, I describe a worst-case scenario for how another California electricity crisis could occur if these recommendations are not followed.