The Cartel Behind the California Energy Crisis

Abstract

In 2000-2001 the California energy crisis cost billions of dollars and the blackouts endangered lives. The causes of the crisis were contested along partisan lines. Republicans (and neo-classical economists) argued that “a perfect storm” of increased demand and reduced supply triggered the crisis and that the root causes were inadequate deregulation, environmentalism, and bungling by the Governor Davis. Their solution was greater deregulation and reduced environmental restrictions. They predicted that price caps would lead to constant blackouts.

Democrats blamed bungled deregulation under the (Republican) Governor Wilson and a cartel. They favored price caps. The Clinton administration supported Governor Davis. Ken Lay, Enron’s head, guided the Bush administration’s response to the crisis. It opposed price caps. Under Bush, the Federal Energy Regulator Commission (FERC) opposed price caps and barred state officials from access to tapes proving that there was a cartel.

The facts never supported the “perfect storm” theory. The theory that best fit the facts was that a cartel caused the crisis. Neo-classical economists rejected the possibility of a cartel because they presume that cartels are unable to maintain the discipline necessary to restrict supply. The three basic assumptions of rationality, utility maximization, and self-interested behavior should cause cartels to self-destruct. It is rational to cheat on a cartel because cheaters prosper. Cartel members know this, so the universal incentive is to cheat first.

Criminological research has falsified this prediction. Cartel discipline is an issue. As a result, successful cartels build cohesion by increasing trust and employing a mixture of positive and negative reinforcement. Some major cartels, e.g., many dango in Japan, maintain discipline more than 50 years after they were created. Moreover, even cartels with imperfect discipline, e.g., OPEC, can cause massive damage.

Keywords: California Energy Crisis, Cartel, Deregulation, Federal Energy Regulatory Commission, Environment

JEL Classification: D4, D43, K14, K42, L11, L13, L94, L97