About 15 years ago, the state that would eventually become the 2nd world country of California chose to restructure part of its electricity industry in hopes of lowering rising costs and rates.
It was a serious effort, backed by the Republican Governor and his appointed utility regulators, but also endorsed eventually by a Democratic State Legislature. When the Public Utilities Commission issued the basic policy direction, it authorized the state’s investor-owned utilities to work with stakeholders to write the detailed rules that would restructure the industry.
In 1995, Enron was still regarded by most as a friend of consumers and a champion of the wonders of private market competition. The administration and market advocates, including the largest electricity customers in the state, saw Enron officials — people who would eventually go to jail — as market experts. They were trusted players in the design discussions. Only a few, including a consumer advocate group and a public agency staff — bureaucrats — thought this was baloney, but this story is not about them.
Watching the health care reform debates has been deja vu all over again, because so much of what we’re seeing now has parallels to the Enron-dominated discussions of electricity reforms back then. So what was Enron trying to do then, and what does that teach us about what we’re seeing now? (And forget what you may have learned in the movie, Smartest Guys in the Room, because that was mostly the official cover story to hide the horrendous mistakes state and federal regulators made in approving the Enron-inspired rules and mismanaging the crisis that later occurred.)
The most important fact to know is that Enron didn’t produce anything. It didn’t own power plants there. But it had a business plan in which it would buy power (and sometimes operational control) from producers, repackage the deals and resell the power and the deals to others. Enron was like a Wall Street trader, a middleman.
Its business plan thus depended on creating a structure in which Enron could extract rents — money — in the chain between producers and consumers. To do that, it needed a structure and rules to maximize the transactions — and thus money — that would flow through the middleman, Enron’s trading system. Enron would then arrange, buy and sell power and financial contracts, and those contracts functioned like insurance against price volatility. In one sense, therefore, Enron sold something like price insurance, and it would make money by minimizing payments and maximizing revenues.
So what kind of structure and rules did Enron demand? First, it needed to eliminate competing institutions that might be able to connect producers and consumers more directly and efficiently. It argued for, and got, a structure that tended to require middlemen.
There was a proposal for a quasi-government "power pool" — a public pool in which producers could sell and consumers/buyers could purchase power directly without a middleman. For a year of debates, Enron and other marketers did their best to eliminate that "socialist," government-controlled concept, but the small band of bureaucrats and allies convinced the state to keep the pool.
Second, once the pool was accepted, Enron’s next tactic was to limit access to the pool. Enron argued for rules that required all non-utility buyers to arrange private contracts to cover their needs, instead of relying on the public pool. That would result in many more opportunities for Enron to be the middleman in those private contracts. The small band of bureaucrats argued against that limitation with some success, but Enron got concessions that tended to discourage many parties from using the public pool.
Enron’s third tactic was to demand operating rules that would force the public pool to operate at higher costs. The bureaucrats objected to these rules and took the dispute all the way to the Governor’s office, but they lost to the Governor’s largest campaign contributors (he still had debts from a failed Presidential run). It was an important defeat.
The Power Pool was eventually created, but it’s rules hobbled it and forced it to operate at higher costs. One particular rule required the public pool to ignore feasible cost-savings and instead deliberately choose higher cost energy when serving customers of the public pool. That made non-pool contracts more attractive and drove non-utility buyers/sellers to Enron’s traders.
Enron and its gullible supporters convinced state and federal regulators that since they were market competitors, their competition would always achieve the lowest cost results, so the public plan should be deliberately forced not to achieve the lowest cost, because that would drive marketers out of business, and they should be protected. California’s largest electricity customers, and federal regulators, bought this ridiculous argument.
Finally, Enron demanded, and got, rules that required the grid system operator to be separated from a part of the public pool — the market separation fallacy. When combined with other ill-advised rules, this meant that the public plan and system operator were often flying "blind," unaware of grid conditions when Enron and other parties were manipulating the market. The result: Enron and others manipulated the market with virtual impunity, raking off hundreds of millions, and (some claim) billions of dollars.
If you recognize this pattern, it’s because we’re seeing analogous tactics and strategies in the current health care reform debates.
We see a powerful group of middlemen, the insurance industry, trying to structure the market to require that they remain in the middle of, and extract a rent from, all money flows between providers and patients, as though that’s the only logical structure, even though it’s not.
We see efforts to eliminate any public alternative — the public plan (operating inside a public exchange) — that might be more efficient in reducing and covering costs.
And we see the middlemen and their political supporters in Congress deliberately hobbling the public plan, raising its costs, and restricting access to that public option, on the theory that we shouldn’t do anything to undermine the current private insurance industry. After all, they argue, private markets are always more efficient than a government operation.
There are, of course, many differences between the products, markets, and details; the analogy goes only so far. And Enron’s California strategy has been misinterpreted to explain many evils that later befell that market, that were caused by other factors. Still, the most important lessons we should learn, at least from this long-ago bureaucrat’s perspective, are these:
Build the public option.
Make it as efficient as you can.
Make it available to everyone (open access), and let people/businesses choose.
Structure its pricing to encourage producers to be more efficient.
Don’t separate the markets, because that encourages manipulation by rent-seeking middlemen.
And never, never, trust the market zealots.
Video from Bill Moyer’s Journal, July 11, 2009, interviewing former insurance executive, Wendell Potter