California moved to a deregulated electricity market in April 1998. For roughly 2 years, wholesale prices were fairly low on average. However, the state experienced periods of higher prices, especially during peak summer hours. Average prices rose dramatically in May 2000 and remained high. For example, average prices of electricity sold in the California Power Exchange during the months of May through December 2000 were between 2 and 13 times higher than in the same months of the previous year. In addition to higher prices, the frequency and duration of periods when the system is in danger of service disruptions have increased. Actual rolling blackouts occurred on 6 separate days in winter and spring 2001, for a total of 16 hours with shortfalls ranging from 400 to 1,000 MW. Blackouts adversely affected consumers and caused business and traffic disruptions. The California electricity market operates within a larger western system consisting roughly of 11 states, and while California relies on imports for about 20 percent of its supplies, it also exports power at times to other states. As a result of this interconnectedness, the price and availability of power in California influence markets in other western states and vice versa. Industry experts and academics generally agree that a tight power supply in California and other western states is one reason why prices increased and service reliability deteriorated starting in May 2000. The demand for electricity in California has grown rapidly since 1995, while very little new generating capacity has been added. For example, from 1995 through 2000, total electricity consumption grew by about 13 percent, compared with about 2-percent growth in electricity generating capacity in the state. In addition, last summer saw an increase in the price of natural gas—used to produce about 40 percent of California’s electricity supply—and in the price of emissions permits that are required to operate certain generators in California. Lower levels of available hydroelectricity during summer 2000 in the Pacific Northwest reduced California’s access to imports of hydroelectricity. Rapid demand growth in other states has also reduced California’s ability to import electricity from those states. Finally, flaws in market design in California are widely believed to have contributed to California’s problems. For example restrictions on the use of long-term contracts to purchase electricity increased the reliance of California’s three investor-owned utilities on spot markets and left them substantially exposed to market risks. While these factors contributed to California’s electricity problems, a number of state officials, economists, and industry experts now believe that the market design adopted by California has enabled individual electricity-generating companies to exercise market power by withholding capacity when supplies are tight in order to drive up prices. They argue that generating firms have withheld supplies of electricity by staging outages in order to drive up prices, and point to higher-than-normal levels of outages since summer 2000. FERC’s study differed from the other two in its methodological approach and reached different conclusions. In addition, all three studies covered different time periods, so their results are not entirely comparable. FERC performed an audit of specific generating plants and companies that had experienced outages during December 2000. On the basis of these audits, FERC found that there was no evidence that the audited companies were incurring physical outages in an effort to drive up prices. The other two studies examined market prices and compared them with estimates of the costs of producing electricity to determine if prices were consistent with generating companies’ exercising market power. Both of these studies, conducted during different time periods, concluded that there was evidence of market power used to increase electricity prices. FERC followed a case-study methodology, analyzing generating plant outages to determine if generating companies used them strategically to push up electricity prices or if they resulted from unavoidable or routine repairs or maintenance. FERC analysts conducted telephone interviews with generating companies to verify the reasons for outages. These telephone interviews covered about 60 percent of the reported outages. In addition, they visited the headquarters of two companies whose generating plants were down for maintenance or repairs to discuss in more detail the companies’ repair policies, maintenance schedules, and operating practices. They also performed on-site inspections of generators at three plant sites and observed maintenance and repairs. In order to evaluate the legitimacy of the repairs or maintenance being performed, FERC employed private-sector consultants familiar with plant operations to accompany FERC analysts during the on-site visits. In addition to the audits, FERC examined market prices, levels of demand, and generator outages for the month of December 2000 to determine whether high levels of outages were correlated with higher prices of power. Based on the results of its audits, FERC found that there was no evidence that the audited generating companies were withholding power in an attempt to influence prices. On the contrary, in every case, FERC found that legitimate repairs or maintenance was performed on the downed generating plants. Moreover, it found that these plants were typically older—30 to 40 years old—and had been used more intensively than usual during the summer and fall of 2000. In addition, FERC found that prices in the month of December were not strongly correlated with levels of outages. In fact, it found that the highest prices occurred during periods with relatively lower levels of generator outages. The other two studies looked for evidence of the existence and exercise of market power in the entire market, rather than focusing on particular instances of generator outages. They employed a methodology that compared market prices with estimates of the marginal costs of producing additional electricity. Marginal cost is the additional cost incurred to produce one more unit of electricity. Prices close to the marginal cost are consistent with a competitive market. High prices, however, may suggest that the market is not competitive and that individual electricity- generating companies can manipulate prices. The first study we examined, by Borenstein, Bushnell, and Wolak, compared prices with estimated costs of producing electricity in the period from June 1998 through September 1999. The authors constructed the market supply of electricity by estimating the cost of generating each additional unit of electricity, starting with the lowest-cost generating plants and adding increasingly costly plants. They used statistical simulation methods to take account of random generator outages, which decrease the electricity supply as units go off-line for repairs or maintenance and increase it as generating plants come back on-line. By matching actual demand at any point in time with their simulated supply of electricity, the authors were able to estimate the competitive price of electricity—that is, the price equal to the marginal cost incurred to supply the last unit of electricity demand. Then they compared the estimated competitive price with the actual price. Based on their analysis, Borenstein, Bushnell, and Wolak concluded that there were periods of high prices and high demand from June1998 to September 1999, which they attribute to the exercise of market power. The authors found that on average, the prices during this period were 16 percent higher than they would have been had generators behaved competitively. In discussion with one of the authors, we were told that while their study provides strong evidence of market power, it does not suggest any illegal activity on the part of electricity-generating companies. On the contrary, he believes that individual companies are sometimes able to exercise unilateral market power to raise prices without violating antitrust laws. The authors did not examine outages to try to determine whether the level or pattern was consistent with companies’ withholding power, nor did they seek to determine precisely how generating companies exercised market power. In discussions with one of the authors, we were told that it is not possible to tell the difference between an unavoidable outage and a strategic outage designed simply to drive up prices. Moreover, a generating company might exercise market power in other ways. For example, a company can simply submit selling bids that are so high that all of its power will not be purchased, thus effectively reducing the volume of electricity sold in the market and causing prices to rise. The second study, by Joskow and Kahn, examined electricity prices during summer 2000. The authors conducted a similar study to that of Borenstein, Bushnell, and Wolak, but their access to data was more limited. As a result, Joskow and Kahn relied on publicly available data for some key variables rather than the confidential and proprietary data used in the other study. Their study also differed from the first in that Joskow and Kahn analyzed outages during June 2000 to determine the extent to which withheld generating capacity was a factor in explaining high electricity prices. In doing so, they compared the volume of electricity generated at specific prices with their estimates of how much electricity could have been produced profitably at those prices, taking into account normal levels of unplanned outages and capacity held in reserve for system reliability reasons. Based on their analysis, Joskow and Kahn concluded that there was strong evidence that market power was exercised to raise prices in summer 2000. They found that higher prices of electricity were caused in part by higher natural gas prices, increased demand, reduced availability of imports and higher prices for air emissions permits. However, they also found that prices in summer 2000 were greater than they would have been had the market behaved competitively. In addition, they concluded that the level of outages experienced during June 2000 cannot be explained by reasonable expectations about repairs or maintenance requirements, or by the need to hold power in reserve for system reliability reasons. However, the authors acknowledge that data limitations make their analysis of withheld generating capacity somewhat rough. Specifically, they lacked data on generating units outside of but selling power in California and contractual arrangements by electricity power marketers doing business in the state. Therefore, they were unable to measure generator outages outside of California. FERC’s study of electricity generator outages was not thorough enough to support its overall conclusion that the audited companies did not physically withhold electricity supplies to influence prices. FERC’s study was largely focused on determining whether or not there were actual physical problems—such as leaks in cooling tubes—in generating units experiencing outages.