Prior to 1996, roughly 70% of electricity service in California was provided by investor owned utilities (IOUs). The IOUs operated as monopolies in their respective service territories, performing all of the functions necessary to generate and deliver electricity to the consumer. In exchange for service, the IOUs were paid a regulated rate which was designed to recover their cost of providing the service plus a reasonable return on their investment. In 1996, California changed the way electric service was provided in order to make it more competitive. Among the changes, utilities would procure their supplies at market prices in an auction or spot market; residential customers could choose their electric supplier; and residential rates were frozen at 10% below their June 1996 levels. The rate freeze was to remain in effect until the later of March 31, 2002, or the date the IOUs fully recovered certain expenses that were still on their books (i.e., stranded costs). The restructured market commenced operations on March 31, 1998.

During the summer of 2000, California experienced record increases in wholesale prices and supply shortages that ultimately resulted in a number of rolling blackouts. Most of California?s residential customers were unaffected by the increased wholesale prices because their rates remained frozen. Regulators and others who have studied what went wrong during the summer of 2000 in California agree that the increase in wholesale prices was due to a combination of factors, one of which was the residential rate freeze. This thesis proposes to show how fixing the price of electricity resulted in excess demand and to quantify the size of the excess. This thesis also shows how much of a price increase would have been needed to prevent the shortages.