During the 1990s, electricity demand in the United States grew faster than did new generating supplies as a combination of stringent environmental laws, red tape, and greater environmental awareness slowed the construction of new power plants. Partial deregulation only made matters worse in places like California by leaving utilities stuck between deregulated wholesale power prices that are both high and volatile and retail rates that remain fixed.1 As a result, many utilities sometimes pay upstream generators more for electricity than they can charge the public when they resell it. The problem came to a head in California last spring—bankrupting one of the state’s three main utilities and pushing a second to the very verge of bankruptcy—and it could also strike elsewhere.
To complete the deregulation of the power industry and to avoid another California-style crunch, regulators must now link electricity prices in retail and wholesale markets. The most feasible way to do so would be time-of-use, or "dynamic," pricing, which allows utilities to pass on to consumers at least part of the price variation occurring within a given day, thus damping demand when supplies are tightest (and prices are highest). To put it simply, customers should pay more...