The California energy situation is a mess. Consumer prices are up 40%, the utility companies are bankrupt and the state has become the electricity provider of last resort. So what caused this crisis?

The roots start with a critical part of the deregulation plan that explicitly prohibited California utilities from entering into long-term supply contracts with power wholesalers. Instead, most purchases would occur in electricity spot markets. By the nature of power transmission, California is necessarily part of a larger market. Electricity providers in other states on the same power grid have continued to purchase their electricity using long-term contracts. Since electricity providers must attend to their long-term contracts prior to selling electricity on the spot market, California has absorbed all the supply-side energy risk for the entire western U.S. economy.

The shock that sparked the crisis had to do with the national supply and demand for electricity. Consumption at the national level has grown faster than overall capacity to produce it, and utilization rates recently increased to levels as high as 98%. Electricity consumption varies widely from hour to hour. A monthly average utilization rate this high implies that at many points, rates were 100%, where every bit of generating production available was in use. When supplies are tight, wholesale prices spike.

The true crisis isn't just in California. We are running into nationwide capacity constraints, where there simply isn't enough electricity that can be produced to meet total demand in peak periods. It's just that the peculiar nature of the California deregulation plan has placed the burden of these problems on the state's consumers.

The long-run solution to the power crisis is simple: Additional capacity for generating electricity must be put in place. Two things can be immediately accomplished by the state. Long-term contracts need to be negotiated with electricity wholesale producers to shift at least a portion of the national shortage problem to other states. In addition, retail prices within California must be increased in order to encourage conservation. Currently, the price of electricity is being heavily subsidized by the state government, which is paying the bill with tax revenues. Whether the price of power is paid in taxes or in higher electricity rates, the California economy and ultimately the residents of the state are still bearing the full cost of the power.

The most severe long-run impact of the power crisis that could occur will likely come straight out of Sacramento. With their actions to date, the governor and state legislative and regulatory bodies have sent very disturbing signals to the market. They have been looking for scapegoats in the private sector instead of blaming the true culprit for the crisis: faulty deregulation. Instead of acknowledging that true deregulation would be best for the economy, the state's governmental bodies have again thrust the government directly into the private markets where it has proven to be ineffective in the past.

These signals may do more damage than high prices and rolling blackouts as businesses, weary of California's interventionist government, choose to invest elsewhere.

Christopher F. Thornberg is a visiting professor of business economics at The Anderson School.