By Bill Mann

There are many of us on the East Coast who have been watching the California energy crisis with some sense of schadenfreude. After all, we're freezing out here, while in California, as always, the weather is mostly beautiful. I'm not sure what Californians are complaining about. Most people never even get to visit California.

People are quick to point fingers in a crisis, and as the situation has gone from a disaster waiting to happen to a plain disaster, most are doing so. But the silly people who single out deregulation as the major culprit have it wrong. Twenty-three states and Washington D.C. have taken on electricity deregulation, but only in California has it blown up. Why? Too many reasons to count.

Rather than point at deregulation, though, let's look at deregulation badly executed, courtesy of the legislators and regulators of California. It is an important lesson for any investor, because electric utilities are not the types of companies that have gotten people excited -- they are the companies that people put their retirement money into. In the case of those holding PG&E and Edison International, their "safe" utility stocks have been creamed, their dividends cut, their security dashed. It is a warning to all of us that we should not consider regulations to be natural law when choosing an investment. Laws can and will change, not always for the better. Those who invested in these utilities for safety of their principal are in danger of grievous losses.

But this set up a crush on the utilities when fuel stock prices began to skyrocket. There were several problems in California. The state had mandated that much of its power should come from non-greenhouse gas producing sources (with the exception of nuclear power). That's admirable, but also significantly more expensive. It had also outlawed coal-fired power, leaving most of the power in California to come from a single source: natural gas. These heavy restrictions, plus a case of NIMBYism writ large in the state -- no, I take that back, it's more like "BANANAism", or "Build Absolutely Nothing Anywhere Near Anything" -- made it an unattractive place for power producers to come build. And so they did not, and for 10 years (until earlier this year) not a single megawatt of new power generation was built in California. Power generators had better fish to fry: They'd have rather drank axle grease than deal with the headaches of the California market.

The consumers didn't pay much attention because their prices were pegged -- until San Diego Gas & Electric completed recouping its stranded asset costs, and retail costs floated in its service area during the hottest summer on record, causing retail rates to triple. The utilities were already getting crushed by increased costs, as natural gas prices surged. Moreover, as demand screamed higher in California (electricity demand in 2000 was 10% higher than in 1999), supply of natural gas moved in sympathy. California couldn't count on its neighbor states to supply power: Nevada, Arizona, Oregon, and Washington all had surging demand of their own, and used to count on California to provide additional supply.

No new plants, no new external sources, surging demand, and fixed pipeline capacity for natural gas is a potent brew. To add insult to injury, perhaps the stupidest part of California's experiment was to prohibit the utilities from buying futures contracts, beholding them to the price of the moment. That, in a nutshell, is why wholesale power prices in California have risen from $30 per megawatt hour to $1,500. Since the utilities' retail price was pegged, they are in dire danger of complete collapse.

I've received several questions about whether the California utilities are a good buy here. Before I answer, consider this: The most recent relief plan is to allow the utilities to raise their retail prices 9%, and the governor has suggested that the state take over the production of electricity. Neither proposal alleviates the deeper problem: California will still be the screwiest, most-restrictive electricity market in the country. A state-run power authority will have no easier time getting siting plans past local political activists than the current incumbents have now. In other words, these utilities, from what has historically been the safest of equity sectors, are unlikely to gain any relief that will give them -- or other private companies -- much room to make a profit on their investments.

In other words, no. Under these conditions these appear to be horrible investments -- and will continue as such until California loosens up the regulatory burdens on power producers. Californians are going to have to choose: aesthetics or darkness, global warming or coal and nuclear power generation. There is no such thing as immaculate conception of electricity, much as we'd like there to be.

Fool on, and have a great weekend. If you're in California, turn off your computer before you go home.

Bill Mann, TMFOtter on the Fool Boards.