5/21/01

KUFM/ KGPR

T. M. Power

Mischaracterizing Our Energy Problems

We do not stand much chance of efficiently working our way out of the energy problems that currently confront us if we do not accurately characterize those problems and then focus on their actual sources. Unfortunately both the administrations in Helena and in Washington, DC, have defined the source of our energy problems in very misleading ways and proposed policies based on those false assumptions.

Consider the claim made by both our governor and the president that the primary source of our energy problems have been environmental restrictions that have kept adequate supplies of electric generation from being brought on line and adequate supplies of natural gas from being developed. Environmental and other regulatory restrictions had nothing to do with the lack of natural gas development and electric generation during the 1990s.

The reason our large energy companies nearly gave up on exploration and development of natural gas during the 1990s was that the price of natural gas was so low that it offered no possibility of earning a profit on the high cost of exploration and development. So the big energy companies abandoned drilling, sold their drilling rigs for scrape metal, and went looking for oil overseas instead. It was low market prices that put a lid on the development of new supplies of natural gas. It was not until natural gas consumption rose to match existing supply that during last year natural gas prices began to rise and natural gas developers got interested again. By then, of course, it was too late for the rest of us. Natural gas prices early this year were four times what they were in 1995 and three times what they were in 1999. Those high prices hit household in the pocketbook both for home heating and on electric bills since natural gas fuels a lot of electric generation.

A similar thing happened in electric generation. Contrary to what our political leaders are now asserting, electric generators during the 1990s were not chomping at the bit to build new electric generation, only to be frustrated by environmentalists and environmental regulation. Consider Montana Power. As loads grew during the 1990s, it needed to supplement its existing generation. It looked at the costs of building new generation and also looked at what it would cost to buy additional electricity from the surplus that was available in the region. The cheaper alternative was to buy electricity from existing generators, Idaho Power Company and Basin Electric in North Dakota.

In the mid-1990s a consensus was reached between Montana electric interests and Montana environmental groups that new gas fired generation could be given fast-track approval if it were sited in the right place. Such generation was proposed in the Butte area, but market prices for electricity were so low that not a shovel of dirt was turned. It would have cost 3.5 cents per kwh to build but only 2 cents to buy electricity on the open market. No one built, again, not because of environmental restrictions but because of the low market price. The Bonneville Power Administration actually entered into a contract with Montana Power to build a new gas fired generator in Washington during the 1990s, but then backed out of the contract, paying millions of dollars in penalties, because that additional generation did not appear economic given low market prices.

The shortage of new gas and electric supplies in the region resulted from market forces, not government regulation. That provides an important warning since our political leaders want to rely more on markets, not less. That is, they want to rely more on the very mechanism that created the current shortage and high prices. That may be why they are trying to mislead the public as to what the source of the problem actually is.

A common feature of commodity markets is that commodity prices are often unstable. Think about the fluctuations in beef, wheat, copper, gold, aluminum and oil prices over the last half-decade. Commodity markets do not assure stable prices. Those who rely on them take steps to insulate themselves from those price fluctuations. Often, for instance, before the bulldozers even begin created a new gold mine, most of the future gold production from that mine is sold into futures markets at fixed prices. That assures that the gold mining company can recover its costs even if gold prices fall.

Public regulation of the electricity and natural gas industries was partially put in place to solve this problem of unstable prices and unstable supplies. The regulators shifted some of the risks associated with building new supply to customers so that electric and natural gas utilities would be willing to invest their capital in developing new resources. In return, customers were assured of stable prices, adequate supplies, and protection from price gouging. To many, that looks like a pretty good deal today

That is not to say that the previous system of utility regulation was flawless. It had a serious flaw; it largely absolved utilities of the need for careful planning by shifting most of the risk associated with new supply to customers. The result during the 1970s and 1980s was the construction of costly excess supply and the abandonment of partially completed facilities. This had serious economic and environmental consequences.

What is clear is that there are flaws in both systems. Uncritically we hopped out of the frying pan into the fire. We abandoned one problematic system that assured us of energy at stable, but, possibly, unnecessarily high, prices due to over-supply and adopted another system that does not assure us of energy supplies and confronts us with unstable, and currently astronomically high, prices.

Which is worse? Well the old system currently looks pretty good. But we do not have to settle for a choice between bad and worse. We could have crafted a system that tried to obtain the best of both systems. Instead, guided by the special interest groups that wrote our deregulation legislation, we got the worst of both systems.

It’s time to stop the mindless ideological chatter about the glories of private markets and the evil of public regulation and go back to the drawing boards and do the homework we should have done four years ago before we leapt giddily out of the frying pan into the current fire. We definitely can do better, but not if we remain hostage to ideological fantasies and special interests.