7/16/2001

KUFM / KGPR

T. M. Power

Coping with Instability in Natural Gas and Electricity Markets

Recent newspaper stories headline the rapid expansion of natural gas exploration and development in the Rocky Mountain region. This is not in response to President Bush’s energy plans, the details of which have not even been submitted to Congress yet. Nor is it in response to panicked efforts by Montana and other state governments. It is simply a market response to the fact that natural gas prices have risen dramatically over the last year or so, reversing the incentives that discouraged natural gas development during most of the 1990s. Just as it was not government policies that discourage natural gas exploration and development earlier, it is not government policies that are now boosting production.

The same is true of electric generation. Despite hysterical assertions by our own state government and the Bush administration that restrictive environmental policies prevented electric generation from keeping up with our expanding economy and population, the facts show the opposite. In the State of Washington 2,000 megawatts of generation were approved by the Washington Energy Facility Siting Evaluation Council between 1990 and 1996, but none of it was constructed because of the regional electric surplus and low prices. In Montana, new generation was proposed in the Great Falls area in the late 1980s and in the Butte area in the mid-1990s, but low market prices also discouraged construction. Now with electric prices sky-high, 12,000 megawatts of electric generation in the Pacific Northwest are now under-construction, permitted, or planned. In all of the Western states 12,000 megawatts are under-construction, an additional 9,000 megawatts have been permitted but construction has not yet started, 20,000 megawatts are in the permitting process, and another 23,000 megawatts have been proposed but haven’t sought permits yet. That is a total of 63,000 megawatts or the equivalent of 90 generators the size of Colstrip 3 or 4.

Of course all of these will not be built because as new electric supply grows, that expanding supply will bring electric prices down while the new demand for natural gas is likely to drive the cost of this source of supply up. The point is, however, that it has been market forces that have been behind the instability of natural gas and electric supply and prices, not government regulatory or environmental policies. The same will be true in the future and, if we are concerned about the economic dislocation caused by recent high electric and natural gas prices, we have to focus on the instability of those markets and how to manage that market instability rather than turning the opposite direction and blaming government for problems that markets have created.

Currently, market responses combined with government policies to reduce demand and cap the more outrageous price gouging have somewhat eased the severity of the Western energy crisis, bringing both natural gas and electric prices down from their towering spikes in late spring and, thus far, helping avoid rolling blackouts during the peak summer loads. But some of these are simply crisis responses that have shut down or curtailed businesses and forced other consumers into emergency behavior. Whether we have yet found a path that leads out of the current energy and economic bind is not at all clear.

One of the troubling aspects of the long-run solution we are now drifting into is the heavy reliance on natural gas as the fuel for new electric supplies. If just half of the 12,000 megawatts of new gas-fired generation that is under-construction, permitted, or planned in the Pacific Northwest were to be brought on line, it would increase the demand for natural gas in the region by 50 percent. To this, of course, has to be added the demand from the rest of the West for more natural gas to expand their electric generation too. We are seeking to bring electric prices down by turning to a fuel source that recently exploded in price too. By moving in that direction, we will link natural gas and electricity prices closely together, potentially setting ourselves up for very high prices and shortages of both.

The key question is whether natural gas supplies can be quickly and cheaply expanded and whether the natural gas transmission system can also be inexpensively and quickly expanded to deliver the much larger supplies of natural gas that electric generators will need. If electric generators come on line faster than natural gas supply and transmission are expanded, those electric generators will bid natural gas supplies and transportation capacity away from current users, including industry, commercial buildings, and residential space heat. Natural gas prices will rise for everyone as will the cost of electricity. Some segments of our economy will have to do without both electricity and natural gas. We may slide back into the type of crisis we have struggled with over the last year.

This is not a prediction, just a serious possibility that carries substantial risks to our economy and well-being. The problem is one of the coordination of billions of dollars of investment in our basic energy infrastructure. We, of course, could just trust to markets as we have so far in the current catastrophic cycle of unstable energy prices, or we can try to use flexible regulatory policies to minimize the risks and costs of extreme price fluctuations.

We know what we want: relatively low energy prices that are relatively stable and secure sources of supply. The question is how best to pursue these. One group, led by the oil men who control the federal government, is urging us to trust the large national and international energy companies who have been gaming the current crisis and walking away with billions of dollars of excess profits while doing serious damage to all other sectors of the economy. We are told that if we would simply turn over air and water quality and our public lands to these profit seeking corporations, our future would be secure. Their past and current performance, however, is not very reassuring in that regard.

Others are proposing that we use public regulation to realign the incentive system that energy companies face so that as they pursue their profits they do not damage the rest of the economy and shift the risks and environmental costs to others. These folks argue that, among other things, we have to focus on improving the efficiency with which we currently use energy, mining, if you will, the enormous waste that is part of the current system. That, we are told, will reduce the environmental damage, help keep our energy bills lower, and increase our overall economic security.

These are dramatically different paths, focused on quite different sets of beneficiaries. It will be largely up to us to push our political leaders towards one or the other of these divergent paths. We know in what direction they are currently strongly leaning while the energy companies drool at the thought of continuing to control the system. Push is about to come to shove. The future character and quality of energy rich states like Montana are likely to be determined in the process.