Chain of events

July 1, 2001
The chain of events is familiar to economics historians: Decades ago, large areas of the US curtailed access and production by oil, gas, and coal producers for aesthetic, environmental, and economic reasons.

The chain of events is familiar to economics historians: Decades ago, large areas of the US curtailed access and production by oil, gas, and coal producers for aesthetic, environmental, and economic reasons. The most interesting reason for the hold-back then was that the reserves should be held for the future - when they were needed. Of course, that time is now, and the production is not there - and won't be anytime soon.

Because there was no local production of oil reserves, the construction of refineries didn't take place. And without large end-users to supply, commodity and product pipelines also met the same fate. Lastly, since cheap electrical power and fuels were easily imported from elsewhere, there was no impetus to produce fuel locally or build power generation facilities.

In effect, local government in the US, with wide consumer support, constrained fuel and power competition, and limited options for aging fuel and power generation capacity and future demand growth.

Sounds like California, doesn't it? It could be, but it also is the pattern across the entire US, which has relied on fuel and power from "elsewhere" for 40 years. Like Californians, other US consumers believed that low oil, gas, and hydro prices, enhanced by ample imports, would forever feed the economic engine.

Now that OPEC is exerting more control over the global oil supply, and natural gas production and distribution can't quite meet rising demand at traditional prices, consumers are accusing oil and gas producers of price-gouging. At the same time, US consumers seem uninterested in examining this sequence of economic events or calling to task legislators who walked them into a captive high-price environment to begin with. There are other distortions in US energy market dynamics:

  • Unlike most other nations, the US government, driven by "states' rights" and local regulation and permitting, restricted oil and gas exploration and development access to a tiny segment of offshore and onshore acreage.
  • Local government agencies' environmental wish lists forced the production of 50-60 different gasoline formulations, all of which lack convertibility. This created single-source refining and wrecked competition on product levels.
  • With fewer refineries, complex fuel requirements, and environmental regulation, building product pipelines to all but the most densely populated or industrialized areas was discouraged.
  • Stimulated by the recent US energy shortfall, nuclear and coal-fired generation capacity permits were quickly granted, but that capacity won't be ready for another 3-7 years, providing nothing in the near term. Of course, when all this new capacity hits the market, a power surplus will develop, triggering steep de-stabilizing energy price excursions.
  • Lastly, the unplanned always occurs. The northern US and southern Canada moved into a low rainfall cycle of unknown periodicity, forcing hydro power curtailments in the midst of high oil and gas prices.

At the present, high gas and power prices are curtailing consumption, and US legislators are arguing over short-term fixes. Unfortunately, once high prices begin to subside, the tougher long-term solutions will be forgotten and hard economic realities ignored.

  1. Regulation of reserves access, fuel formulation, gas production, and gas and power distribution, in whatever form it exists, is at least an inter-regional task and should probably be a national function. Local legislators won't accept this easily, but they always seem to want national solutions when prices rise.
  2. Price caps on power and fuel always encourage greater consumption and discourage new supply, exactly the opposite of what is intended. In fact, "excess profits" are what stimulate new competition, on Wall Street or Main Street.
  3. Market signals for price and supply work quickly when competition among fuel and power suppliers exists. When market over-regulation begins to channel competition and discourages new entry, prices and distribution respond poorly to supply and demand signals.
  4. When inter-dependent economic events transcend several generations of decision-makers, there is every likelihood of recycling a history of ineffective short-term energy fixes.

The only role of government should be to ensure there is fair competition and access for new competitors. After that, it must leave markets alone to fund and penalize competitors and new entrants, according to efficiency, innovation, and growth. The process is messy, but it works.