Politics and Energy Go Together Like Love and Marriage


Remarks by CEI President Fred L. Smith, Jr., to new members of Congress at a luncheon held by the National Association of Manufacturers, Washington, DC

January 24, 2001


How did an effort to make America more comfortable, to enhance mobility and to make the world a brighter place (that is, to increase the availability and convenience of energy for more and more Americans) become so demonized?  Why has “conservation” – “use less energy” – become a slogan of so many energy activists?  How has a can-do nation become so convinced that the energy pie is finite, that sustainable development considerations force us to live in ever-tightening circumstances?  Why has the pessimistic Demand Side approach (“conserve ourselves into happiness”) become so dominant?


A Brief History of Public Policy and Electricity:

When Farraday and Edision and the others found the electromagnetic forces and began to find ways to produce them commercially, uses were found for them and America rapidly began to electrify.  The first links were from local generators over poles and wires to neighborhood homes – and there were many suppliers.  These early networks (telephones were similar) were often competitive – but creative politicians and firms argued that such competing networks were “inefficient” “wasteful” and in most communities (although not all) government awarded regional monopoly charters and moved into rate regulation.  The deregulated industry was extinguished almost everywhere. 


An aside:  That a separate line or pipe or cable is the “ideal” way to reach every home is wasteful may be viewed as obvious; however, note that the various regulated utilities never integrated – never created a right-of-way conduit or chase that would have led to every house, to be used jointly for electricity (possibly via several competing companies), gas, telephone, water, sewerage, cable television, fiber optics, and what have you).  If networks are indeed “natural” monopolies, then we don’t see them in nature and government has clearly failed to address them reasonably. 


America (and the world) moved into political control of electricity.  In some of the United States (and most of the world), power would be produced and distributed politically.  In most of the United States, private parties would take this responsibility but they would be regulated heavily to ensure a “fair rate of return.”  Over the decades, this system created a massive system of regional power grids with weak linkages between them.  The system “suffered” from over-capacity – the results of crude pricing rules (little peak pricing or interruptible contracts – and thus a massive base load).  As costs increased, larger users sometimes found it advantageous to become self-generators.


Electricity arrived during the heyday of Progressivism, the belief that the economy was best managed politically from Washington.  And that concept in America’s optimistic period led to massive involvements in energy production and distribution. Hydropower was the first great investment with the TVA and the BPA becoming show pieces of the magnificence of the state.  Distribution and marketing grids followed, with the various federal power marketing administrations and the REAs.  Later the federal government became heavily involved in promoting nuclear power.  This era might be characterized as the Progressive Promotional Era, the view that the private sector was inadequate to expand America’s growing needs for energy and that government would assist by expanding our energy supply.


Along with these type interventions, were also rules on pricing and industry structure.  PUHCA restricted national firms (and thus national grids) from fully developing.  The surprisingly breakthrough came via PURPA, which forced utilities to purchase electricity from off-system generators under “fair” rates.  The alleged intent was to encourage alternative energy, but the major effect was to encourage co-generators and independent operators to go into the electricity generation market.  Initially, the rates approved in this area were very high. Firms could simply continue buying their electricity from the grid at low rates and (via co-generation) sell it back to the grid at a high markup. Such “spinning” of electricity around the grid did nothing, of course, to expand supply, but did create a lot of interest in deregulation.


This early Progressive Promotional phase had its problems but it did create lots of energy – and lots of good things were done with it.   But for various reasons, the optimistic phase of progressivism – its focus on expanding the supply of energy (and other resources) – gradually gave way to today’s pessimistic, limits to growth, sustainable development, renewable energy, “conservation” attitudes.  For the last 30 or so years, we’ve been in what might best be labeled the Progressive Precautionary phase. We have been worried about the adverse consequences of energy exploration and development: the Exxon Valdez, pipeline leakages EMF and cancer, nuclear wastes. 


Gurus from Lester Brown to Paul Ehrlich to Amory Lovins gained an audience with their view that “conservation was our most important source of energy.”  Rather than expanding supply, we could simply eliminate waste – the “negawatts” created by such creative conservation programs would more than offset the slight additional energy needs of the United States.  We could conserve ourselves into a brighter future!


The Greenies loved this “limits to growth” ideology and continue to do so.  Read any story of the California situation and somewhere someone will be quoted as saying “Well, we may need a bit more supply, but I would rely more on conservation.”  This is a bit like talking to a starving man, and suggesting that while a meal might be needed from time to time, dieting is a far more intelligent prospect.


The results of this cut across the whole energy policy field.  America began to restrict domestic exploration and development of all energy sources. Alaska was closed to further development, as gradually were most of the offshore lands and then the interior.  America’s energy policy became “Never Develop It Here” and while older fields became more productive, the major oil industries began to disinvest and move abroad.  Ken Derr, who was criticized for such offshore moves, stated: We didn’t leave; we were exiled!  World supplies of oil, coal and natural gas continued to expand but at a slower rate as Reagan deregulated energy and supply/demand equilibrated swiftly.  One should note that fuels have varying degrees of transportability. Coal and oil move quickly although oil can more efficiently move through pipelines.  Natural gas must be liquefied (a costly process) and carried in complex LNG ships and handled via special facilities. 


The onslaught of the anti-nuclear movement and fears over global warming slowed interest in these alternative fuels.  Nuclear power was effectively written off, and is still far from being back on the table. Coal power found itself laboring under an immense regulatory uncertainty.  Would there be carbon levies, if so, how large, what was the comparative costs of coal vis-à-vis other fuels under the various Kyoto-style proposals?  No one knew and this made coal a more risky option generally.


The Progressive Precautionary era left America vaguely guilty about its energy policies, created a massive misinformation campaign about the potential of alternative (especially “renewable” fuels) and created instabilities in the pricing structure of energy.  The latter point began to force change – traditionally commercial and industrial users had paid somewhat higher rates than residential.  But in a world where efficient smaller generators were increasingly available, these larger users began to leave the grid – leaving behind the costs to be borne by other “big” users.  That system was unstable and began to create economic problems for the utilities.


That problem led to a reluctance to build new capacity also; a reluctance reinforced by the “negawatt – we don’t need any more stinking power” attitude promoted by the environmental establishment.  Environmental and community activities also became increasingly active in blocking the siting of anything anywhere for any purpose.  America moved rapidly from NIMBY (not in my backyard) to BANANA (build absolutely nothing absolutely nowhere always) to NOPE (not on planet earth).  Transmission lines and even natural gas lines were blocked as an assault on the planet.  America’s energy future was based on the hopes that others would soon go on diets – or perhaps others somewhere would compensate for our shortfalls.  America did have an energy policy but its major element was to pretend that we didn’t need energy much anymore. 


One final point of confusion in this silly-energy era, which is the idea that efficiency (finding recipes that allow us to more economically produce some product) is the same thing as energy efficiency (finding a recipe that allows us to produce the product with less use of energy) is the same thing as conservation (reducing the amount of energy used).   An efficient operation looks at all possible “recipes” and picks that which – given the prices then extant – offers the lower cost; if energy costs are high, then energy savings may be sought; if energy costs are low, then we may seek to save labor or capital).  That is, an efficient operation may be more or less energy efficient.  When energy costs are low and falling, then rarely will efficiency be enhanced by focusing solely on energy efficiency.  Moreover, factor efficiency rarely means less use of the factor anyway.  When one finds ways of using wood or energy or metals more efficiently, the costs drop and often this creates new and unexpected demand increases.  Generally, only an energy efficient industry will use much energy! 


This confusion was rampant in America (and to some degree still is) and reinforced the view that energy-efficiency research would allow us to have energy without expanding supply.  Indeed, even a few years ago, former DOE official Joe Rohm and Amory Lovins (among others) were babbling on about how the e-commerce would make it possible to further de-energize the American economy.  This was foolish and in retrospect, tragic.


One final positive step did occur.  When Ronald Reagan assumed the presidency, he immediately moved to deregulate energy.  Fearful cries were everywhere – this would mean sharply higher prices.  After all, gas and other energy prices had been going up all during the Carter energy conservation era – with the end of these “good” programs (unfortunately, they didn’t end) things would only get worse.  They didn’t: gas prices flattened almost immediately and began slowly falling throughout the 80s and early 90s.  It was only the slow strangulation of supply that has led to the current situation in these deregulated markets.



California Breaks Out (Temporarily):

Still, the United States seemed light years from deregulation.  Railroad and transportation regulation moved ahead and strange things happened in the telecommunication area but electricity restructuring seemed far in the future.  Then some surprising breakthroughs occurred in the UK (an economist Stephen Littlechild was given authority under Thatcher and began substantive market restructuring of the UK electricity grid), California appointed some non-industry types to the California Utility Commission – and all of a sudden California looked ready to free up the system, to allow buyer and seller to negotiate directly with one another.  There were two major complexities:


·        The Open Access Issue:  How would one transit from the current situation where only one delivery system to most users (and almost all residential users) of electricity existed?  Should the approach be simply to allow rates to grow only slowly with prior-announcement, accompanied by programs to encourage alternative delivery systems (most American cities are being rewired and repiped continuously, those efforts provide ways of piggy-backing in new networks), should the existing utilities be required to allow part of the capacity (physically, lines being strung on the same poles or perhaps simply being required to allocate a portion of their wire capacity to competitors).  These issues raised difficulties regarding operating policies, grid maintenance and upgrades, and pricing policies.  It would make little sense to “deregulate” generation if all the rate-making authority were simply pushed up to the transmission system.


·        The Stranded Cost Issue:  During the regulated era, companies had every reason to over-capitalize.  The costs of capital were added to the rate base making recovery easy and more profitable (the Averch Johnson effect) and thus utilities had major debt loads that it was feared might not be sustainable in a free market.  This problem too was transitional and arrangements were considered to share the risks of transiting to a less regulated system.


·        Demand Side Management:  One additional policy concern was the widespread program (several hundred million per year in California along) to address the “market failure” issues of energy conservation.  People, it was alleged, were too short-sighted to intelligently use energy; their discount rates were too high; their awareness too low; landlords might have different interests than tenants; and on and on.  An enlightened program of government cross-subsidies would encourage people to use less electricity and thus avoid the painful need for supply expansion.  NRDC (whose former Chairman had moved on to head Southern California Edison) and other utilities liked the program – in a regulated rate system, any approved cost could be automatically passed along to the consumer.  Of course, the viability of such cross-subsidy programs disappeared in a free market and thus environmentaliststs tended to oppose deregulation.  (Consumer groups split with the Greenies on this, it might be noted).


Free market groups leaped into the issue creating CCE – Consumers for Competitive Electricity and calling for substantive restructuring.  The goal was to move as far as possible toward allowing consumers and producers to reach longer term voluntary agreements on energy.  All restrictions on entry and exit would be removed; government intervention in electricity would be phased out over time.


That happy state of affairs was effectively derailed by an unholy coalition of utilities fearful of bankruptcy, environmentalists fearful of consumer rejection of their policies, and politicians fearful that rates on someone might go up. 


The “compromise” was to free up generators (the utilities for some reason were required to sell off their generating capacity –save for nuclear and hydro which posed special liability problems), were granted a rate increase (a fee levied on transmission to ensure that the “stranded costs” of the utilities would be covered), and environmental programs were continued (albeit at a somewhat slower rate).  To ensure that consumers wouldn’t pay, a rate cap (actually given expectations on future energy costs at the time, a rate floor) was created which could be pictured as pro-consumer while it was expected to help the utilities.  And that became California “Deregulation” – one side of the market free, the other totally regulated.  Moreover, fearful of the mistakes made in the past by utilities (costly “take or pay” contracts entered into during the natural gas shortage era), California banned contracts for long term power supply.  In effect, California utilities would buy their electricity one day at a time with no ability to hedge their bets or vary prices. 


This insanity was prompted by widespread confusion about the future availability and prices of electricity from out-of-state (where it had been cheaper than in California), the belief that the new e-commerce world would reduce energy use levels (people apparently assumed that computers ran off solar cells), and the belief that the world was awash in natural gas.  Several things made this go astray.  Policy pushed almost all energy development nationwide into natural gas (much faster than in years past), moving natural gas from a seasonal fuel to an annual fuel, and thus reducing the inventory/stockpile capacity that had existed.  This year alone some 20,000 megawatts of natural gas power plants have come on line.  Natural gas exploration and development is down and it is not easy to get natural gas anywhere without pipelines – which have increasingly been blocked. 


The grid links to out-of-state power sources are large but now largely exhausted and power needs are growing in these regions also.  With no ability to sign long-term contracts, California had no ability to expand capacity in, for example Wyoming where coal is plentiful and economic needs significant.  Indeed, some believe that the ban on contracts was intended to block any incentive for coal usage.  (An interesting story: in Australia, Japan was persuaded to develop a coal project only after Australia indemnified the company against any risks associated with a Kyoto style tax burden!)  Natural gas usage, which had flattened during the Carter (“There’s no natural gas and thus we can’t use it” era) began slowly to recover and by the 90s was roaring into the lead.  But increased demand with bans on exploration and development and transmission capability weren’t producing adequate new supplies – and, as noted above, the growing importance of year-round utility gas usage weakened the inventory/buffer capacity of the system.


Thus, when gas prices went up sharply, the utilities found themselves trapped – their “rate floor” became a “rate ceiling” and they began losing money fast.  They couldn’t buy from abroad cheaply, spot prices were high and rising, they couldn’t pass along rates quickly – and the situation became that described today.   Short-term relief was provided by enacting the interruptible power contracts, but these are not plentiful, have only limited use and are playing out rapidly.   An insolvent industry seeking to buy mostly from abroad and finding it difficult.  The primary solution is to throw the California taxpayer into the fray – hoping that higher tax rates will be politically less salient than electricity rates.  (Note natural gas rates are going up with a lag because they’re not under the electricity rate cap rule).



What to Do Now?

First, this is California’s problem – not ours.  California has been La La Land – living under the delusion that they can have gourmet meals every day while never experiencing the unpleasantness of dirty dishes.  Santa Barbara is beautiful – how will it be without air conditioning and street lighting?   There are risks and irritations of energy production and distribution but there are also risks of energy scarcity – and these are becoming clearer day by day.


There is nothing unique about electricity.  Had California banned the expansion of supermarkets a decade ago, arguing that California’s were already overweight, and had begun an aggressive campaign of diet books and subsidizing attendance at Richard Simmons’ exercise sessions, there would be “food-outs” throughout the state. 


Conservation creates nothing; it simply moderates demand.  Neither energy nor food needs can be met because someone else is dieting.  The only intelligent way to moderate demand is not to rely upon pleas from politicians but rather incentives from the market.  Cutting the links between buyer and seller has created a kind of energy-rent-control problem in California. 


There is no short term supply fix.  Generators already have every incentive (save the recent risk of not being paid) to send electricity into shortage areas.  The immediate response must be demand side and that requires immediate price decontrols – possibly phased in over the next three months (natural gas price increases suggest the longest possible delay that should be permitted).  When demand and supply are out of equilibrium one wishes everyone involved in solving the problem. Only the market can create that rich a set of adaptation incentives.


Energy assistance programs exist and the truly needy might well be helped during this transitional period.  However, the best way to help the poor is to do so directly – not to keep low the rates of dot com billionaires in Silicon Valley. 


The problem may well get worse before it gets better.  Absent demand side effects, we face sharply higher demands for natural gas.  If current power expansion plans all were completed, the United States over the next three years would have doubled its output of natural gas and natural gas transmission capability.  That is not going to happen – and yet natural gas will be put further in strain.  Recent movements in natural gas futures suggests tightening situations.


The state must act by freeing up consumer prices, seeking to soften transitional problems for smaller businesses and low-income consumers, and moving expeditiously to accelerate the faster possible development of supply and transmission capacity.  Governor Davis has suggested criminal penalties for anyone exacerbating this problem.  Levying charges against a few of the NIMBY groups and their green supporters would be a useful step in that direction.  The state should assign an Energy Ombudsman to represent the consumer interest in energy expansion at every site hearing, capacity expansion, EPA review, etc.  The voices against available energy are large and well-funded – some undoubtedly by California already – the other side of the equation must be heard.


California should push immediately for expanded grid capacity to other states – possibly the Powder River basin in Wyoming and encourage long term contracts to allow new coal-fired capacity to come on line within the next two to four years.  The nuclear option should be reconsidered also – nuclear upgrades have already played an important role over the last five years in allowing expanded energy use and it is time to consider a new generation of nuclear plants.


California should also work with the distribution grids and the other network systems being modernized in the various communities to encourage that these costly dig-up programs leave behind capacity expansion opportunities – for electricity but also water and gas and fiber and cable.  Whatever natural monopoly problem may exist in these areas had been exacerbated by the balkanization of regulated services. 


The federal role is important also.  Secretary Abraham should move as quickly as possible to move America’s energy policy toward a balanced Supply/Demand system.  There is no inherent major conflict between supply expansion and environmental protection.  Environmental groups historically have found it possible, with much earlier and far more invasive technologies, to allow oil and gas exploration in environmentally sensitive areas.  Slant drilling and 3-D seismology allow us to lighten and reduce our footprint on the earth even more. 


The whole complex of energy “efficiency” standards, CAFE, demand side and green light programs should be eliminated at once.  Efficiency is important. We should not allow it to become distorted into a obsession with one specific factor – energy or timber or land.  Mankind wishes to find better recipes, but the ingredients of those recipes should be left to the marketplace and the consumer. 


And of course President Bush has an excellent opportunity to repeat the Reagan policy of freeing up as much of the energy system as possible within the federal scope and using the Bully Pulpit of his office to argue that states tell their citizens the truth.  Lying to people about “easy conservation answers” has been cruel.  It should be ended swiftly. 

Bush could re-legitimize the role of energy abundance in making it possible for the peoples of American and the world to live a better life.  Energy has been demonized – it is time for its virtues to be extolled.


And finally business – both energy producers and energy users – should use this whole exercise as a lesson.  Moving from government subsidies and controls to a market system is complex.  One should not rush to accept short-term agreements that are attractive if these cripple one’s future ability to adapt.  The market is and will change frequently – only a flexible business community free to enter and exit, free to contract or not, can possible offer America a brighter, more comfortable, more mobile energy future.  Getting in bed with the regulators can be exciting – but it creates no long-term stable relationships.