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a difference a few months make. Last spring, President Bush and
politicians far and wide warned that a long, dark, energy night
would descend across America unless we adopt some sort of comprehensive
national energy "plan." While the policy prescriptions
offered by Democrats and Republicans of course differed, both liberals
and conservatives were convinced that markets were broken and only
a muscular intervention by the federal government could get us out
of "Carterville." But alas, the energy crisis that loomed
so large only a few months ago disappeared this summer like a shimmering
mirage on the horizon of a political desert.
As some of
you may have noticed, energy prices dropped a whopping 5.6 percent
in July, the steepest decline since April 1986. Gasoline prices
dropped an even more stunning 11 percent. Energy gluts and declining
profit margins are causing investors to freeze or even cancel energy
infrastructure projects that looked so promising but a few months
ago.
Forgive us
if we gloat, but we told you so. There is not and never was an energy
"crisis." Supplies were not and are not running dry. Markets
were not and are not broken. Regulations have not strangled the
industry.
What happened
then? First, the economy slowed down. Second, political and ideological
gridlock prevented politicians and regulators from doing much harm
while the markets did that supply and demand voodoo that they do
so well.
Now for the
details.
On the electricity
front, the western power crisis was sparked primarily by a massive
increase in natural gas prices. That increase, in turn, was triggered
by a drought (which reduced the output from dams and thus increased
the demand on gas-fired generators), unseasonable weather (increasing
home cooling and then home heating demand), historically low levels
of natural gas inventories (50 percent below the five-year average
in February 2001), and bottlenecks in the pipeline system that kept
gas suppliers from meeting local demand.
This summer,
natural-gas prices have returned almost to pre-crisis levels which
have, in turn, reduced electricity prices almost to pre-crisis levels.
One reason that supplies are ample is because natural gas inventories
are now higher than usual. In fact, the scarcity last winter was
somewhat do to the competition between summertime demand —
buyers looking to stockpile natural gas to replenish inventories
— and then-and-now wintertime demand. Summertime demand "won."
Another reason
that natural gas supplies are robust is because North American production
is up … even without access to additional federal lands. U.S.
domestic production has increased about 4 percent over a year ago
while Canadian production is up 8 percent, which may not sound like
a lot to you but those are big numbers in the energy industry.
A secondary
cause of the power crisis was the large number of gas-fired generators
that were down for repairs last winter. As much as a third of the
state's generating capacity was offline at any given time during
the worst of the crisis. The maintenance backlog from last summer
is now over and a large amount of generating capacity has returned
to the market.
Most newspaper
stories tell us that an important reason for the spectacular electricity
price drop is a spectacular drop in demand. True: Electricity use
in the areas served by the California Independent System Operator
is 4.4 percent lower through July 2001 than the first 7 months of
2000. These newspaper stories then go on to tell us that one of
the main reasons for the drop in demand has been unseasonably cool
weather. False: If you examine the number of "cooling degree
days" in California (the difference between the average daily
temperature and 65 degrees) and weight those figures by population,
you'll find that temperatures through July 2001 where most Californians
live are actually 14 percent warmer than last year.
The drop in
electricity demand is actually something of a mystery. Some of it
is almost certainly due to the retail electricity price increases
imposed in California this summer, but some of it is also probably
due to the crisis mentality that has gripped the state. Once Californians
accepted that the scarcity was real and that it could get even worse,
conservation kicked in beyond what prices alone might have delivered.
And some of it can be attributed to the slowing economy and the
slumping dot.com sector in particular. No one knows, however, exactly
how much each of these events contributed to the drop in demand.
The gasoline
story is, however, a lot simpler. The widespread warnings of $3
a gallon gasoline were about what might happen if a key refinery
or two blew up or if a key pipeline or two ruptured unexpectedly.
Such things are indeed possible (in fact, a fire on August 14 at
a Citgo refinery in Lemont, Illinois has increased Midwestern gasoline
prices by 26 cents per gallon in the last two weeks), but they don't
happen all the time. And they didn't happen in large part this summer.
Unfortunately, most people missed the qualifications in the midst
of the panic and braced themselves for a storm that was never sited
in the first place.
When gasoline
prices went up this spring, people bought less gasoline. And while
it's true that no new refinery has been built in the United States
in about 30 years, there's still room to increase production from
existing refineries when profit opportunities present themselves
…as they did (for a change) this summer. Moreover, foreign
refineries for the first time in memory found it profitable to produce
significant amounts of America gasoline for export. And what do
you know; prices have been dropping steadily since Memorial Day.
The moral of
the story is that markets aren't "broke" when prices spike.
They're working fine; they're just not delivering news that consumers
or politicians are wild about hearing. But no matter how unpleasant
price spikes are in the short term, they're absolutely necessary
to remedy the underlying economic problems. For those of you who
either forgot your introductory economics or have simply spent too
much time reading the op-ed pages (a practice which can dull the
mind), here's how it generally works. On the supply side, high prices
—> high profits —> increased investment —>
increased supply —> declining prices. On the demand side,
high prices —> reduced demand —> declining prices.
While it's
no surprise that liberals find such market success stories a constant
revelation, the real surprise is that the ostensibly "hard-right"
Bush administration had such little faith in a free-market system
it's constantly praising. When the President's chief economics advisor,
Larry Lindsay, was asked by the Washington Post a day after
the administration's energy plan was released whether Cato was right
to argue that markets alone could and would alleviate energy shortages
without any additional federal intervention, Mr. Lindsay said "I
don't think so."
Well, think
again Mr. Lindsay. Price hikes may come and go, but the invisible
hand never takes a vacation.
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