"The number one problem facing electric utilities in the
cold months ahead is getting adequate supplies of coal, oil, and
- David S. Freeman, director of the White House Energy Policy Staff, quoted in BusinessWeek, October 3, 1970
"No homes are going to be without gas or
- Paul McCracken, chairman of the President's Council of Economic Advisors, quoted in the Los Angeles Times, October 11, 1970
"Fuel oil and coal rationing and price controls were
urged by the American Public Power Association in a letter to
President Nixon last week."
- Alex Radin, general manager of the association, quoted in Chemical and Engineering News, Sept. 7, 1970. Radin also called for antitrust action against the 'concentration of ownership of competing fuels' and suggested an embargo on coal export.
As blackouts and brownouts occur with increasing regularity, as fuel prices suddenly shoot skyward, as winter takes its toll of the poor and aged who cannot heat their homes because there is no fuel - it is small comfort to listen to the anxious promises of bureaucrats and the strident demands of lobbyists for price controls, rationing, and other forms of coercive intervention. One does not look to political rhetoric for explanations or analysis; to determine the source of the power crisis requires an inquiry into the economic and political context of the market for power and for its ultimate source, fuel.
A major theorem of free-market analysis is that coercive interventions in the marketplace- whether by restrictions on supply, demand, or prices - inevitably produce shortages and/or surpluses. This is so because in the dynamic process of price determination, supply and demand are continually readjusted so as to be in balance at the free market price. When government interferes with part of this process, the remainder continues to operate as if conditions were normal. If the government enforces a price ceiling on a product, demand for the product will still be a function of its price, but because of the artificially low price, consumption will increase. Unless the fixed price is fixed high enough to afford the producer a good profit, he will have little incentive to expand. Hence, a shortage of the product will develop. In the same fashion, price floors (e.g. farm price supports) tend to produce surpluses.
The power crisis now facing this country consists in a peculiarly interlocked group of shortages, not only of electrical generating capacity but also of every major fuel supply. Behind these shortages lies a system of controls and interventions which not only have failed individually to achieve their intended purposes but have also worked at cross-purposes with one another. I n short, if one wished to wreak havoc in the field of power generation, it would be difficult to design a system that would succeed better than the current patchwork of interventions.
The ultimate source of power - whether for heating or for electricity - is fuel. The four primary types of fuel in use today are coal, oil, natural gas, and uranium (for nuclear power plants). Nuclear power plants provide less than 1% of the nation's total electricity and there is no shortage (at present) of uranium; for a variety of reasons, however, a number of nuclear power plants which were expected to be in operation by this time have been delayed, often by several years. Thus, although the delay in nuclear plants contributes to the power shortage, it is not in itself a part of the fuel shortage. It has contributed to the problem because electric utility officials, not anticipating the delays, were counting on the increased nuclear capacity and, consequently, did not pay sufficient attention to assuring adequate supplies of coal, oil, and gas for the current season. The major shortages of these three fuels are being blamed by the utility companies.
The causes are more complex than that, however, as an examination of the fuel market demonstrates. I n recent years, both because of anti-pollution regulations and because of its relatively low cost, clean-burning natural gas has become an increasingly popular fuel. In order to protect consumers from the perils of capitalism, however, the Federal Power Commission ( FPC) regulates natural gas pricing. In the 1950'sthe FPC made a vain attempt to regulate individual producers, on a case-by-case basis. Even the federal bureaucracy recognizes some limits on the amount of paperwork which can possibly be handled; therefore, in the 60's, the Commission switched to regulation by geographical area. Even so, the injection of politics into the pricing process resulted in an administrative nightmare. The criterion for setting prices was supposed to be based, not on what the consumer's demand indicated (the market price), but rather on what the political process determined was a "fair" return for the producer, regardless of demand. As a political process, the rate decisions were often challenged in court by one faction or another, who differed on the definition of "fair". The court cases often took several years, and when a previously-set price was eventually ruled "excessive," the producer was ordered to pay huge refunds.
The combined effect of lower than-market prices and the continual threat of court-ordered refunds, needless to say, has had a powerful disincentive effect on the producers' desire to explore and develop new sources of natural gas. At the same time, the lower-than-market prices provided a strong stimulus to demand for natural gas, since as time went on it became a relatively cheaper and cheaper fuel. The final straw was provided by the money market of 1969 and 1970; with interest rates at 9 and 10%, gas producers could frequently earn a much better return on their money by investing it, rather than spending it on bringing in new sources of gas. Thus, fall and winter of 1970 found many of the pipeline companies and utilities unable to buy sufficient gas from the producers- the latter simply were not producing at the old fixed price. It should be pointed out that as of now there is no actual shortage of natural gas supplies; known reserves (i.e., neglecting all probable but unconfirmed sources) are sufficient for many years. It is just that there is no reason for producers to bring it to market at current prices.
The FPC is finally beginning to bestir itself and admit that something is wrong with its position; it has cautiously proposed exempting small producers from price regulation and has talked about granting large producers a 5 cent per 1000 cu. ft. increase (on new-well gas only). Industry economists estimate that the free-market price would currently be about 10 cents above the current average price of 40 cents per 1000 cu. ft. Thus, the FPC's moves are only a minor step, applying to only a fraction of the market; further, they leave unchanged the basic principle that the government, rather than the market, should determine the price. In that the Commission only invites further shortages. Pipeline companies are taking what few steps they can to obtain more gas.
Several are planning to import liquified natural gas (LNG) from Algeria and Venezuela, although the first small amounts will not be available until late 1971. The price of the imported LNG is expected to be between 65 and 70 cents per 1000 cu. ft. - another indication of how far out of line the current 40 cents price is. Pipeline and utility companies presumably have enough demand for gas to be willing to pay such a price by next winter. If the past is any guide, the shortages will probably be worse by then.
Oil production is probably more entangled in politics than any other industry. Although a complete analysis is beyond the scope of this article, the salient points concerning regulation of supply and pricing can be summarized briefly. The U.S. oil market is divided between the thirty "majors" - large international oil producers - and some 15,000 "independents" - small and medium-sized domestic producers. The federal government controls the market by setting oil import quotas and regulating interstate oil shipments, while the state governments set monthly production quotas. With this type of politico-economic structure, the lobbying aims of the majors and the independents are somewhat different. The majors tend to oppose import quotas and assistance to Israel; they have a stake in Arab oil and want to ensure that they can continue to obtain it and sell it in the U.S. The independents, by contrast, "count amongst Israel's best friends…and they are careful always to advocate a policy which will prevent the flow of Arab oil from endangering their industry, wealth, and future" (from Survival, June 1970). They consequently favor strict import quotas.
The President's Task Force on Oil Imports found that import quotas, by restricting imports to 12.5 percent of U.S. consumption, drive up the price of oil from a free market level of $2.24 per barrel to about $3.90 per barrel. Put another way, the Task Force estimated that American consumers last year paid about $5 billion more for oil products than they would have in the absence of import restrictions. Thus, the widespread complaints by users- both individual consumers and utilities- about the high price of oil supplies, is largely a result of the quota system. In addition, the state regulatory agencies, such as the Texas Railroad Commission, set monthly oil production quotas for the industry, at a certain percentage of the wells' maximum production rate (e.g., for September 1969 the Texas quota was set at 3,354,696 barrels per day - 53.7 percent of the wells' ability to produce). The effect of such quotas ( another cozy arrangement between the government and the producers) is to restrict the supply in order to support the artificially high price level. The quotas thereby prevent "destructive competition" between producers, in response to the high demand by consumers and utilities.
Once more, the regulations contribute to the non-market high price and short supply. There is an abundance of oil, both in the U.S. and abroad (not only in the Middle East but also in Canada, Latin America, Indonesia, etc.) Foreign oil prices are generally about half of U.S. prices and are generally trending downward, while U.S. prices continue to increase. (As this is written, the foreign oil price is temporarily inflated by the tanker shortage caused by the Middle East war. This is only a minor exception to the general trend, although it does exacerbate the current supply problems.)
It is massive political interference with the market that gives the illusion of shortages to the U.S. consumer.