Inflammatory Rhetoric
Most of what you've probably heard about natural-gas control isn't true. And much of it probably came from a single source…
Pipeline to Disaster…Bleak Harvest…Gas Bill Blues—the titles virtually jump off the page at you. They represent just a few of the mountain of reports, studies, and press releases issued by the consumer advocacy group Citizen/Labor Energy Coalition (CLEC) and its research affiliate, the Energy Action Educational Foundation (commonly referred to as Energy Action). Moreover, the documents' contents seem to warrant fully the unabashedly alarmist tone of their titles, for together, they paint a grim picture of what will happen if the price of natural gas is deregulated: millions unemployed, skyrocketing prices, and many thousands left without heat—all because of the natural-gas industry's rapacious hunger for profits.
The price of natural gas, whose regulatory history stretches back to the '30s (see sidebar, p. 28), is presently regulated under the Natural Gas Policy Act of 1978. Congress passed the act to reverse the decline of the nation's natural-gas supply—a decline fostered by 40 years of regulatory policy and sharply felt during the bitter winter of 1976–77, when increased demand resulted in a painful shortage. To stimulate production, Congress in 1978 removed price controls on certain categories of newly produced gas and allowed the gradual decontrol of the other categories, working up to total decontrol of all so-called new gas by January 1, 1985. Price controls on so-called old gas were to be left intact until all is used up.
The Reagan administration, however, has long considered revisions of the 1978 act, including decontrol of all gas in one move—as it did for oil in early 1981. Thus, within government, the gas and energy industries, and the public at large, the debate over natural gas has grown to a fever pitch.
The Citizen/Labor Energy Coalition and Energy Action, two formerly independent consumer groups that merged in 1981, are among the most vocal in the debate. They fervently advocate regulation and oppose any decontrol of gas prices, even as provided by the 1978 act. The consequences of decontrol, they warn, would be horrendous:
• A 1981 Energy Action study predicted that if gas is decontrolled, "across the country, industries will be crippled—and many small businesses bankrupted—by sharp and unavoidable price increases. Decontrol will cause an increase in unemployment, a decline in productivity, and a big boost to the inflation rate."
• A 1982 CLEC study, Pipeline to Disaster, claimed that if gas had been decontrolled in 1981—signs of which were emanating from the Reagan administration—over the subsequent four years the economy would have lost almost three and a half million jobs, "an average of 860,000 per year."
• And a CLEC study released in February this year, Gas Prices Out of Control, says that under the 1978 decontrol, "consumer gas costs will rise by at least $135 billion over the next four years." And if the Reagan administration "succeeds in accelerating the decontrol process, costs would rise an additional $50 billion," predicted the study.
This aggressive assault on decontrol has gotten a lot of attention. CLEC and Energy Action have become "authorities" within the natural-gas debate. Their representatives testify on energy issues before congressional committees. The mainstream media—from United Press International to the Los Angeles Times to Time magazine—report the groups' statistics and approach their spokesmen to comment on natural-gas issues. The results of their studies are regularly reported as facts by the AFL-CIO News, the Senior Citizens News (the monthly newsletter of the 4-million-member National Council of Senior Citizens), the ultraleftist In These Times, and the communist paper Daily World.
It is not insignificant, then, to wonder whether CLEC's and Energy Action's reports, with their powerful—if populist—argument against the decontrol of natural gas, are to be believed. Who are these self-styled "consumer activists," and what do they want?
Birth of a Coalition
The merger of CLEC and Energy Action in December 1981 marked the formation of one of the most powerful activist coalitions ever assembled by the left. Energy Action was founded in 1975 to research energy issues from a consumerist perspective. Through its original executive director, James Flug, it had become a well-established presence on Capitol Hill, with close ties to Sen. Ted Kennedy (D–Mass.), thus ensuring the organization numerous contacts in the media and an airing of its views. What it lacked, however, was a constituency.
Like most consumer groups, Energy Action claimed to speak for the public, but its actual membership was never very large. In fact, shortly before the merger, in questioning before a House subcommittee, Flug was forced to reveal that most of the group's funds came from only a few large donors (such as Paul Newman). With this blow to Energy Action's credibility, its marriage to CLEC couldn't have come at a better time.
Established in 1978, several years after Energy Action, CLEC represented a loose amalgamation of labor unions, so-called consumerist groups, and local activist groups with ties to the leftist Midwest Academy in Chicago. By counting the members of its affiliate groups (especially the larger labor unions), CLEC claims to represent a large enough group of people to give it the credibility that Energy Action had lacked—it now boasts a membership of more than 13 million. At the same time, Energy Action's "research capability" helped CLEC give ammunition to its troops out in the field.
Actually, the merger really did little more than to formalize a relationship that had long existed between the two groups. Before the merger, Jim Flug had already been a member of CLEC's executive committee, and the groups shared a common view. Among the other CLEC executive committee members were Tom Hayden, of the Campaign for Economic Democracy; Ellen Berman, of the Energy Policy Task Force; Douglas Fraser, of the United Auto Workers; Lloyd McBride, of the United Steelworkers; Jerry Wurf, head of AFSCME, the public-employees union, until his death in 1981; and Robert Brandon, of Public Citizen, one of Ralph Nader's groups. (Brandon assumed the organization's executive directorship at the time of the merger.)
CLEC's success in organizing at the local level is unsurprising given its close ties to the Midwest Academy. The academy was founded in 1973 by Heather Booth, who also founded CLEC. In fact, she served as executive director of both organizations up to the time of the merger. The academy was an outgrowth of Booth's desire to see "a network of popularly-based statewide organizations with growing ties to labor and Left Democrats."
According to a June 1982 article in In These Times (a publication of the leftist Institute for Policy Studies), in establishing the academy "Booth set out to combine Alinsky's [Chicago activist Saul Alinsky of Rules for Radicals fame] methods with some of the goals of the '60s left. The students not only learned how to write a leaflet, organize a press conference and stage a dramatic protest, but also were encouraged to read Sheila Rowbotham's Women, Resistance, and Revolution, and articles on workers' control of industry by British socialist Michael Barratt Brown."
The article reported that "the Academy alumni constitute an informal network of political organizers that span the concerns of the post-'60s left.…In 1979, the network was formalized through the founding of Citizens Action, a national organization of eight statewide groups, and CLEC. CLEC, founded by Booth and [International Association of Machinists] president William Winpisinger, brought labor officially into the Booth coalition strategy."
In a December 1980 article, In These Times writer David Moberg explained CLEC's raison d'être thus: "Energy supplies and prices are too important to leave in corporate hands. Both must be controlled by government in the public interest to assure equity, to minimize disruption of communities, to promote conservation and renewable energy sources, and to minimize monopoly power." To achieve this end, Booth envisioned CLEC as one component of "a common anti-corporate political program that would be supported in 1984 by 500 candidates running for a variety of political offices," according to Moberg. These candidates, the leftist network hopes, will spearhead multi-issue coalitions and will be funded in large part by labor unions. The movement's need for union funding was made all the more necessary by a loss of federal funds that accompanied the advent of the Reagan administration.
Even from the organization's earliest days, some questions had been raised concerning CLEC's receipt of federal funds. There was, for example, a February 15, 1979, memorandum from John Lewis, associate director of domestic operations for Action, a federal agency established in 1971 to promote citizens' self-help groups. Lewis cited a number of areas of concern about CLEC's relationship with the Midwest Academy. "In reviewing the staff of CLEC," noted the memo, "we discover that Heather Booth is listed as the Executive Director of CLEC. She is also the Director of the Midwest Academy which is providing training to CLEC. There appears to be a conflict of interest which needs to be reviewed." Lewis's concern was that since the Midwest Academy was receiving Action funds to train activists, was CLEC being funneled federal funds without going through the required review process?
"It should also be noted," continued Lewis, "that the addresses of CLEC and the Midwest Academy are the same, 600 West Fullerton, Chicago, IL 60614. Unless that address is of a large building involving many organizations that are not affiliated with each other sharing a common address, then we should question whether or not CLEC is simply using the Midwest Academy's Chicago address for its own convenience. While the commonality of the address deserves some consideration, the substantive question is whether or not there is in fact a genuine organizational separation between CLEC and the Midwest Academy."
The 1979 Action memorandum raised one other issue that provides, at a minimum, a bit of comic relief. "A final note: CLEC conducted a Regional meeting several months ago to develop its Coalition. The meeting was conducted in Cherry Hill, New Jersey, which is one of the wealthiest communities in the country, a place where low income people are not likely to frequent."
But it seems as though CLEC eventually worked out its problems with the federal government—at least for a time. Between 1979 and 1981, the group received several grants from federal sources—including $30,000 from Action, $57,640 from the Department of Energy, and $200,000 from the Community Services Administration—as well as the government-funded services of eight VISTA trainees. With the Reagan-initiated cutoff, however, CLEC has turned to a time-honored means of fundraising—door-to-door soliciting—to supplement its labor-union funding. More important, door-to-door canvassing not only raises money but brings CLEC's message to the general public as well.
It is this grass-roots campaign that makes the efforts of CLEC and Energy Action unique. Active in some 35 states, with a special emphasis on five major metropolitan areas (including Washington, D.C., and New York), CLEC estimates that its message reaches 50,000 people every evening. This tactic is made all the more effective by CLEC's extensive use of local volunteers—often college or high-school students. It would be hard to overestimate how persuasive a CLEC spokesperson might be when the person is the son or daughter of your next-door neighbor and is armed with Energy Action's impressive statistics. The question is, are the statistics valid?
In spite of the impact of CLEC's and Energy Action's studies, the fact remains that among observers of the energy scene, they are the subject of controversy. The most frequent criticism is that CLEC and Energy Action "hype" their figures to prove their points and frequently ignore basic economic principles in computing these figures. Critics contend that their reports are, at a minimum, biased; at worst, outright fantasy. Do these charges stand up?
Slippery Oil Analyses
Typical of the criticisms concerning CLEC and Energy Action studies are those levied at Energy Action's Divestiture Factbook. The report was published in 1976 to promote passage of a Petroleum Industry Competition Act, which would have required major oil companies to divest themselves of certain assets. The energy industry called the study misnamed, because it "summarizes familiar and still unsupported and unsupportable charges."
For example, implicit in the study's criticisms of the oil industry is the assumption that the oil markets are not competitive. The weight of evidence, though, does not support this view. Some 10,000-odd firms are engaged in exploring for and producing oil and gas, and concentration in the oil industry is lower than the average for all manufacturing in the United States. Moreover, a relatively large number of companies have entered the business since the end of the Second World War, so entry into this market appears to be quite easy.
Finally, despite a few bulges in the oil industry's profit picture—which coincided with some of the larger OPEC price increases—oil-company profitability has not generally exceeded that of other manufacturing concerns. During the five years following the 1973 OPEC embargo, oil-industry profits averaged about 1½ percentage points above the average for all industries. Today, oil profits have declined to levels below the average for all industries. So the tests that economists apply to determine competition in a market—degree of concentration, ease of entry, and profitability—all tend to oppose the notion that the oil industry's structure is monopolistic (dominated by a single large firm) or even oligopolistic (dominated by a few large firms).
Could Energy Action merely have interpreted these facts differently? There is, after all, wide room for disagreement among economists. This explanation seems doubtful when one considers cases in which the figures used by CLEC and Energy Action exceed the bounds that could properly be attributed to differing economic interpretations.
To illustrate this, consider one of the most widely quoted CLEC reports—a 1981 study of the effects of decontrolling natural-gas prices, entitled Gas Bill Blues. In describing their methodology, the study's authors state: "For each region the per month increase in well-head costs is computed by determining the difference between current well-head costs and the well-head costs equivalent to $60/barrel of oil ($10/Mcf)." (The wellhead price of oil or natural gas is that charged by the producer, who drills and operates the wells. The price of oil is in dollars per barrel and that of natural gas in dollars per thousand cubic feet [Mcf]. Analysts compare the prices of oil and gas based on the amounts of each that will yield the same amount of energy—this being expressed in BTUs, for British thermal units.) The CLEC study's methodology is assailable on two counts.
First, the $60-per-barrel oil price projected by CLEC for 1984 strains credulity under current market conditions and was little more credible when CLEC released its study. With the recent disarray in OPEC and the widespread discounting of oil prices by its members, the average composite of crude oil now stands at around $31.00 per barrel. To reach $60 in 1984, it would have to increase nearly twofold over the next two years. But oil prices had actually peaked in March 1981, when the composite price (an average of foreign- and domestic-oil prices) hit $37.48 per barrel. By the time CLEC issued its report, in September 1981, the composite price had dropped to $34.11.
Second, even if we give CLEC's analysts a large benefit of the doubt about $60 oil (after all, projecting oil prices is at best a risky business), their figures are still way off-base, for it is not just the specific oil price they use to determine future gas prices that is at issue. Of far greater concern is the manner in which CLEC's analysts used that price to derive the equivalent price of natural gas.
Projecting natural-gas prices is an arcane art, but there are certain methods and practices upon which virtually all experienced analysts agree. Among them is the notion that the wellhead price the market would establish for natural gas—that is, the price under decontrol—would equal some fraction of the price of an equivalent amount of crude oil, using heat content (BTUs normally) as a measure. Thus calculated, credible estimates of decontrolled gas prices range from a low of 55 percent of the price of an equivalent amount of crude (this from the American Gas Association) to a high of 70 percent (Department of Energy). In no instance is there any widely accepted estimate that uses the full world price of crude oil as a basis to calculate the equivalent wellhead price of natural gas. Several factors account for this.
First, the so-called burner-tip, or retail, price of natural gas is based on three elements: (1) the price of gas at the wellhead, (2) the cost of transporting it by pipeline to the local market, and (3) the cost of distributing it by the local utility to the ultimate end-user. Normally, transportation and distribution charges constitute the largest portion of the consumer's cost. At present, in fact, they account for fully 60 percent of the average retail price.
Second, the largest user of natural gas is industry, where the ability to switch to the alternate fuel (residual fuel oil) is widespread. Therefore, the end-use price of gas must be low enough to compete with alternatives. This effectively puts a cap on what pipelines are willing to pay at the wellhead that is considerably below the full crude-oil equivalent, calculated on a BTU basis. (This is especially true now, since the price of residual fuel oil has averaged nearly 20 percent less than that of crude oil in recent months.)
Empirical evidence shows that when faced with high natural-gas prices, industrial customers do not hesitate to switch to alternatives. After passage of the Natural Gas Policy Act in 1978, when certain categories of gas were decontrolled, pipelines competed vigorously for the new supplies, fearing to be caught short of reserves (as many were during the record-cold winter of 1976–77). The price of this new gas was thus bid up. The pipeline serving the local gas utility in the Baltimore area, for example, locked itself into high-cost-gas contracts resulting in a 30 percent boost in gas prices for end-users. The utility's subsequent loss of industrial load was so alarming that it went to court, attempting to force the pipeline to accept cheaper gas from other sources. Nationwide, industrial users consumed 9 percent less gas in 1979 than in 1973 and are expected to double that reduction by 1990. And for commercial users, gas consumption was about 12.5 percent lower in 1979 than in 1973.
Third, higher gas prices will reduce not just industrial and commercial use. Over time, even some residential users will either switch to alternate fuels or install more-efficient equipment to reduce consumption. And many, of course, will simply turn down their thermostats, take shorter showers, and use the oven less. For example, residences consumed 15 percent less gas in 1979 than they did in 1973. Even using as a cap the price of number-two fuel oil—which most oil-heated residences consume—any natural gas selling for $10 per thousand cubic feet at the wellhead would be uncompetitively expensive. (Because the Natural Gas Policy Act of 1978 created around 30 pricing categories for gas, prices at the wellhead vary by as much as 3,500 percent. By "rolling in" the price of expensive gas with cheaper-priced gas, pipelines are currently paying at the wellhead an average of between $2 and $3 per Mcf.)
Why then, given these facts, did CLEC choose to base the wellhead price of natural gas on the full world price of crude—an inordinately high price to begin with? And most important, were these isolated examples, or were they characteristic of CLEC and Energy Action analyses? As I studied the groups' reports and press releases, those were some of the questions I sought to answer. And they were among the questions I put to CLEC analyst and Energy Action Director Edwin Rothschild in a recent interview.
Anticorporate Missionary
Energy Action's offices are located just off Washington's trendy Dupont Circle in a nondescript building that belies the organization's importance as a source of information and opinion to the media. Typically bustling with activity, there can be little doubt to even the casual observer that Energy Action is serious about its mission. Phones ring constantly, stacks of the latest Department of Energy and Federal Energy Regulatory Commission reports rise from desktops, secretaries pound away at typewriters. To no small degree, the level of activity in Energy Action's office indicates how much of a shot in the arm was its merger with CLEC.
When the two groups merged, in 1981, Ed Rothschild stayed on as director of what is now called the Energy Action Project of the Citizen/Labor Energy Coalition. At the time of the merger, Rothschild had been with Energy Action for some six years, having risen to the position of director prior to the union. Intense and articulate, his staccato denunciations of "big oil" reveal a missionary zeal that underlies his assault on corporate America. A clear element of distrust of large oil companies seems to pervade his thinking.
He believes, for example, that collusion and price-fixing are widespread within the oil industry. "I don't think OPEC works alone," Rothschild says. "I think they [the OPEC producers] work together very closely, albeit from a different perspective, with the international companies." It is this belief that leads Rothschild to conclude that regulation of the oil industry is necessary. Yet, paradoxically, Rothschild also claims to prefer market solutions. "I don't like government regulation," he told me, "I really don't."
While Rothschild may claim not to like regulation, his solutions to energy problems invariably have a regulatory component. So I pressed him to offer circumstances he felt would permit gas decontrol. "I wouldn't go for decontrol under any circumstances," he said flatly.
Rothschild did admit, however, that there is mounting evidence that a competitive market exists in oil. Although not yet ready to concede this point, he claimed to have an open mind on the subject. "If I see continued price erosion, and more and more price competition in the world market, I'll become a believer that the market can work in oil," he said.
He does not believe, however, that he could ever see a competitive market in natural gas as long as the current market structure exists. Since interstate pipelines purchase gas from field producers and sell it to end-users, they have a "conflict of interest," claims Rothschild, that precludes competition.
What about CLEC and Energy Action's track record on the issue of oil decontrol? I asked. A number of their earlier studies, before oil was fully decontrolled in early 1981, had warned of the costs of such decontrol. I brought up, for example, an Energy Action press release of March 1979 with this headline: "Price Decontrol Brings Oil at 'Astounding' Costs of $56–$870 per Barrel." The text of the release went on to elaborate: "During 1980 and 1981, for each barrel of oil newly produced as a result of decontrol, the cost to the US economy could range from at least $56 per barrel under the most optimistic assumptions, to about $870 per barrel under assumptions which many experts believe are realistic. This compares to the current average U.S. domestic price of about $9.50, the U.S. 'new' price of approximately $12.50 per barrel, and the current OPEC price of $13.34."
The release quoted James Flug, then Energy Action's director: "'The essential flaw in the whole decontrol theory is that Americans would have to pay decontrolled prices for huge amounts of oil which would have been produced anyway. Thus, even if decontrol does in fact stimulate a few extra barrels of oil, the total cost to the economy of those few barrels is so high as to make decontrol the most nonsensical, irresponsible, and expensive energy supply strategy imaginable.'" As I reviewed the release and Flug's comments, a number of questions arose in my mind.
For one, the exact nature of the "cost" figure used is highly puzzling. In Energy Action's analysis, the "cost" was computed by taking the additional revenues that would accrue to producers in the early years of decontrol, and then dividing them by estimates of the marginal production that removal of price ceilings would stimulate. No attempt was made to adjust this so-called cost for state severance taxes (often as much as one-eighth of the selling price). The oil companies' increased production costs for pumping up harder-to-get-at oil were not considered. Nor was it acknowledged that only in the absence of controls are such enhanced recovery techniques economic. Most important, the study made no mention of the need for capital to finance exploration and the development of new fields. Nor did it mention the time frame needed for such efforts to show results. It is here, perhaps, that the study was most seriously flawed.
For more than two decades, from about 1957 to about 1979, investment in domestic exploration for oil had been declining. As a direct consequence of that decline, the level of domestic "proven reserves"—the total of identified and measured amounts of oil in the ground—shrank, and US oil consumers slowly became more dependent on foreign sources. The availability of cheap, Mideast crude was the initial cause of the slowdown in investment. But the Nixon administration's imposition of domestic price controls on crude oil in 1971 greatly exaggerated the trend by seriously hindering investment in exploration. In fact, the express purpose of later price decontrol was to address this very trend and, at a minimum, to halt the steady erosion of the domestic reserve base. With luck, some geologists and economists thought, the trend might even reverse.
As with any long-term trend, however, results were not expected in the short term. Even after oil is discovered, it normally takes at least three years to bring an oil field into full production. Development wells first must be drilled, gathering lines put in place, and, sometimes, treatment plants installed. For an offshore oil field, the time frame is even longer, taking as much as 10 years. Therefore, the short time horizon assumed in Energy Action's study—two years, at most—totally disregarded the time frame within which most of the benefits from decontrol would materialize. (In its report, Energy Action cited certain studies as the source of its estimates of post-decontrol oil supply. Interestingly, for the years beyond Energy Action's two-year time horizon, these same studies projected much higher figures for additional oil produced as a result of decontrol.)
So I asked Rothschild about the $870-per-barrel figure used to assess the cost of oil decontrol in the study. At first, Rothschild was somewhat evasive. He said he was unsure if he had worked on that particular study, noting that it was published under Energy Action's previous director, James Flug. Eventually, though, he did acknowledge that he had worked on the report but said, "It wasn't really a marginal-cost study." Yet, the press release said that it was measuring the "per barrel cost of such additional supplies"—in other words, what economists would call marginal supplies. But, what then was the study measuring? I asked Rothschild. "All of the cost increase" of decontrol.
What did happen to the per-barrel price of oil following decontrol is now, of course, a bit of history. As economic theory predicted, the market bid up the price of oil from its artificially low price under controls, and the higher prices stimulated both more production and consumer conservation. The price peaked in March 1981 (at $37.48 per barrel) and has been on a downward trend ever since, presently averaging about $31.00 per barrel.
A particularly disturbing—and revealing—aspect of the Energy Action oil-decontrol study is its assumption, albeit unspoken, that, while the market price of crude oil would not reflect its true value, a federally established controlled price would. This notion flies in the face of both logic and economic theory. If there is a willing buyer for a commodity and a willing seller, then the price they voluntarily establish through their transaction is an accurate measure of that commodity's worth to both parties. If it were not, no transaction would take place. It is only when a third force—government, for example—coercively interposes itself in such transactions that the price fails to reflect the true value of the commodity to each party.
More important, this assumption gives rise to the notion that the profits—or, in the scholar's jargon, the "economic rents"—from the production of oil do not belong to the firm or individual who produces it. Here again, with the exception of Marxist economic theory, there is no widely accepted discipline that would support Energy Action's implicit assumption regarding the rents from oil production.
This point came up in my discussion with Rothschild, this time in connection with gas decontrol. Although he claims to believe in the necessity of "incentive prices," Rothschild does not believe that producers should receive a market price for their gas. "What is inhibiting new gas drilling is not the price—it's the glut," he said. But more to the point, he questions the right of producers to reap the full economic benefit of their production. Asking, "Why should the economic rents be kept by producers of that gas?" Rothschild made clear his opinion that natural gas is, in some sense, a commons—something that belongs to all.
Moreover, Rothschild rejects the notion that price controls create artificial prices. "Where you draw the line between what's artificial and what's real is really a serious philosophical argument," he contended. But "under controls," he said, "you would have adequate prices and incentives."
Ignoring the Facts
Clearly, Rothschild is thoroughly familiar with at least the terminology of energy economics and with economic theory about how the energy market operates. I wanted to know, then, why some of the CLEC and Energy Action studies in which he participated seem to completely ignore basic principles of economics. As an example of this, I mentioned CLEC's assertion, in its Gas Bill Blues study of 1981, that the wellhead price of natural gas would rise to the full BTU-equivalent world price of crude oil if federal price ceilings were lifted.
"When we did our first study back in February of 1981," Rothschild told me, "we made a number of assumptions. We said that, early on, oil companies said that gas would be the equivalent of oil at the wellhead. We quoted some people making that argument. I don't buy that argument. But, if in fact that were the case, that would be [an] extremely high price of gas. But there is no question in my mind—realistically speaking, we don't think that the price of gas is going to go to the wellhead oil equivalent price." Remember, Rothschild represents an organization that predicted that following decontrol, gas prices would increase to the full equivalent of $60-per-barrel crude oil.
Even more surprising is what followed. "Where the equivalency will be," Rothschild said, "is more at the consumer end, where the price will more nearly equate with number-six or number-two fuel oil, depending on the markets served." What makes this statement so astonishing is that that's precisely where industry experts predict the decontrolled price of gas would eventually settle.
My question, then, was why CLEC/Energy Action had apparently reversed its previous posture. Rothschild had a ready reply: "We now are not going to talk about wellhead equivalency any more, because no one buys it, no one believes it's going to happen, and realistically, it's unlikely." But, then, I wondered, if they now see that prices wouldn't go that high, does this mean that the organization will no longer advocate controls? Not on a bet. "There's no question that we would have a regulated price," said Rothschild.
And some of the methods that CLEC/Energy Action seem willing to accept in the name of regulation of the gas market are disturbing. For example, during our interview Rothschild expressed open admiration for the ability of Canadian officials to seize a firm's records. "They don't have to go through the process of getting subpoenas," Rothschild noted. "They can just walk in and get the files." This ability may well facilitate bureaucratic inquisitions. But like most infringements on freedom, it holds enormous potential for abuse. When coupled with Rothschild's view of the illegitimacy of profits from gas production, the scenario is, to say the least, alarming.
One can almost picture the hordes of Energy Department bureaucrats swarming over the files of firms ranging in size from Exxon to no-name independents holding only a few barrels of oil or small amounts of gas. In such circumstances, the smaller producers would most likely be the ones charged with violations and driven out of business, for they can least afford the expensive legal talent to cope with complex regulations. Ironically, circumstances precisely like these, which Rothschild seems to favor, might eventually bring about the very big-oil domination of the industry he believes now exists.
It is not only economic theory that CLEC and Energy Action studies ignore—sometimes they simply ignore the facts. For example, in June 1981, Energy Action released Where Have All the Dollars Gone? A press release accompanying the report quoted Rothschild: "This report shows that the [oil and gas] companies are accumulating cash faster than they are able, or willing, to spend on the legitimate search for oil and gas."
What are the facts? Between 1978 and 1980, oil-industry revenues from domestic production grew at a 37 percent annual compounded rate. Over the same period, outlays for exploration and production grew by a 49 percent annual compounded rate. Moreover, between 1980 and 1981, when domestic net income for the oil industry was essentially flat, outlays for exploration and production grew by fully 45 percent.
Rather than underspending on exploration and production, domestic firms are actually spending substantially more than their domestic net income. In 1979, investment in domestic exploration and production exceeded domestic net income by 47 percent; in 1980, by 44 percent. In 1981, when the profits of the 25 largest oil companies totaled $28 billion, these companies invested $53 billion in exploration and development—nearly double their profits. Overall, the oil industry invests about $1.50 this way for each $1.00 of profit.
These figures hardly depict an industry that has far more income than it is willing to put into exploration. It appears, then, that garnering headlines by issuing sensational reports is of far more importance to CLEC and Energy Action than is reasonable and economically sound analysis of the facts.
Controls and More Controls
A further, glaring example of this headline-hunting tactic is a statement issued by William W. Winpisinger—president of the International Association of Machinists, president of CLEC, and an avowed socialist—on the occasion of CLEC and Energy Action's merger. At a December 1981 press conference to announce the merger, Winpisinger alleged that had natural gas been fully decontrolled earlier that year—as the Reagan administration had once proposed—"every American household" would have ended up "paying $50–$100 per month more in their gas bills." This certainly would have been a serious burden for millions of families—if it were at all possible. No such increase, however, could have ensued.
The magnitude of the price rise Winpisinger projected was by itself so large as to lack credibility. The burner-tip price would have had to increase by between 91.7 percent (to equal a $50-per-month increase) and 183.4 percent (to equal a $100 rise). Moreover, these events would have had to occur in the face of a number of restraining factors.
Mr. Winpisinger made no mention, for instance, of what local public-utility commissions would be doing while the price hike took effect. Nor did he consider the effect of long-term contracts, which many pipelines companies hold with producers. Recent estimates indicate that as much as 16 percent of all natural gas is under long-term, fixed-price contracts at levels substantially below the current market rates, much less the enormous prices Winpisinger's statement alleges.
Finally, no consideration seems to have been given to the interaction of the supply and demand of natural gas and how this works to hold down prices. (If increased prices for gas stimulate greater production and thus increase the supply, more gas will have to compete for buyers. But as prices rise, demand will decline: some users will switch to other fuels—which, in the face of gas-price rises, will have become competitive—and some will reduce their consumption. Producers, then, respond by lowering prices. Eventually, the price will stabilize at some midway point.)
While the CLEC statement may have been good press, it was bad analysis. But press relations have always been both CLEC's and Energy Action's strong suit. "High-exposure, low-cost lobbying" is their "trademark," one Houston Post writer observed. "Their studies predicting heating bills could double, or even triple, under total decontrol were loudly denounced as containing 'hyped-up figures' by those supporting decontrol, but nonetheless made headlines, and generated letter writing campaigns to Congress."
One study that made headlines is an Energy Action report, released in May 1981, on oil companies' land holdings. It claimed that the "major oil companies are sitting on land the size of the state of Texas that is not producing any oil or natural gas." The press release accompanying the report quoted Ed Rothschild: "These findings clearly demonstrate that the major oil companies, not the Federal Government, have been locking up land in order to cash in on higher oil and gas prices" in the future. He went on to say, "This private lock-up has resulted in less oil and natural gas production and more reliance on OPEC oil as well as immense profits for the companies." These are headline-grabbing statements indeed, but do they have any basis in fact?
To arrive at these conclusions, Energy Action cleverly drew an artificial distinction between what it called "developed" and "undeveloped" acreage. The only trouble with this distinction is that it had no relevance to the issue at hand—that is, whether or not the oil industry was deliberately holding back production on its leases. Energy Action defined "developed acreage" as land on which oil or natural gas was already being produced in commercial quantities. But this totally ignores the fact that many other activities must precede the commercial production of fuel from a given lease. Further, it ignores the fact that a dry hole could be drilled or that noncommercial quantities of oil might be discovered. In short, the definition is such that it assures a "proper" conclusion, even if accidentally.
Perhaps more disturbing, though, is that other information—such as the domestic-rig count or the number of exploratory wells drilled—would have all tended to refute the contention that oil firms were not vigorously pursuing new domestic supplies. This information was certainly available to Energy Action—it exists in numerous public documents—yet it was not cited or even considered.
On another point of methodology—CLEC's and Energy Action's use of nominal, rather than constant (inflation-adjusted) dollars when projecting future costs—Rothschild said to me, "The general public doesn't deal in constant dollars." I noted that the use of nominal dollars would tend to overstate the effect of an economic phenomenon. When pressed as to whether some measure with less bias, such as indicating future costs as a proportion of income, might not be preferable to the use of nominal dollars, Rothschild responded, "I think that's right. That's a good way of doing it." But if it is "a good way of doing it" now, why hadn't CLEC and Energy Action done something like it all along?
While Rothschild now acknowledges that previous studies overstated how high the price of natural gas would rise under decontrol, those studies remain a part of the public record and continue to misinform people. Why, one might ask, aren't corrections issued? Similarly, now that experience has proven that CLEC's initial predictions regarding the cost of oil decontrol have proven incorrect, why isn't the record set straight there, as well?
As he does with these questions, Rothschild deftly jumps around the various issues of natural-gas decontrol. After acknowledging, for instance, that the market clearing price would be about where the industry says, and that price incentives are needed to stimulate production of new gas supplies, and that current controls don't work, he still suggests that the obvious answer to the problem is more controls. This, it should be noted, despite the fact that Rothschild claims that he doesn't like government regulation.
Time and again in my discussion with Rothschild, he glossed over inconsistencies and contradictions in CLEC and Energy Action studies, often acknowledging at the same time the validity of my criticisms. Still, in the end, he continues to advocate the same positions and to make largely the same arguments.
This was made painfully clear on March 22, 1983—after my interview with Rothschild—when he testified before the Subcommittee on Fossil and Synthetic Fuels of the House Committee on Energy and Natural Resources, on the subject of further controlling rather than decontrolling natural gas prices. In his prepared statement, Rothschild said: "In its report, 'Gas Prices Out of Control: The Cost of Inaction,' the Coalition found that maintaining the status quo-the Natural Gas Policy Act—would raise wellhead prices by 70 percent over the next four years and residential bills by 55 percent." The hype is still there. No doubt the sensational headlines will continue to follow.
Milton Copulos is director of energy studies at the Heritage Foundation and a member of the National Petroleum Council, a presidential advisory committee on oil and gas issues. He writes a weekly, nationally syndicated column on energy and the environment entitled "Man and His Universe."
PRINCE OF FUELS
Natural gas is a "fossil fuel"—like oil, it is the product of the decaying remnants of ancient microscopic sea life—and is found beneath the earth's surface and beneath the ocean bottom. The highly combustible substance is a mixture of various hydrocarbons, 80 percent or more of which is methane. When ignited, methane gives off water and carbon dioxide. Because it is nonpolluting and simple to use, natural gas has been called "the prince of fuels."
Natural gas provides nearly 27 percent of all energy consumed in the United States. About half of the nation's homes—45 million or so—are heated with gas. Indeed, of all the gas domestically consumed each year (currently about 20 trillion cubic feet), 41 percent goes to residential and commercial space heating. Industrial uses—of primarily, fueling boilers—account for another 38 percent of all gas used, and 18 percent goes to generate electricity.
While oil rarely occurs at more than 15,000 feet under the ground, large amounts of gas have formed at such depths. But until fairly recently, the technology to explore for gas was an off-shoot of oil-exploration technology. Hence, there was no reliable way of finding gas at depths below 15,000 feet. In the mid-'70s, with the development of computer-enhanced exploration methods, all this changed. Now, with good accuracy, geologists can identify gas reservoirs as far down as 40,000 feet. In 1975, the US Geological Survey estimated the amount of untapped, recoverable domestic gas to be about 470 trillion cubic feet; today, that estimate is between 750 trillion and 1,000 trillion cubic feet (albeit much would require expensive recovery techniques).(Some less-conservative estimates are nearly double that figure.)
Accounting for much of this newly identified gas are discoveries of huge reservoirs in several regions. Fields of deep gas, for instance, have been discovered in the Overthrust Belt, a 40-mile-wide strip of land that runs through the Rockies from Canada to Mexico. In the Anadarko Basin, in the Texas-Oklahoma region, another huge reservoir of deep gas has been identified. The Alaskan North Slope and southern Louisiana's Tuscaloosa Trend, too, have been shown to contain large amounts of gas. In the East, huge gas fields have been identified off the Atlantic coast, stretching from Florida to Maine. Still, perhaps less than 5 percent of all onshore areas likely to yield commercial amounts of gas have actually been explored, and even less of the offshore areas.
So promising are the estimates of domestic gas resources that this fuel has been eyed lustfully by many as a way of breaking OPEC's hold on the economy, by others as the primary source of "clean" energy until solar power and other technologies can take over. Indeed, some environmental groups—such as the Conservation Foundation and the National Audubon Society—have backed the decontrol of gas: if prices are decontrolled, they will go up, say these environmentalists, thus forcing gas users to conserve this resource. Moreover, they reason, the rising prices will spur the development of alternative energy technologies.
How much of these reserves producers find profitable to recover mostly depends on regulations and price controls—or the lack thereof. Clearly, in a free-market environment, producers would most likely recover as much gas as consumers would be willing to pay for. Under price controls and regulation, however, distortions will occur in the interaction of supply and demand—that is, the negotiations through which producers and consumers determine what the commodity is worth to each. Artificially low prices result in shortages (as occurred in 1976–77); partial decontrol—the current policy under the Natural Gas Policy Act—stimulates production of the most profitable category of gas (decontrolled gas, that is), thus requiring the economy to invest more resources to produce less energy.
—Eric Marti
THE UNNATURAL GAS MARKET
When we light the oven to cook dinner or turn up the heat to take the chill off a cold evening, few of us are likely to think about the natural gas we are using and the complex market structure that brings it to us. Only when the monthly bill arrives do we give the subject any thought, and then our concern is the dollar figure on the stub. But, as for few other commodities, what the consumer pays for natural gas is principally determined by a host of federal regulations and the market structure they have spawned.
In the early part of this century, most natural gas was used locally, in the area where it was produced. By the 1920s, however, improvements in pipeline welding made possible the transportation of gas over long distances. Gas then quickly came into widespread use throughout the country. This sparked intense competition within the gas industry and eventually gave rise to calls for government intervention.
In 1935, Congress, responding to complaints from special interests, instructed the Federal Trade Commission to examine the competitive practices of pipeline companies, which bought gas from producers and sold it to utilities. Reporting back in 1936, the FTC alleged that chaotic, cut-throat competition was threatening to drive small gas producers out of business. The FTC also accused the pipelines of discriminatory pricing practices and urged federal intervention.
Congress responded in 1938 with the Natural Gas Act. Interstate pipelines were put under the jurisdiction of the Federal Power Commission (FPC), which had been created a few years earlier to regulate the interstate sale of hydroelectric power. The 1938 act specifically excluded from federal price controls the "gathering and production" of natural gas. But in 1954, with a landmark Supreme Court decision in Phillips v. Wisconsin, federal controls were extended to include the wellhead prices—those paid by pipelines to gas producers in the field—of gas earmarked for the interstate market (gas produced in one state and sold in another).
Over the next two decades, the FPC (later renamed the Federal Energy Regulatory Commission), under intense political pressure, exercised its power to keep the price of interstate gas low. With artificially low prices, producers had correspondingly less incentive to explore for new supplies of gas. So over the years, the proven reserves of natural gas—that is, the identified below-ground supplies of gas ready to be tapped—steadily diminished.
By the mid-'70s, the situation was approaching crisis proportions—a sudden surge in demand would throw the interstate gas market into disarray. During the 1976–77 winter, blizzards and record-low temperatures blasted the Northeast and Midwest, regions heavily dependent on gas. As demand rose to record levels, interstate pipelines were caught short of supplies. Federal regulators ordered gas service to industrial users curtailed to ensure residential consumers enough fuel to heat their homes, and Congress passed the Emergency Gas Act in 1977 to provide for the transfer of surplus gas (due to a lack of federal controls) from the intrastate to the interstate market.
In 1978, Congress passed the Natural Gas Policy Act (NGPA), which is still in effect today. Although widely described as a "decontrol bill," what the act really accomplished was an extension of federal controls to intrastate gas sales. The NGPA established a complex system of categories and subcategories—around 30 in all—of domestic gas wells. Pricing levels were established for each category and subcategory of gas. With one exception, prices are limited to some level below that which the market would establish.
The central idea of the act is to allow gas prices to rise gradually to a target level by 1985. But with that level based on an estimated 1985 crude-oil price of $15 per barrel (about half the current world price), the federally scheduled rises soon fell behind the market.
The single exception to federally imposed ceilings is the price of so-called deep gas—gas extracted from below 15,000 feet. At the same time, the price of "old gas"—gas that had already been tapped by April 1977—is to be held constant (with allowances for inflation) until it is all depleted. Because deep-gas producers can charge whatever the pipelines will pay—and other producers must accept below-market prices—an anomaly has ensued: the price of deep gas has risen to as much as $11 per thousand cubic feet, while other gas (mostly controlled, old gas) is selling for as little as 21 cents per thousand cubic feet. But the high price that deep gas can command has skewed investment away from less-expensive—but price-controlled—sources; so more and more of the gas replacing the shrinking supplies of old, cheap gas has come from deep wells. Consequently, consumers are getting the worst of all worlds. Prices go up while supplies diminish, for the high cost of drilling deep wells means that fewer can be drilled with the same amount of capital than would be the case if more-accessible supplies were sought.
Within the gas market, meanwhile, there are few incentives for pipelines to hold down the price they pay at the wellhead for gas, and this is a direct outcome of regulations. Federal regulators issue the required "certificate of public necessity and convenience" only if a pipeline can furnish proof of adequate supplies to meet its customers' needs for 20 years. Most supply contracts between pipelines and producers, therefore, are for relatively long periods—10 to 20 years and sometimes longer. Following the shortage of 1976–77, for example, this resulted in many pipelines' locking into high-priced contracts.
In addition, most states prohibit local distributors (utilities) or large industrial gas users from contracting directly with producers. Moreover, pipelines and utilities—with federal and state sanction—can raise their rates to cover increased costs, which are thereby passed on to the end-user.
Soon after passage of the NGPA, as prices began to rise quickly and supplies became uncertain, many industrial users of gas installed "dual fuel capability" boilers, which can burn either gas or oil. Initially, the units were installed to ensure that factory operations could continue if gas service was curtailed. Today, they allow companies to take advantage of the lowest-priced fuel available—oil's price decline has made it increasingly competitive with natural gas.
Industrial-sector conservation hits residential consumers with a second price whammy. First, the consumer pays a higher price for the gas itself—a higher price caused largely by price controls that discourage production of low- and medium-priced gas and encourage production of high-cost gas. Second, the consumer pays a larger transportation charge: A pipeline's charge is based on its fixed costs plus a return on investment. When industry decreases its use of gas, the pipeline spreads its fixed costs over a smaller number of units moving through the system. Hence, the per-unit transportation cost is larger for all consumers, including, of course, residential users.
So bollixed up is the current national policy on natural gas, then, that proposals for reform of every species imaginable have issued from numerous quarters. The current passel ranges from putting all gas under price controls (and even rolling prices back to early-'70s' levels) to fully decontrolling the price of all gas immediately. And so the debate goes on.
—Milton Copulos