2/8/02

Bob Lowry

OPINION: SHORT CIRCUITS IN ENERGY MARKETS: ALABAMA/CALIFORNIA

By HENRY THOMPSON

California utilities are paying 25 cents per kilowatt hour and more for electricity this winter that by law they have to sale for 7 cents, not exactly the way to stay in business. The same California lawmakers that created this ridiculous situation want to confiscate property of the utilities as collateral for paying their $12 billion debt with taxes. The electric industry in California has not been "deregulated" but is held captive by the state government.

Halfway around the world, OPEC leaders meet and decide to tighten the world oil supply. When the price of oil jumps, people demand other types of energy and all energy prices jump. What is the connection and where does this leave Alabama? Welcome to the future of energy markets where there are may be only two certainties: someone will have to pay the bill and nothing will be like it used to be.

For the past 75 years, states have granted monopoly status to utility companies. No other firms could generate, transmit, distribute, or sell electricity inside the state. State public service commissions regulate the monopolies, aiming to make them behave like efficient competitive firms. The utilities might be somewhat inefficient but with abundant energy sources the price of electricity was low and supplies reliable. Now energy scarcity is increasing, energy prices are rising, and lawmakers who have little idea about the industry in the first place are deregulating or restructuring it.

Part of the proposed restructuring is "retail competition" allowing electricity customers to choose their supplier. Customers in high price states are pushing for the right to buy from other suppliers. With retail competition, electricity producers will also be free to choose their customers. Low cost suppliers like Alabama Power will choose to sell to customers in high price states like Georgia and Florida. With increasing export demand for cheap Alabama electricity, the price of lectricity inside Alabama would rise. Already Alabama exports about one-third of its electricity.

California is the exact opposite, effectively importing about all of the electricity exported from Washington, Oregon, Utah, Arizona, Montana, Wyoming, and New Mexico, not to mention Canada and Mexico. This interconnected region has been forced to increase exports to California this winter, causing higher prices for local customers. Closer to home, Florida is an importer of electricity from two low cost states, Alabama and South Carolina.

The push to restructure arises from increasing energy scarcity and rising prices. Energy comes in various raw forms. Oil and coal remain the basic energy sources but they cause pollution, a costly local problem. There are ample supplies of coal, the main fuel for electricity generation, but pollution concerns may limit coal burning or require very expensive scrubbing. Either way, get ready for higher electricity bills. As oil is depleted over the coming decades, its price will rise exponentially. It may sound crazy, but oil prices of $150 a barrel and $10a gallon gasoline are on the horizon.

Natural gas is a popular fossil fuel because it burns cleanly. Natural gas from the Gulf Coast comes up the slowly expanding pipeline system to a new generation of efficient gas turbine generators. But the pipeline system is expanding much more slowly than demand and natural gas prices will climb steadily with increasing scarcity. To complicate matters, all fossil fuels release carbon dioxide that may be limited by international agreements on global warming.

Nuclear reactors run on cheap uranium but nobody knows what to do with the radioactive waste. The nuclear generators in use are getting old and no new ones are being built or even planned. Hydroelectricity has been an energy source but now the only talk is about which dams to tear down.

What are the solutions to this dismal energy picture? Nobody knows, but be wary of any proposed government solution. Any energy "plan" would be doomed to failure. Consider for instance the oil tariffs of the 1950s, designed to keep domestic oil fields in operation but amounting to a policy of "Drain America First." Remember also the price caps on gasoline during the OPEC oil embargoes of the 1970s and the long lines at the gas pump.

There are thousands of people working in the increasingly competitive energy industries trying to innovate, improve technology, and develop cheaper and more efficient energy systems. In competitive markets, innovation will lead to alternative energy sources and efficiency.

Competition will work in the energy markets. The shortage of electricity in California would disappear tomorrow without the regulated retail price. There would be shortages or blackouts if consumers had to pay the market price. Faced with high prices, consumers economize. Electricity prices in California will ultimately depend on the path of restructuring and investment. If the state government plays a bigger role in the energy markets, there will be limited incentives to investment.

One principle to remember for the future is that prices for raw energy will rise as sources are depleted. Final consumers have to pay these higher prices or the market system of production and distribution will collapse. Economics and history very clearly teach that there is no other system of production and distribution that works. California's present energy collapse is another example of failed market intervention by government.

Competition in the energy markets is on the way. During the transition, Alabama should let the high price states like California and Florida take all the risks. After all, they have the most to gain from the transition to retail competition. Projections from the Department of Energy and various economic models suggest that retail competition throughout the Southeast would result in a regional price of electricity higher than the present price in Alabama.

Alabama should encourage wholesale and industrial competition. Over the past decade, competition has begun in the wholesale electricity market and interstate transmission has been increasing. There is no need for Alabama to rush into retail competition as long as the price of electricity in Alabama remains among the lowest in the country.

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(Thompson is an Auburn University economics professor and consultant to government and business in international and energy economics.)

feb01:AU-energy

CONTACT: Thompson, 334/844-2910.