a. The Issue of Electric-Power Deregulation
PNM successful campaign to pull the plug on the state Legislature’s plan to deregulate electric utilities in 2007 portends nothing but high prices in the long run. Our politicians should study the California’s electricity-crisis case. The California debacle is used by those who favor electricity regulation as a demonstration that free markets are inappropriate for electric-power markets.
At the turn of the 20th century in state after state throughout the country public utility commissions were established with the responsibility to regulate the utilities. The consensus was that public utilities are natural monopolies, and, unless regulated, would charge the public monopolistic prices. Today, at the turn of the 21st century, we challenge the need to regulate electric public utilities for two reasons: First, the technology of wheeling electricity over long distances has improved dramatically: High voltage transmission lines and improved alloys used in their production lowered the transmission costs significantly. Consequently, electric power can be wheeled from the Four Corners Power Plant to California at a relatively very low cost. Second, over the years, economists realized that state regulatory agencies became captives of utilities to the point that regulated prices, even if not set at monopolistic levels, are higher than what alternatively would be competitive prices. In 1995 the country was ready to embrace the open power markets. What happened in California changed everything.
In 1996, the California legislature voted to restructure its electric industry. All retail customers were allowed to buy power from electric service suppliers of their choice. The monopoly of the local California utilities was thus broken and utilities were transformed into middlemen. But, unfortunately, politics of different interest groups played a bigger role in the restructuring process than economic analysis. Consequently there were two fatal flaws in the deregulation plan: First, for stranded costs considerations, retail prices were capped at a level that had been then above the anticipated wholesale price. Second, the utilities were required to acquire power for their customers solely on the spot-wholesale markets. The new market structure became effective in April of 1998.
In the Spring of 2000 Four factors combined to push wholesale prices way above the expected $25/Mwh: (1) demand for electricity intensified due to unanticipated economic growth and unseasonable weather; (2) drought reduced the supply of hydroelectric power; (3) rising natural gas costs increased wholesale prices on the spot market instantly; (4) rising prices of emission credits increased the variable costs of generation. As a result, from the early spring of 2000 to the early summer of 2001, spot wholesale electricity prices soared to unprecedented levels. Since the retail price remained capped, the utilities absorbed the difference and eventually became bankrupt.
At the beginning of summer of 2000 the utilities could have saved Californians money and blackouts by entering into long-term contracts. At that time, the utilities had known that gas prices were expected to rise and the water level behind the dams were expected to recede because of the drought. But, the California regulatory agency, guided by the bogus deregulation of 1996, ignored the requests of the utilities to purchase future electricity at reasonable prices. The electric-power market collapsed, and the state took over purchasing wholesale and selling retail power.
Finally, in June of 2001, the factors that initially caused the crisis reversed course. In particular, the demand for electricity began to abate and natural gas prices were falling across the Unites States. The wholesale prices of electricity returned to a reasonably low level. The crisis passed, but California’s lost billions of dollars in the process and will continue to pay high prices far into the future. It is ironic that out of desperation, at the beginning of 2001, Governor Davis instructed the California Department of Water Resources to negotiate long-term contracts with wholesale suppliers of power. It is likely that, since wholesale prices were still relatively high, he saddled California residents with obligations to pay $40 billion for electric power with a market value of only $20 billion.
The lesson from California to New Mexico: There is no alternative to the discipline of competition in an open market. If, and when, New Mexico decides to deregulate its power market it should take the following steps: (1) break the monopolies of utilities in their respective service areas by allowing users to access electricity from out-of area and out-of-state suppliers of their choice; (2) allow electric-power prices, both wholesale and retail, to move freely, up and down, in the marketplace such that supply and demand are always in balance; (3) allow users to freely choose between buying electricity on the volatile spot market, or, alternatively, enter bilateral long-term stable contracts with power suppliers.
At the end of the day the choice is between the regulated local monopoly with relatively stable but very high prices or a completely deregulated electricity market with more volatile, but, on average, significantly lower prices. Rational users will always prefer the latter.
b. Natural Resources
New Mexico is rich in natural resources: It ranks 13th in the production of coal (third in reserves) and third in the production of natural gas (second in reserves). It exports almost half of its generated electricity, over 80 percent of its natural gas and 40 percent of its coal. Both natural gas and coal are sold on very competitive markets. Our policy recommendation is simply to leave the decisions of how much to produce, and of that what fraction to export, to the entrepreneurs on the open market. Some pro-development New Mexicans lament the fact that much of our natural gas and coal are exported as raw materials rather than electricity. Environmentalists oppose converting these natural resources into electricity because water is a factor of production in the generation of electricity. Orders of magnitude are relevant here: Annual depletion of water in New Mexico is in the order of magnitude of 2.5 million acre feet. Irrigation accounts for 75 percent of the total depletion. Currently, water consumed in the generation of electric power is about 70,000 acre feet, a mere 2.8 percent of the total annual depletion. In the future, electric generating firms could purchase additional water rights in the marketplace without raising water prices appreciably.
Last, but not least, our elected leaders should not be tempted to raise the tax rates on our exhaustible natural resources for the simple reason that, although up to a point higher tax rates will yield more revenue, higher taxes will also result in a reduction of employment and weakening of economic activity.
c. Wind and Other Green Power
Generating electricity by burning coal, natural gas or using nuclear reactors on average costs between 3 and 4 cents per kwh. Of the three, the additional external cost to society and the environment is highest from coal and lowest from nuclear power. Once the federal government resolves the issues of nuclear waste, catastrophic insurance and who bears the decommissioning costs, nuclear generation of electric power will be revived. New Mexico, which is rich in uranium will definitely benefit from this trend.
PNM and Florida based FPL Energy built a 204-megawat wind-generation facility, or what is otherwise known as a wind farm. This deal was undoubtedly stimulated by New Mexico’s legislature endorsement of a rule mandating that five percent of utilities’ energy must come from green sources by 2006, and ten percent by 2011. Any minimal environmental gain from this project will “spread” over the entire southwestern states-it will be gone with the wind. According to the Wall Street Journal (August 27, 2002), although wind energy is clean, its cost is still 5.84 cents per kwh in good wind sites, and 3.89 cents in optimal wind sites. We cannot be sure if PNM embarked on this project because of federal subsidies (1.8 cents/kwh), or because wind farms politically endear PNM to the environmentalists who, in return, might support its battles to retain monopoly. It is difficult to conjecture what motivated the Public Regulation Commission (PRC) to dream up such a grandiose plan. Could it be the increasing instability in the Middle East? War in the Middle East could cause another energy crunch that might affect the transportation sector that depends on foreign crude oil, but not the electric-power sector that depends on plentiful domestic natural resources, such as coal, uranium and natural gas.
Could it be concerns for clean air? Probably. But, first, applying renewable energy in the generation of electricity in New Mexico would reduce the use of coal by the San Juan Generation Station near Farmington. The blessed wind does not recognize state boundaries. Consequently, the air pollution-reduction at the San Juan Generation Station would be spread over Arizona, Utah and Colorado: It will be gone with the wind within days. Do we, New Mexicans, like to pay higher prices for electricity to give our neighbors a free ride on clean air? I believe the answer is a resounding “no”, and this is why clean-air policies should be initiated at the federal level.
Second, mandates, known otherwise as social engineering, are arbitrary and economically inefficient. The decision as to when renewable sources should be used in the generation of electricity is best left for the marketplace. Of course, external costs from air pollution are involved in the generation of electricity. The external costs of using coal, gas turbines, nuclear reactors or even wind cannot be dismissed. But, clean air and water policies should be left for the federal government.
The federal energy policy is far from perfect. The energy industry enjoys outrageous subsidies and market distortions. Advancing renewable energy through subsidies is a bad idea. Such subsidies, like the 1.8 cents tax credit per kwh generated by wind, lead to political-pressure groups that invest time and money in lobbying for higher subsidies. The subsidy to ethanol is an example that has not met the test of time. The subsidy to ethanol, which is derived from corn, is alive and well even after it has been shown that it generates less energy than it takes to produce, and other gasoline-cleaner-supplements are available in the marketplace. Since it takes more energy to produce ethanol than ethanol produces, it probably causes more pollution than we would have with no subsidy at all. But it seems that the farm bloc has the political power to perpetuate a bad subsidy forever. Instead of subsidizing green energy resources, the federal government should tax natural resources that, in the process of producing electricity, generate conventional pollutants (sulphur dioxide, nitrogen oxides and mercury) and carbon dioxide.
As an illustration, a unit federal tax should be imposed per kwh of electricity derived from coal, and the revenues from this tax should be used in the development of clean coal technologies. Nuclear energy does not release any greenhouse gases, but its price does not reflect its true marginal cost. A permanent nuclear-waste facility in the Yucca Mountain should begin serving all nuclear reactors in the United States as soon as possible. Nuclear waste and decommissioning costs should be borne by owners of nuclear reactors. Also, the Price-Anderson Act which provides unlimited government insurance for nuclear reactors in case of catastrophic accidents should be rescinded. Electric utilities should pay for nuclear catastrophic insurance, and they should generate nuclear energy and sell it in the marketplace at a price that covers its true costs.
Mandating renewable energy in the generation of electricity is a tax on New Mexico citizens as rate payers-we don’t need higher taxes. California is mandating these senseless green initiatives in spades. In the unlikely event California mandates really do lead to discoveries producing long-term benefits, New Mexico will benefit without having to tax our citizens. Last, but not least, The New Mexico legislature is urged to guide the PRC to focus on its only logical mission, namely to protect New Mexico consumers from natural monopolies.
- First, the substitution between labor and capital. Faced with a higher minimum wage rate, employers would invest in less labor-intensive machinery that would enable them to hire more-skilled workers at the expense of less-skilled workers.
- Second, the rise in the price of services rendered by the affected industries would drive up prices, thus inducing consumers to purchase less – resulting in worker layoffs. For example, higher prices charged by hotels would induce some opera fans to return to Albuquerque rather than spend the night in Santa Fe after the opera. Some number of tourists from around the country would change their plans too.
The water crisis in New Mexico is overblown. We actually have a reasonably lively water market, and it is superior to those in most states. Professor Micha Gisser discusses the development of our water rights, impediments to improving them and ways we might reduce those impediments. Micha Gisser is senior fellow at the Rio Grande Foundation and Professor Emeritus of Economics at University of New Mexico. He has written extensively on energy and natural resource economics.
a. The Water Market in New Mexico
It is unfortunate that during the drought we suffer from inordinate attention from politicians and laymen given to a “water crisis” that does not exist. In what follows I attempt to first show that we have a sound water system in New Mexico which is based on water markets in which private water rights are traded, and, second, to shed light on some of our problems that are basically minor.
New Mexico has superior water rights when compared to all other states in the Southwest United States. During most of the 20th century, farmers, manufacturers, miners and municipalities have traded thousands of water rights in a lively market. Economic growth will undoubtedly intensify the future demand for water. Since water is a scarce resource, the “bad” news is that with a relatively fixed water supply facing New Mexico, water prices have only one way to go-up. The “good” news is that users can easily incorporate the trend of rising water prices in their benefit-cost calculations and adjust accordingly. While water is scarce as indicated by its rising price, there is no way government could legislate away the scarcity.
The prior appropriation doctrine was adopted by New Mexico when the state enacted the Surface-Water Code in 1907. The Surface-Water Code permits an appropriator to sell his surface-water rights, quantified by consumptive use, in whole or in part, and apart from his land, to any user provided the use is not detrimental to existing water rights in the stream. For example, a user upstream may attempt to purchase water rights from a user downstream. Such a transaction may be detrimental to a third user located between the two users. Twenty four years later, in 1931, the legislature of New Mexico enacted the New Mexico Underground Water Law, which adapted the state’s surface-water law to groundwater. The groundwater law restricts users by imposing an annual aggregate consumptive water use. If the aquifer is fully appropriated, potential users may only acquire water rights by purchasing existing rights. The State Engineer has jurisdiction over all surface waters and groundwater in declared underground basins. In New Mexico, an appropriator desiring to sell a water right must make formal application to the State Engineer. The State Engineer approves the application for transfer provided it is not a detriment to existing rights. Consumptive use is the measure of the transferable right, and hence both diversion and return flows are closely monitored by the State Engineer. For example, A, with a return-flow-coefficient of 0.5 can sell B with a return-flow-coefficient of 0.75, fifty acre feet of consumptive use according to the following rule:
100 acre-feet(1 – 0.5) = 200acre-feet(1 – 0.75)
Implying that A decreases his diversion by 100 acre feet, and B increases her diversion by 200 acre feet. Interestingly, basing water rights on consumptive use is efficient from the standpoint of economic theory. Users are guided by the price of water, which indicates its scarcity. When they voluntarily exchange rights in the market, water tends to flow towards the highest value use. This promotes conservation and economical use of water.
Adjudication is a legal process of determining the relative priority dates of water rights, and their quantification. Seniority gives the user a better priority. Quantification is an on going process, mainly because it is based on the farm practices of the day. For example, in the late 1940s and early 1950s, in the Ogallala, farm land was adjudicated consumptive-use water rights at a rate of 2.5 acre feet per acre and a return-flow coefficient of 1/6. Later, the State Engineer raised the adjudicated consumptive use to 3 acre feet per acre and the return-flow coefficient to 1/3. The adjudication of Pueblos’ water rights is another relevant illustration: In the wake of the New Mexico v. Aamodt (1976), the Tenth Court of Appeals speculated that, on one hand, the United States gave the Pueblos a quitclaim deed to lands recognized by the Treaty of Guadalupe Hidalgo, but, on the other hand, that the Pueblos may have reserved Winters rights. Either way, the Pueblos probably have the most senior rights in New Mexico. Since on the issue of quantification the court failed to provide any clear answer, the Pueblos filed their claims at various district courts, and the adjudication cases are still pending. Obviously there is a backlog of adjudication cases waiting their turn in the district courts. Our courts are over loaded with a backlog of water cases, and they could use additional judges, mediators and clerks. But a Water Court should be created only if a further study could demonstrate that a Water Court is the best way to handle the current backlog.
c. Domestic Wells
Owners of existing domestic wells pump water whose legality derives from a permit issued by the State Engineer. In the past, this procedure was justified by the smallness of the fraction of domestic wells in total water depletion. With the rapid economic growth leading to intensification in the demand for water, owners of domestic wells tend to treat water as a free good. They should be treated like all other users of the scarce water in New Mexico. Owners of existing domestic wells should be assigned water rights based on past use, say five-years average, so that they incorporate its price into their personal calculus of how much to use, trade or conserve.
The water law should also be amended to require persons who intend to become owners of domestic wells to purchase existing water rights from other users, subject to the rules and regulations as promulgated by the State Engineer. The water law should be amended to require that all owners install in their domestic wells water meters acceptable to the State Engineer, for the purpose of monitoring their annual use.
d. Use it or Lose it
The current “use it or lose it” provision in New Mexico’s water law doe not make any economic sense, because it leads to wastefulness, and it should be eliminated. An owner of water rights who for some economic reason cannot use his or her water today, but expects to resume using it in the future, should be allowed to maintain ownership. He or she should be able to either rent the water to other users, or simply curtail using it in the short run and resume using it whenever he or she pleases. The idea of “water banks” is welcome but may not always work: As an illustration, it will work if by reducing the pumping of groundwater by 100 acre feet, the associated aquifer would be enriched by the same amount (adjusted by consumptive use consideration). It will not work in the case of surface-water, unless the owner has access to a reservoir, like Albuquerque.
e. Relationships With Contiguous States and Mexico
I. Background Information. In New Mexico water rights are well defined based on consumptive use, and are traded efficiently in a lively market. Unfortunately, however, The market for water, however, stops at the border. Contiguous states have different water laws, and their water rights are defined differently. Private water rights are traded neither between Mexicans and New Mexicans, nor among users in New Mexico and users in the contiguous states. The surface water of the two major international rivers, the Rio Grande and the Colorado River are apportioned by treaties. In 1906, the U.S. and Mexico signed a treaty that committed the U.S. To deliver to Mexico 60,000 acre-feet annually from the Elephant Butte Dam. The Elephant Butte Reservoir was constructed at the time for storage and regulation of the Rio Grande so that the terms of the treaty could be met. In 1944 the two countries entered another treaty that (a) guarantees to Mexico 1,500,000 acre-feet per annum from the Colorado River and (b) apportions equally between the two countries the surface waters of the Rio Grande between Fort Quitman and the Gulf of Mexico.
Surface water is apportioned among states within the U.S. by compacts that in essence are like international treaties. Some seven compacts were signed between New Mexico and contiguous states. Here we mention only the most important four compacts:
The 1922 Colorado River Compact (approved by a presidential proclamation in 1929) divided equally the Colorado River’s water between the upper basin states – Utah, Wyoming, Colorado and New Mexico – and the lower basin states – California, Nevada and Arizona.
The 1938 the Rio Grande Compact signed by New Mexico, Colorado and Texas (approved by Congress in 1939.) This compact produced water-delivery agreements from Colorado to New Mexico and from New Mexico to Texas.
The Upper Colorado River Basin Compact of 1948 (approved by Congress in 1949), apportioned a fraction of the Colorado River water among Colorado (51.75%), Wyoming (14%), Utah (23%), Arizona (50,000 acre-feet) and New Mexico (11.25%). This compact eventually produced the Navajo Dam and the San Juan-Chama Diversion Project.
The Pecos River Compact was signed by New Mexico and Texas in 1948 and approved by Congress in 1949. The compact was intended to provide for the equitable division and apportionment of the use of the Pecos River’s water between the two states and secure and protect existing developments within the states. In particular the compact guaranteed for Texas a quantity of water available to it under the 1947 conditions. Following the 1974 Texas complaint submitted to the U.S. Supreme Court, the Pecos River Compact was revised.
Water laws prevailing in the Southwest vary from state to state. To eliminate the impediments to inter-state tradable water rights, contiguous states must adopt a uniform water law, and allow private sales of water rights across state borders. The following section illustrates how users in both New Mexico and Texas lost an opportunity to increase their water supply, respectively, for 150 years.
II. Particular Problems with Texas. Once, when New Mexico had a realistic chance to enhance its water supply, bureaucrats and politicians squandered it. In the late 1980s El Paso, a border city in Texas, submitted applications to drill 266 wells in the Mesilla Bolson and 60 wells in the Hueco Bolson, both in New Mexico. The bolsons are huge mines of water, and hydrologists had argued that El Paso’s return flows back to the Rio Grande would more than offset the pumping effects on the river, for 150 years. The project would have provided additional water to El Paso and New Mexico. Since El Paso is on the “wrong” side of the border, New Mexico resisted, and the project was lost in a lengthy legislative and legal process. Later, Texas returned the favor. In 1974 Texas filed a complaint against New Mexico in the U.S. Supreme Court. Texas alleged that New Mexico had breached the Pecos Compact during the period extending from 1950 to 1972 by depleting stateline flows by 1.2 million acre feet of water more than the compact allowed. New Mexico lost the case, had to compensate Texas to the tune of $14 million and had to accept an unfavorable restrictive delivery obligation. Since our water market stops at the border with Texas, only interstate negotiations can resolve this conflict. With a considerable political effort and luck, the two states could work out a compromise that would enhance the supply of water available to both states by reviving the El Paso project in exchange for updating the Pecos formula based on hydrological data that has accumulated since 1947. If we want to reduce the flow of Pecos water to the Red Bluff Reservoir, we should let Texas pump water from the Mesilla and Hueco Bolsons. In the long run, the users in the two contiguous states would benefit greatly from adopting a uniform water law and adopting free water rights trade.
f. Schemes to Enhance Water Supply
Schemes to enhance water supply may represent economic boondoggles. In the early 1980s, a study commissioned by the High Plains Study Council elaborated on a proposal to recharge the Ogallala aquifer by hauling water to the High Plains from distant rivers. The expected cost of importing one acre foot was in the range of $226 to $569. It did not bother those who produced the report that the net value of crops produced on an acre in Lea County would be less than the cost of importing water to irrigate that acre. For example, salt cedars, originated in parts of Eurasia and China, have been blamed for water quantity and quality problems. The roots of salt cedars stretch out in order to find water, and consequently they dry up aquifers and lower water tables. The evapotranspiration rates of salt cedars by far exceed those of native species-cottonwood, willow and arrowweed. Proposals to remove salt cedars in order to enhance our water supply should be studied. Unless a comprehensive and serious study can demonstrate that the economic benefits of salt cedars removal exceed the economic costs, a project of salt cedars removal should be dismissed. In other words, we should investigate whether the net value of crops produced on an acre in some valley along the Rio Grande would exceed the cost of removing salt cedars to free up the water required to irrigate that acre.
g. Municipal Water and Mandated Conservation
In an ideal market many consumers would buy water in the marketplace from many producers, subject to perfect water laws. Because of the complex hydrologic aspects of water grids in densely populated areas, as well as the large scale economies of treatment plants, municipal water systems, like local telephone providers, are natural monopolies. Under these conditions an enlightened municipality should set the price of water equal to the marginal cost of pumping and delivering plus the annualized cost of water rights. If at such a price a municipality has an excess supply over the quantity demanded, it could either store, rent to others or sell some of its water rights. Alternatively, given a water shortage, it could either store, rent from others or purchase some water rights on the open market. Normally, economic growth leads to municipal demand intensification and politicians, instead of purchasing water rights from farmers, tend ride on popular tides generated by water conservation advocates.
We should resist social engineering , e.g. proposing a comprehensive conservation efforts that will outline specific plans to install efficient plumbing fixtures in our bathrooms and invest in low water-use landscaping in our backyards. Such conservation mandates result in economic losses. Suppose, to use an illustration from simple Economics, that a mandated replacement of your current lush landscaping by xeriscaping would save you $150 worth of annual lawn watering. Assuming an investment of $5,000 in xeriscaping. Then, at an interest rate of 4 percent and a life of 20 years, it will cost you annually $368-a net loss of $218. Moreover, you value the elegance of xeriscaping relative to the charm of lush landscaping at less than $218: otherwise mandated conservation would be superfluous for you. Note finally that public water use accounts for a minute fraction of the total water depletion in New Mexico. The abundance of water use in agriculture indicates that a small transfer of water from agriculture to municipalities will sustain economic growth in our cities at a lower price increase far into the future.
h. Instream Flows
New Mexico’s water law is imperfect in that it does not recognize rights to instream flows. The demand for instream flows is derived from various recreation activities. The problem has become acute in recent years because the demand for instream flows has intensified with a rising standard of living, and also the need to protect the endangered Silvery Minnow. When drought conditions are mild, opportunities exist to manage the water in upstream reservoirs to help the Silvery Minnow without thrusting the entire burden on a singled-out group of irrigators. This may not be the case in low-flow years. Whether or not we accept the endangered-species philosophy, we should resist putting the burden of protecting the Silvery Minnow on a singled-out group of irrigators, or other groups of users. One possible solution is to upgrade the water law in New Mexico to allow a limited state acquisition of water rights on the open market for the purpose of enhancing stream flows during drought years. In high-flow years, the state could either store its water, or rent it to private users.
Another solution would be for the state government, or better the federal government, to purchase from water users low-flow options on the open market. A low-flow options for one acre-foot is a legal contract requiring the participating water user to diminish his or her diversion from the stream (Rio Grande) by one acre foot when the snow pack in March is below a level which is specified by the option contract.