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Energy and Environment Oil & Gas

Politics and the State’s Energy Problems

New Mexico businesses— whether directly engaged in the energy industry or not— should be wary of proposed policy changes supposedly targeted at energy companies. If enacted, these laws would actually harm users of energy (residential as well as business users).

The misguided proposals under consideration would tax alleged “windfall profits” and address global warming in a wasteful and counterproductive way. New Mexico politicians have a disproportionately powerful place in all this. Democratic Sen. Jeff Bingaman is the new chairman of the Senate Energy Committee and the senior Republican and immediate past chairman is Republican Sen. Pete Domenici. Meanwhile, our ambitious Gov. Bill Richardson, a former Energy Department cabinet secretary, has spoken out for both misguided proposals.

THE NEW CONGRESS AND THE “WINDFALL PROFITS TAX”: Although neither Bingaman nor Domenici seems to be enthusiastic about a proposed windfall profits tax on oil and gas companies, the newly resurgent Democratic leadership in both houses has control of the agenda and is making noise about such a proposal.

A little perspective is needed here: Even during the “spike” of gasoline prices when Hurricane Katrina knocked out much import and refining capacity, the price of gasoline came nowhere close to its all-time high. When we compare prices over time, we need to adjust them for changes in the purchasing power of the dollar. Adjusted for inflation, 1981 gasoline prices were some 24 percent higher than they were during last year’s $3-plus-a-gallon “spike.” Moreover, disposable income in New Mexico has increased since 1981. The average New Mexican’s disposable income could buy 88 percent more gasoline even at the peak of the 2005-06 “spike” than it could in 1981.

The last thing we need now is for government to make matters worse by bashing profits. Seeking profits (and avoiding losses) is what drives all sectors of that market economy; and it is why we are prosperous.

When we see rising profits we can be sure that more resources will be devoted to the profit-generating activity. It may come about a bit slower in the case of oil and gasoline (compared, say, to Microsoft) because of the difficulties of bringing new wells into production or of building and expanding refineries.

Oil companies’ profits may be a little higher than their long-term average; but those profits are not unreasonable compared to other industries. Moreover, taxes paid by oil companies are actually higher than their profits.

CARBON “CAP AND TRADE” AS A SOLUTION TO GLOBAL WARMING: Putting aside questions of whether recent temperature variations are outside the normal swings that have occurred over many centuries, and (if so) whether or not such changes are human-caused, a policy that administers a system of artificial caps on energy sources, poses serious problems for our national— and state— economies:   Giving federal and state bureaucrats control over how much carbon is emitted and from what sources would be counterproductive, highly complex and a nightmare to administer. It would mean higher energy prices and a system that is wide open to political favor seeking.

The politics of carbon emissions would inevitably result in large, unfair transfers of wealth. For example, under the Kyoto treaty, to which the U.S. is not a party, purchases of carbon credits are flowing from the European Union to Russia in massive amounts. Do we want to have the U.S. become victim to this sort of dollar outflow?

It turns out, intentionally or not, that the U.S. is at a real disadvantage when it comes to reducing carbon emissions compared to Europe and Russia. The year selected as the base year from which to reduce carbon emissions (1990) just happens to coincide with vigorous economic activity in the U.S. and recessions in Europe and Russia. In 1990 Europe and Russia were already well below their normal emissions. Nonetheless we find that Europe and Russia are unable to meet their targets.

There are changes in energy policy that would be helpful and would especially benefit our energy producing state. We could strike a better balance between benefits and costs when it comes to regulation. We could allow the building of new refineries. We could relax restrictions on drilling and exploration for oil. All of these actions would reduce the costs and risks for producers, thereby benefiting New Mexico.

Categories
Economy Oil & Gas Transportation

Don’t Take Pols’ Hooey on Gas Prices

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Have you noticed that politicians are constantly talking about gasoline prices?

As the 2006 election approaches, claims and counterclaims about the cause of high gasoline prices are becoming more intense. But the din of political opportunism has trumped sound economic analysis. Politicians are taking advantage of the complexity of oil markets, rather than trying to educate us.

For example, House Minority Leader Nancy Pelosi recently visited Albuquerque on behalf of Patricia Madrid’s bid to unseat Rep. Heather Wilson. Wilson was accused of being “beholden to big-oil,” with the implication that she and her Republican colleagues are somehow responsible for high gasoline prices. Nor has Wilson shown a keen awareness of energy economic realities with her “sound bite” approach, as is exemplified by her misguided and unrealistic effort to see “price gouging” where none exists.

What the public really needs – but has not been getting from at least this particular race, and indeed from few political contests – is a “fact-based” approach based on economic realities.

Because we can’t rely on politicians when trying to comprehend why prices at the pump are so high, let’s dig beneath the rhetoric to be better informed about gasoline prices: Prices are determined in a market by demand and supply. In the past few years, demand for petroleum products has been increasing, primarily because of increasing prosperity in China, India and a few other countries. Increasing demand, everything else being equal, increases the price of petroleum products. Also, risk of supply disruptions due to instability in some of the major oil producing regions has added a speculative component to demand, further driving up price.

Another factor driving prices higher is that the world’s oil supply has not increased as quickly as demand has grown. War and threats of more war have kept supply from increasing in the Middle East. Hurricanes, particularly Katrina, have reduced supply.

Most recently, pipeline problems experienced by British Petroleum reduced the amount of oil coming from Alaska by nearly 300,000 barrels – a loss of about 6 percent of U.S. daily output. In addition to the issues above, which can loosely be called “market-oriented supply problems,” other problems have been the direct result of government interference. Foremost among these is the reluctance on the part of Congress to allow more drilling for domestic sources of oil.

Politicians have also refused to allow increases in refining capacity for several decades and have also smeared oil companies as villains by threatening them with “price gouging” laws despite the lack of any evidence of such practices.

The fact is that oil exploration and drilling is inherently risky, and it takes millions of dollars and years of investment before the first barrel is pumped out of the ground. These political threats obviously add another element of risk that reduces supply. The threat of “windfall profits” taxes has also added a political risk to the risks faced by oil companies.

Although it may play well in the polls, bad-mouthing the oil industry and threatening it with higher taxes only raises its risk, which hampers research and development efforts and thereby reduces future supply. Did you know that cumulative oil industry research-and-development expenditures over the last few years have exceeded profits? Why would we want to discourage those efforts by piling on more risk?

So there you have it; there is no mystery to gasoline prices. The fundamentals of petroleum markets have caused the increase in gasoline prices, specifically increased demand without increased supply. Politicians like to talk like they can legislate away the scarcity of oil, but instead they make things worse.

Because of the increase in price, we have heard much misleading political rhetoric about evil big-oil profits. Yet the oil industry has profits that are generally in line with other industries. Those profits may be a little above average now – 8.5 percent of revenue versus 7.7 percent for all industries – but since the oil industry waxes and wanes with market conditions, it often sees profits that are below average. Big government actually takes more from big oil in taxes than the industry makes in profit.

If there is anything that is evil in the political din over gasoline prices, it is the politicians. Do not trust them to enlighten you.

Messenheimer is an economist with the Rio Grande Foundation, a free-market oriented think tank based in New Mexico.

Categories
Economy Oil & Gas Transportation

Hysteria Over High Gas Prices is Pumped Up

The hysteria surrounding the spike in gasoline prices has risen to the level of the late 1970s and early 1980s “oil-crisis” madness. Most of the media is actively participating in the doomsday chorus, and the House of Representatives recently voted 389-34 to make gasoline “price gouging” a federal felony. It is time for some serious economic analysis.

First, let us examine gasoline prices expressed in today’s dollars from 1971 to 2005. During the first three years of the 1970s the price has been about $1.50 a gallon, then, because of the OPEC disruption and the Iran-Iraq war, it soared to unprecedented high levels, hitting a peak of $2.70 a gallon in 1981, and then receded gradually, returning to its early 1970s price of $1.50 in the mid 1980s. Until 2003, gas prices fluctuated around $1.50 a gallon. In 2003 gasoline prices began a climbing trend, reaching an annual average of $2.31 in 2005.

Surprisingly, today our economy is robust despite the spike in oil prices. There are two reasons for this: First, at a price of $1.50 a gallon, due to personal income growth and increased automobile efficiency, the percentage of average household income spent on gasoline fell from 4.5 percent in 1971 to 3.1 percent in 2001.

Second, President Bush’s tax cut in May of 2003, supported by accommodating monetary policy, gave the economy a huge boost that easily swamped the impact of rising gasoline prices. Politicians who advocate restoring taxes to their pre-May 2003 level should think again.

The present spike in gasoline prices— surprise, surprise— occurred because supply and demand for a change have not been going hand-in-hand. Demand for oil has intensified since the economies of China and India have at long last taken off. But the growth in oil supply slowed down considerably in the wake of Katrina and Rita, the instability in the Middle East and in response to the new ethanol legislation fiasco. That policy forced oil companies to shoulder the distorting 54-cent a gallon tariff to protect ethanol producers.

In the short term Congress could alleviate the market pressures by rescinding the ethanol tariff, abolishing— or at least relaxing— the “boutique” regulations that hinder gasoline mobility across the United States, and doing something about the NIMBY (not in my backyard) activists who are responsible for the freeze in the number of oil refineries.

Politicians who incite against the oil companies are working for re-election, not for American consumers. In particular they have launched a witch hunt for price gougers.

Economic theory is very straightforward on this issue: Price gouging is possible only if producers collude. For example, a lonely wheat farmer in Minnesota cannot raise the price of wheat over the prevailing price in the marketplace. But, if all wheat farmers colluded they could conceivably become a cartel of gougers. Hypothetically, since the oil and gas industry is somewhat concentrated, oil and gas companies could conspire and raise the price to a monopolistic level.

However, this is very unlikely: First, charges of price fixing may send oil executives to jail. Second, if oil executives were willing to take the legal risk involved in price fixing, they would collude when the price is $1.50, not $3 -a-gallon, when everybody wants to stick it to them. It is safe to assume that oil executives’ brains do not shrink when gasoline prices rise.

Some oil industry bashers advocate slapping the oil companies with profit taxes. Economic theory is also straightforward on this issue: Initially such a tax will not affect the level of production because it will not modify the conditions for profit maximization. In the long run, however, oil companies will have less profit available to reinvest in new drilling and better technologies. The impact on future oil and oil-substitute production will be devastating. So, what to do in the long run?

The long run begins in Alaska. The first step to accelerate the supply growth of oil should be taken by drilling in the Arctic National Wildlife Refuge. The environmentalists continue to argue that drilling in ANWR and shipping oil via pipe across Alaska will devastate caribou and other wildlife. Fact is that the caribou herd in the Prudhoe Bay oil field has grown more than sevenfold since the Prudhoe Bay project started in the mid-1970s.

Last, but not least, there is a danger in the free world’s relying on the turbulent Middle East for its huge exports of crude oil. Advancing alternative energy resources through selective subsidies or regulations is a bad idea— it leads to economic inefficiencies and political pressure groups that invest time and money in lobbying for even higher subsidies for their specific product.

To reduce our reliance on oil from the Middle East we must eliminate the anxiety stemming from oil-price instability. For this end, Congress should initiate setting a floor for the price of oil at a relatively high level, maybe something in a range of $40-$55 per barrel. This could be implemented by imposing a flexible duty on imported crude oil. This is a bad idea whose time, unfortunately, has come.

Micha Gisser is professor emeritus of economics, University of New Mexico, and a senior fellow, Rio Grande Foundation.

Categories
Economy Energy and Environment Oil & Gas

Drilling for Votes: N.M.’s Representatives in Washington Have No Business Accusing Big Oil of Price Gouging

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Price gouging can be defined as “pricing above the market when no alternative retailer is available.” Sure, gas prices are higher than most of us might like, but this recent talk about collusion among oil companies to gouge consumers is rubbish, and our elected officials know better.

Unfortunately, rather than admitting their own recent mistakes are at least partially to blame for high gas prices, Sens. Pete Domenici and Jeff Bingaman, along with Rep. Heather Wilson, are pointing their fingers at big oil.

First, the facts on so-called price gouging. Unlike the U.S. Postal Service, Amtrak and public schools, oil companies face real competition. Why else would gas stations display their prices so publicly? If these companies could really manipulate prices at will, why wouldn’t they have colluded to sell gas for $3 a gallon five years ago, when prices were low?

In a competitive environment, if you choose to purchase a product or service from someone, whatever the cost, price gouging is simply not taking place. If it were, then those of us who purchased homes when prices were low and are planning to sell for double and even triple the original price are gouging, too.

The real wild card is, of course, Congress. While talking up the gouging issue, our elected officials seem unwilling to face up to their own mistakes, so they have chosen to demonize the oil industry.

In an effort to promote policy solutions instead of useless name-calling, New Mexico’s congressional delegation, especially the ringleaders on price gouging – Domenici, Bingaman and Wilson – should consider the following ideas provided by the Competitive Enterprise Institute:

Open a small portion of the coastal plain of the Arctic National Wildlife Refuge to oil and gas production. If there is as much oil as the U.S. Geological Survey’s estimate shows, this would increase America’s proven domestic oil reserves by approximately 50 percent. There is majority support in both the House and Senate for opening the refuge, but an obstructionist minority blocked enactment last year. The Senate again voted 51 to 49 earlier this year to open the refuge.

Open the Pacific, Atlantic and eastern Gulf of Mexico offshore areas to oil and natural gas production. America’s deep-sea reserves are potentially enormous, but – except for the western Gulf of Mexico, which is the United States’ largest producing oil field today – they have been put off limits by the federal government. Environmental concerns about deep-sea production are unwarranted. The last significant offshore oil spill in the United States was in 1969. Hurricanes Katrina and Rita last summer destroyed many oil rigs and platforms in the gulf but did not cause any significant spills. Congress should enact legislation this year to open offshore areas currently under moratorium and share federal royalties 50-50 with the states involved.

Repeal the new ethanol mandate included in the energy bill passed last year. The new mandate requires refiners to double their 2005 use of ethanol to 7.5 billion gallons per year by 2012. Higher demand is causing ethanol prices to soar. The mandate will require 22 percent of the U.S. corn crop to provide 4 percent of gasoline supplies. Repeal the current 54-cents-a-gallon tariff on imported ethanol. Domestic ethanol producers already receive 51 cents per gallon in federal subsidies. They don’t need any more protection.

All-too-often, our elected officials look for short-term electoral gains at the expense of sound policy objectives. We are now reaping the consequences of an energy bill that has failed economically and politically. Rather than enacting unwise price-gouging legislation, New Mexico’s elected officials should use their influence to promote a healthier debate focusing on real solutions.

Gessing is president of New Mexico’s Rio Grande Foundation, which describes itself as an “independent, nonpartisan, tax-exempt research and educational organization dedicated to promoting prosperity for New Mexico based on principles of limited government, economic freedom and individual responsibility.”

Categories
Economy Energy and Environment Oil & Gas

Economic Aspects of Energy in New Mexico

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.