Saturday, September 17, 2005

The Energy Bill: It Could Have Been Worse

The Energy Bill: It Could Have Been Worse

August 12, 2005

The Energy Bill: It Could Have Been Worse
by Peter Van Doren and Jerry Taylor

Mr. Van Doren is editor of the Cato Institute's Regulation magazine and Mr. Taylor is director of natural resource studies at Cato.

With Congress returning home for its summer recess, analysts are taking stock of the 1,724-page energy bill legislators passed last week on their way out the door. The press seems to be of the opinion that the bill did too little to address fundamental energy problems. That's an observation worth celebrating, not jeering. Past Congressional attempts to address "fundamental energy problems" resulted in an array of price controls, fuel-use restrictions, ambitious crash energy projects, and anti-profit regulation. The fact that Congress ignored such approaches this time around -- even in the face of higher energy prices -- is worth a few moments of grateful reflection.

That's not to say that the Energy Policy Act of 2005 is good public policy. The legislation is premised upon the idea that energy markets are different from other markets and that they require political micromanagement. But price signals play the same role in the energy sector that they play in the rest of the economy. Unfortunately, neither Congress nor the public is content to leave energy choices to producers and consumers. Tax subsidies and regulations create investment and consumption patterns that would not exist if decisions were made by market actors.

The good news is that this energy bill is radically different from those once routinely passed by Congress when energy prices rose.

Consider: The inflation-adjusted price of gasoline has increased 56% since 2002. Real-price increases of half that magnitude over similar time periods in the 1970s prompted the introduction of price controls. Yet not only doesn't the energy bill contemplate such price controls, one cannot find a single serious politician who embraces such ideas. Why?

We'd like to think that the disappearance of price controls from the public agenda has something to do with lessons learned. Economists have convincingly demonstrated that our bad memories of the 1970s (long gasoline lines, shortages at independent stations, etc.) were the result of the policies enacted to respond to price increases rather than the price increases themselves. We have no independent evidence that the public or Congress understands such arguments, but Washington is acting as if it understands, and that is good news.

Another example: In response to interstate natural gas shortages (caused, incidentally, by price controls), Congress in 1978 prohibited utilities from burning natural gas to generate electricity and gave the Federal Energy Administrator the authority to ban the use of natural gas in other commercial boilers. Fast forward to the present -- natural gas prices have more than doubled since 1999 and all new electricity generation build over the past 15 years or so has been fired by natural gas. Yet no one has contemplated restricting commercial gas use.

Although concern over our increasing reliance upon foreign oil was an all-purpose justification for most provisions of the 2005 bill, Congress never contemplated anything nearly as serious as the Mandatory Oil Import Control Program, which imposed a strict quota on petroleum imports from 1959-1973. Hard restrictions on foreign oil led to higher energy costs, hastened the depletion of domestic reserves, and seriously distorted investment decisions pertaining to oil exploration and petroleum refining.

In the 1970s, soaring oil prices encouraged Congress to launch the equivalent of the "Apollo Project" to commercialize and market synthetic petroleum. The result was the Synthetic Fuels Corporation, a public-private entity for which Congress conditionally authorized a staggering $88 billion in 1980. In contrast, Congressional enthusiasm for clean coal, biomass energy, nuclear power, and exotic fuel cells in the 2005 energy bill will cost the Treasury only a fraction of what Congress had contemplated spending for synthetic fuels 25 years earlier.

A central concern of energy policy in the 1970s was the distribution of corporate energy profits, gained primarily by owners of low-cost production assets when the market price rose to cover the costs of newer and more expensive oil, gas, or coal reserves. When prices rose in 1973-74 and again in 1979-80, Congress attempted to redistribute profits from producers to politically favored classes.

Congress first did so by distinguishing between existing production levels ("old" oil) and increased production levels induced by the price increase ("new" oil). It applied price controls to the former and allowed market prices for the latter. This created unequal profits among refinery owners, who had differential access to "old" and "new" oil. The net effect was to create incentives to import oil exactly at the time when our stated policy was to reduce imports.

Natural gas policy likewise attempted to force commercial and industrial users to pay for all the marginal "new" natural gas and preserve the "old" price-controlled natural gas for residential customers. The rapid price increases for commercial and industrial users backfired because their demand was more price-sensitive than it was for residential consumers. As a result, pipelines were stuck with natural gas at high prices that had no demand.

When oil price controls were repealed in 1980, Congress replaced them with a windfall profits tax in order to capture energy profits for the government. Luckily, its provisions were never implemented, but the tax reflected Congress's continuing obsession with how much money various actors made in energy markets.

Now fast-forward 25 years. Corporations in the oil and gas sector are making money again, but it barely manages to elicit even a raised eyebrow in Washington. One has to really strain to hear cries of "price gouging" and no active investigations of the usual bogeymen -- collusion, profiteering, or conspiracy -- are in the works.

When energy bills actually meant something beyond the now standard array of handouts and subsidies, they invariably meant economic disaster. If energy bills have largely become like transportation bills -- vehicles for members of Congress to shovel money at favored constituencies accompanied by over-the-top justificatory rhetoric -- then maybe the glass is half-full rather than half-empty. Yes, energy policy could be better. But the really bad policies of the past are no longer even considered, yet alone enacted.

This article originally appeared in the Wall Street Journal on August 11, 2005.


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