How To Create An Energy Crisis

Does government really make a mess of everything? In today’s guest letter, professor Hans Sennsholz shows how bureaucrats engineered an energy crisis:

HOW TO CREATE AN ENERGY CRISIS

It was not until the middle of the eighteenth century that economic knowledge emerged as a new discipline worthy of any attention. Heretofore, some economic thought had been gleaned from writings on religion, politics, and jurisprudence. In California, this may still be true today.

The work of the Scotsman, Adam Smith, was truly epoch- making in the development of economic thought. In his An Inquiry into the Nature and Causes of the Wealth of Nations, which appeared in 1776, he explained the law of supply and demand: “The market price of every particular commodity is regulated by the proportion between the quantity which is actually brought to market and the demand of those who are willing to pay the natural price of the commodity, or the whole value of the rent, labour, and profit, which must be paid in order to bring it thither.”

In the halls of the state government of California this simple principle apparently is as yet unknown.

The supply-and-demand principle points to three ways of creating an energy crisis. One, legislators and regulators fix energy rates that do not allow for rent, labor, and profit to bring it thither. In modern terminology they set energy prices below market prices. Two, legislators and regulators do not set rates but prevent producers from meeting a growing demand through stringent emissions and zoning rules, which causes the rates to soar until there will be a “rate crisis.” Third, legislators and regulators may do both, fix rates below the market and prevent the supply from adjusting to the demand, which is bound to create a double-prong crisis.

California political leaders chose the double-prong approach. In 1996 California legislators unanimously passed a 67-page electricity-restructuring law. They called it “deregulation” by which, in typical political duplicity, they meant re-regulation.

It contained something for all the different players. The number of regulators was increased with the addition of two new quasi-governmental organizations – the Power Exchange, which controls all transactions between utilities and electricity generators, and the Independent System Operator, which operates the electricity grid, purchases the needed power and charges the utilities.

Consumer groups got an immediate 10 percent rate cut and price caps at roughly the 1995 level. Powerful environmental groups were reassured of stringent environmental rules and zoning restrictions. The utilities, finally, were given strong financial incentives to sell their fossil fuel-fired power plants. They subsequently reduced the self-generated power from 72 percent to just 20 percent, purchasing the balance on the market.

Fearing corporate collusion, the law prohibited long-term power contracts and made the spot market – the most volatile of all – the only market. While consumer rates were set by the government, wholesale prices were to be negotiated from minute to minute at the PX. With retail prices fixed at roughly 12.5 cents per kilowatt-hour and wholesale prices soon soaring to 40 cents or higher, the utilities’ losses mounted, approaching $15 billion, forcing Pacific Gas & Electric (PG&E) to file for Chapter 11 protection on April 6.

Adam Smith’s simple principle of “bringing it thither” would solve the crisis immediately. But it is unlikely that the politicos who created it are willing and ready to solve it. Their economic understanding obviously is gleaned from politics itself, that is, the plotting and scheming of those seeking personal power and position. Facing a crisis, their primary concern is political survival; to admit their culpability and liability would be committing political suicide.

They rant and rave, always pointing toward the producers of energy. It is they who heartlessly, scandalously, viciously, and immorally conspire to create energy shortages in order to reap exorbitant profits.

Every utility law the California legislature passes and every decision the governor makes seems to compound the problem. With the utility companies in or near bankruptcy the State now purchases electricity in the wholesale market for delivery to customers. To pay for the power which it has already purchased and to keep the lights on during the summer, it is authorized to sell up to $12 billion in revenue-backed bonds.

Future taxpayers will cover present losses.

The legislature also created another power authority: the California Consumer Power and Conservation Financing Authority which may issue bonds to build state power plants. Moreover, it is preparing legislation authorizing the State to issue more bonds to buy the transmission lines from the utilities. If they refuse to sell, the governor threatened to use the power of eminent domain. In short, the State is taking over the electricity industry.

Whenever a food shortage descends on Cuba, Fidel Castro invariably raves about profiteers and laments about the weather. In the coming months the governor of California may sound like Fidel, holding forth about evil industrialists and bewailing the unbearably hot summer.

Yours truly,

Hans F. Sennholz
Baltimore, Maryland
May 23, 2001

From 1992-1997, Prof. Sennholz served as the President of The Foundation for Economic Education. He can be reached via his website: www.sennholz.com

*** Like kernels of corn on a hot stove, individual stocks and stock sectors are “popping” higher one-by-one. First pharmaceuticals, then financials and now, technology stocks of all stripes.

*** Indeed, the technology stocks have taken the lead, just like old times. Cisco showed the way by adding almost 3% to its 13% advance on Monday. For its part, the NASDAQ ended a sixth straight day in the plus column by gaining eight points… just like old times…

*** The Old Economy couldn’t seem to keep pace however, as the Dow closed more than 80 points lower.

*** What about Old Man Gold? He managed to hang in there, finishing unchanged on the day. Gold stocks did not fare as well, however, as most fell more than 5%. Despite today’s retrenchment, gold mining shares remain one of the market’s strongest sectors.

*** “Last year, bankers were greeted at the opening night party by semi-naked women, nipples visible and dabbed in gold paint, daintily pretending to be fairies,” the Financial Times reported. No, the gala event being described was not last year’s Agora Wealth Symposium (nor is any such festivity anticipated for this year’s Symposium in Las Vegas, although we have not yet ruled it out). Rather, it was the European Technology conference in Barcelona, Spain.

*** This made me think I should take a trip there and check it out for myself. Alas, eyewitnesses report that at this year’s conference no scantily clad “fairies” appeared. Instead, as befits the less exuberant post-bubble era, fully clothed flamenco dancers provided the entertainment. Then, as if orchestrating a self-parody, guests to this year’s event were given “a tiny stainless steel champagne bottle filled with detergent and a delicate bubble blower. Within minutes, the hall was filled with bursting bubbles.”

*** It’s not all bursting bubbles out there in cyberspace. The new “e-performance” report by McKinsey & Co. states that one in five dot.com companies is a profitable enterprise.

Similarly, ActivMedia Research’s recent report, “The E- Commerce Shakeout: Surviving the Maturing Web,” observes: “There are a solid core of profitable Web businesses continuing to thrive online.” By the research firm’s estimation, a solid 58% of all “dedicated profit centers” online are profitable.

*** I can report to you dear reader, that our own e- commerce efforts are profitable. And thank God! I have 5 more children to put through college.

*** But poor Jeff Bezos. Once TIME magazine’s Person of the Year…once the wunderkind of e-commerce…once nearly as rich as Bill Gates…the poor man is now the target of jokes and lawsuits. He’s been named in 3 federal cases. And now he’s being investigated for selling a measly $12 million of his own stock. But it wasn’t the amount that rubbed the SEC the wrong way. It was the timing. Bezos allegedly sold days before a negative report was released.

*** Fred Hickey’s High Tech Strategist observes, “Power One, which does approximately one of its business with Cisco, said that its net new orders were negative in the first quarter due to cancellations by several top customers.”

*** Likewise, “Cypress Semiconductor admitted that order cancellations in the first quarter (mostly from cell phone manufacturers) virtually offset every new order it received in the period.”

*** The macro-economic news is not much better. “With profits down from $192 billion to $152 billion, [in the 4th quarter of 2000],” writes Dr. Kurt Richebacher, “U.S. manufacturing has been earning substantially less than the $166 billion in 1995. Listening to proliferating CEO warnings about revenues and profits, it’s clear that the worst has hardly started.”

*** Bad news, schmad news. Investors are not about to let reality get in the way of their investment hopes and dreams. Since April 4, Cypress Semi shares have climbed 58%, while Power One stock has soared 91%.

*** Investors seem to be singing along with Bob Marley and the Whalers, “Don’t worry about a thing. Every little thing is gonna be alright. Singin’ don’t worry about a thing…”

*** The New York Times: “FISHER SAYS PRICES OF STOCKS ARE LOW… Quotations Have Not Caught Up With Real Values As Yet, He Declares”

The Fisher responsible for this ill-timed headline was the Yale economist, Irving Fisher, America’s leading economist of the era. And the year of publication was 1929. Most folks know Fisher for his epically ill-timed pronouncement: “The nation is marching along a permanently high plateau of prosperity.” Five days later the market crashed.

With the benefit of hindsight, we may chuckle smugly at Fisher’s folly. Now, it’s not so easy. Since WWII, the average P/E of the S&P has been about 14. It is 25 today. And yet, nearly every financial commentator swears that stocks are cheap.

*** Says Fred Hickey, “You have to believe that stock prices can be held at grossly inflated prices through the magic of rate cuts and money supply growth indefinitely.”

*** David keeps beating up on Goliath. “Tiny companies with market capitalizations below $250 million are up 24% on average this year,” USA Today observes, citing a report by Salomon Smith Barney. “[Meanwhile] corporate giants with market caps above $20 billion are down 7%.”

*** Here’s a tiny company that has the additional virtue of being pretty darned cheap. Grant’s Interest Rate Observer introduces us to the Zapata Corporation, a company with interests in food packaging and fish meal. The remarkable thing about the company is the share price – recently around $16 a share. It is remarkable because the company has $29 in cash for each share. And it has another $21 in other realizable assets.

Dot.coms or asbestos businesses will sometimes trade at prices far below the value of their short term assets. But Zapata is neither. Still, management was able to lose nearly $10 million on a dot-com venture called ZapNetwork. That business was dropped, but as Grants warns, there is no telling what other bad ideas lurk in management’s ambitions.