Wednesday, January 10, 2007

The High Price of Idiocy

Is energy a necessity or a commodity?

It’s both. It’s a necessary commodity. Food and clothing are also necessary commodities. People ask this question because they feel that if for some reason the free market is unable to provide an indispensable commodity, the necessity still must be answered, usually by government.

Energy, expensive here in the Northeast for a variety of reasons, does not yet fall into this category, though deregulation, by contributing to a surge in price, has nudged it in that direction.

The factors affecting a rise in energy costs are more complex than we are given to understand by people interested in demonologizing the energy industry.

Energy is a product delivered through transmission lines the way, say, oranges and apples are delivered to grocery stores by trucks using highways, which serve as a distribution system. Given a competitive market, the price of these commodities may be lowered through healthy competition; this was the expectation for energy prices as Connecticut moved into a deregulated market system. Competition depends on supply and demand. All things else being equal, the price of an apple in a Connecticut grocery store should be reasonable in a competitive market--provided that the product is delivered through the distribution system so that it is present in the store when the purchaser wishes to buy it. If the distribution system is in poor repair and the product does not get to market in sufficient numbers to drive down the price, apples and oranges will be expensive.

Energy is expensive here in the Northeast, among other reasons, because there are not enough transmission lines. The distributive mechanism is both insufficient and inefficient. As a consequence, there are too few units of energy chasing too many customers. Under these circumstances, the price of energy will be high, because the supply system cannot deliver the goods in sufficient numbers through the pipeline. The same would hold true with apples and oranges if the highway system in Connecticut were in such poor repair that trucks could not deliver the product to grocery stores in sufficient numbers. If the supply of energy cannot reach the customer through the pipeline, the price of energy will be high.

There is another important factor involved as well. In a deregulated market, the creation and maintenance of the transmission system depends upon investors. Uncertainty drives away investments. What produces uncertainty in the distribution of energy? Swift and unprincipled changes in what one might call the rules of the game.

In a free market system, energy producers receive capital to improve their product through investors. Think of an investor as someone placing a bet on a baseball game, and ask yourself: Would the investor be likely to place a bet if he were certain that the rules of the game would be subject to whimsical changes? Suppose two teams, Team A and Team B. Team A follows the time honored rules of baseball, but Team B changes the rules according to its fancy: Sometimes batters are ruled out after two strikes rather than three, and the distance between home plate and the pitchers mound changes every third game. Would the investor be likely to bet his money on Team A or Team B? Uncertainty drives away productive capital. Investors always will “bet” their money on a product that is more likely to increase their outlay. And uncertainties in the market, usually introduced by well meaning politicians, drive investors away.

In addition to other factors that increase the price of energy by constricting supply, unpredictability, which drives away investment, and low capacity transmission systems are the two most easily correctable factors driving up the cost of energy in Connecticut. The second requires an investment in new transmission lines – which, I mentioned tongue in cheek in another column, might require gagging Attorney General Richard Blumenthal -- and the first requires an acknowledgement on the part of legislators and others that changing rules governing the way business is conducted in the private market place often does more harm than good.

A little courage combined with humility often is more productive of good than a reckless rush forward into the unknown, and good government more often requires a cautious maintenance than radical readjustment.
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