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How Sweet it is! - the Natural Gas Shortage California's Democrat Governor Gray Davis has been quick to spout the typical Democrat line - calling businessmen who run electric utilities evil and claiming they are "gouging" poor citizens to "bring California to its knees." This is baloney, and Davis' threat to call out the National Guard to take over California utilities earned him a quick trip to Washington for an unprecedented meeting with Federal Reserve Chairman Alan Greenspan and Treasury Secretary Lawrence Summers. Politicians always reduce wealth and make us worse off when they interfere with the market - no matter how much they claim they want to "help" poor people. But Gov. Davis' threat to strong arm the California utilities could force them into bankruptcy, causing turmoil and a possible collapse in financial markets already reeling from falling stock prices. Let's use some pictures to be clear on the facts. The first picture shows the supply and demand for natural gas:  California's - and our - problem is not caused by evil businessmen and the answer is not more government control of the market. Very simply: The green line that slopes up as it moves right shows that it costs more to produce more natural gas. This is the Supply curve. It reflects the fundamental law of the universe that to get more of anything you have to pay more. This is the reason you are more tired after running 20 miles than you are after running 2 miles. The green, red, and purple lines that slope down as they move right are Demand curves. Your demand for any product is based on the benefits that consuming that product provides to you. Demand slopes down because the benefit from almost any product decreases the more you consume. You get less benefit from the 10th hamburger than you did from the first. The intersection of the green Supply and Demand curves - labelled D0 - shows the situation without the factors that are causing the problem. This is where Supply and Demand would normally intersect. The first part of the problem is caused by California environmental regulations. California does not allow utilities to use lower cost fuels like oil or coal. All electricity must be produced with natural gas. California law causes demand for natural gas to increase, shown in the picture by the red Demand curve labelled D1. The second part of the problem is caused by the unusually cold winter. The cold weather has also increased demand for natural gas, causing the Demand curve to shift again, this time to the purple line labelled D2. The market price, of course, is determined by the point where supply and demand intersect, shown by the line labelled "Real Market Price" in the picture. But that's not the end of the story. Now let's look at a picture that shows how the market situation for natural gas affects supply and demand in California's electricity market:  Because California law requires all electricity to be produced by natural gas, the California electricity market reflects the operation of the supply and demand for electricity produced by natural gas. Thus the first increase in demand for natural gas we saw in the earlier picture - the shift in demand to the red line labelled D1, also shows up here as an increase in demand for electricity produced by natural gas. Without the environmental regulations, the supply of electricity could be bigger - the supply curve could shift to the right - because electricity produced by oil and coal could enter the market. Also in this picture, the increased demand caused by cold weather is shown as a shift of the demand curve to the right to the purple line D2. But California has another, even more serious problem, price control. California uses law to restrict the maximum price utilities can charge for electricity. As the diagram shows, the current price for electricity is below the cost of producing it, even without the increases in demand. This is why California utility companies are in danger of going bankrupt. Power company executives understand the situation and have asked the California regulators for higher prices. Notice how California's price control affects supply and demand. Because the price is kept artificially low, the amount of electricity that utility companies can afford to produce is low - it is shown by the intersection of the black price control line with the green supply curve that shows how costs increase as more electricity is produced. But the low price also causes consumers to demand a larger amount of electricity, shown by the intersection of the black price control line with the purple demand curve. If Gov. Davis does not allow California's energy price to rise to the real market level, power companies will have to produce less than consumers demand if the companies are to avoid bankruptcy. How much less is shown by the distance along the quantity axis labelled "Blackouts." No amount of populist Democrat rhetoric will alter the facts. Clinton knows it, which is why Gov. Davis was called to Washington. Clinton has extended his Executive Order that requires power companies in other states to essentially donate electricity to California to make up its shortfall - which is why blackouts have not yet happened. But Clinton's order ends January 6th. Then Gov Davis - and Californians used to government price controls - will have to face the cold facts of the market. |
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