Flexibility the Key to Security, RFF Energy Conference Warns

by John W. Anderson

January 28, 2002 - Flexibility is the key to national energy security, two panels of economists agreed at a conference on Jan. 28 at Resources for the Future.

That means flexibility in pricing, in switching among fuels and in decentralizing power sources, they said. But present trends are often moving in the other direction, they found.

Under present policy the proportion of the country's electric power generated by coal and natural gas alone will rise to 80 per cent by the year 2020, according to Shirley Neff, senior economist for the Senate Committee on Energy and Natural Resources.

"We don't see that as a very good trend," she said.

Increasing energy production --- for example, by drilling for oil in the Alaska National Wildlife Refuge (ANWR) --- will not make the present energy structure more stable, two of the speakers warned. The future of ANWR is a major political issue in Congress, as it tries to write a national energy policy.

"Opening ANWR would do absolutely nothing for energy security, and absolutely nothing for [price] volatility," said Robert Weiner of George Washington University.

Production from ANWR would perhaps provide a little more competition to the Organization of Petroleum Exporting Countries (OPEC) but does not address the basic problem, commented Michael Toman of Resources for the Future. The price for oil is set by a world market in which OPEC is the largest single force. The effect of oil from ANWR might even make the American energy system less secure by pushing down prices and increasing consumption.

Estimates of potential production from ANWR range as high as nearly 1 million barrels of oil a day. That compares with total American consumption of nearly 20 million barrels a day, of which nearly 12 million barrels are imported.

To make the economy less vulnerable to shocks from oil supply disruptions, the economists agreed, the only solution is to reduce American consumption.

But they also recognized the dilemma of national policy toward oil.

"On the oil demand side we seem to be stymied," Neff observed, pointing out that the country refuses to raise gasoline taxes to discourage consumption, but is also reluctant to tighten the fuel efficiency standards for cars and trucks out of a concern that it would hurt American manufacturers in competition with imports.

In the case of electricity, Neff said, one crucial question is who will ensure the actual delivery of power under the deregulated system now taking shape. In the past, she noted, that responsibility lay with the states but that no longer applies in the nationwide power market that is currently evolving.

The conference discussed at length the effects of price volatility on the economy. Eric Hirst, a consultant, argued that in the electricity market price volatility is not the problem but rather the solution, conveying important signals to both producers and consumers. But several other economists noted that the political system traditionally has tried to protect consumers from swings in prices, and that habit has often been carried over into the deregulated markets.

"One of the big disappointments has been that restructuring has not been accompanied by more efficient pricing," said Howard Gruenspecht of Resources for the Future.

While price swings may be beneficial, the speakers noted that electricity outages are more serious. The cost of an outage appears to range from $3000 to $20,000 per megawatt hour, about 100 times the typical wholesale price of power, Gruenspecht said.

In the oil markets, sudden rises in prices have repeatedly tipped the American economy into recession, Mine Yucel of the Dallas Federal Reserve Bank pointed out.

For the past two decades the federal government has maintained a Strategic Petroleum Reserve (SPR) as a shock absorber against disruptions in the world market. But it has been largely immobilized by a continuing disagreement over how to use it. One view holds that the government should sell oil from the SPR frequently to dampen price rises. Another view is that the SPR should be used only in case of a major crisis.

The SPR is the first line of defense in theory, Toman said, but in practice the last line.

Wiener suggested that the government sell options to buy the oil at, say, $40 a barrel to set a ceiling on the market and reassure buyers that the price will not go higher. With that, he said, the decision to sell from the SPR would be automatic, not a political choice. Under present circumstances having the SPR and not using it is worse than having none, he suggested, since not using it sends a signal that the government fears worse disruptions ahead.

Even apart from jumps in the basic world price of crude oil, the American markets for refined oil products --- especially gasoline --- are becoming more volatile, said Barry McNutt of the U.S. Department of Energy. One reason, he said, was the fragmentation of the market by state and local requirements for special fuels to meet the requirements of the Clean Air Act.

Another reason, several of the economists added, was inadequate investment in refining and transportation facilities because of low and volatile prices.

McNutt asked whether there is any practical alternative to the growing volatility. Legislation to require refiners to hold large inventories or to offer subsidies to energy investment seem unlikely, he said, as is any significant loosening of environmental rules.

"I see price volatility as being a continuing characteristic of the product market," McNutt concluded.

###

Since 1996 J. W. Anderson has worked at RFF as a journalist-in-residence. He writes for RFF publications, mainly on issues related to climate change, energy, and air quality. He is also a contributing editor and correspondent for Weathervane, RFF's web site on global climate policy. He can be contacted by E-mail at janderso@rff.org.