There He Goes Again … and Again

Sept. 5, 2006

By Lewis Tagliaferre

I planned to discuss electric transmission issues this time, but President Bush has preempted that topic with an urgent issue that prompts me to comment. I will get back to electricity shortly, though.

Several times in speeches recently, Bush has said, “America is addicted to oil” and that we need to find substitutes for supplies from unfriendly countries. When you realize that his words are distributed instantly all over the earth, that’s a pretty strong admission (aside from its impact on terrorism). If you compare the $10-billion profit of Exxon/Mobil against the $3-billion loss that GM reported last quarter, you may begin to realize how important it is to maintain gasoline supplies at reasonable prices from unfriendly nations.

It seems that American motorists sent a strong message that $3 per gallon is their limit before they begin to adopt alternatives for personal transportation. Consequently, it is extremely interesting that gasoline prices dropped dramatically after the Labor Day weekend, along with the price of crude. Advertising by many auto-makers is emphasizing higher-gas-mileage vehicles, including electric hybrids, because hydrogen-fueled vehicles are a long way off. The Bush Administration has proposed a Renewable Fuels Standard (RFS) Program designed to double the present use of renewable fuels such as ethanol and bio-diesel. The program, authorized by the Energy Policy Act of 2005, will promote use of fuels largely produced by American crops. Opponents say these alternatives are not as efficient as they seem when all factors of production and distribution are considered. Creating such an infrastructure nationwide will take years.

So, the bottom line on oil is that consumers are being rattled while auto-makers and the government are responding slowly. The question that remains: Which international forces will dominate the worldwide distribution of oil as rapidly growing nations of Asia bid for an increasing share? It is a lot easier and less costly to build land-based pipelines from producers to consumers in that part of the world. As long as foreign oil producers believe that American dollars are desirable to get, and as long as they reinvest in U.S. treasury bills, the tankers may keep sailing across the oceans. But, domestic refineries have reached capacity and are aging past their useful life, so imports of refined gasoline must also increase. The incessant demand for foreign oil will continue to drive U.S. foreign policy no matter who is president.

What can you do? If your boilers and heating systems are fueled by oil, perhaps this discussion will stimulate some interest in assuring that they are operating at peak efficiency; perhaps they should be replaced by modern fuel-efficient models. If you can’t do it for your bottom line, then consider doing it for the country.

The pressure toward reducing demand for oil has shifted emphasis to use of natural gas for domestic heating and electric generation. The increasing demand from unregulated generators and overall growth has caused the price of natural gas to triple in a few recent years. Trading in natural gas prices has become a highly risky endeavor for hedge funds because the traditional fundamentals of investing seem to apply no longer. Natural-gas prices seem to have become decoupled from known financial principles as short-term shortages can send prices skyrocketing. One solution is the proposed increase in imports of liquefied natural gas (LNG) from nations like Russia, which has the world’s largest gas reserves. But local jurisdictions often successfully oppose citing LNG terminals near population centers due to safety concerns. Plus, the special tankers needed are very expensive to operate and slow to build.

With environmentalists able to curtail exploration on public lands and so restrain domestic production, the future for gas prices seems to be anything but predictable. The bottom-line question here: How high and volatile must gas prices become before they stimulate serious attempts to reduce demand or to find economical alternatives?

That leads me back to electricity, which, as you know, is generated by converting coal, oil, gas, and nuclear fuel into steam, in addition to falling water. Each of these energy sources comes with issues. Environmental opponents consistently lament that coal is polluting the atmosphere, oil is too political, gas is too expensive, and nuclear-waste storage is unsafe. Plus, there are no more rivers to dam up. Consequently, the price of electricity (that was consistently falling during the last century as produced in centralized fossil-fueled generators by vertically integrated and regulated companies) is now subject to a complex maze of federal, state, and local laws and regulations. Authority in the Energy Policy Act of 1992 to decouple electric generation and to separate it from regulated interstate transmission and local distribution business models has not been adopted consistently among the states. Even in those states where options were adopted, markets have been a rocky road, and incumbent utilities have successfully delayed or deferred implementation to protect their investments at-risk from rogue competition. Competition among suppliers still has not impacted consumer choice extensively; where it does exist, prices have risen painfully high in most areas.

What has developed, though, is a growing wholesale market between unregulated generators and some power retailers. This market is being thwarted by choke points in the transmission lines built by utilities to connect their remote generators to local distribution systems that gradually have evolved into an interstate system. Organized consumers would like to see that interstate system of transmission lines operated like the federal highway system, which enables trucks to carry merchandise anywhere from producer to user. The trouble is that electricity does not work that way. It is subject to well-known Kirchoff’s laws that require a continuous closed-loop for the flow of electrons from generators through the using appliance, such as a motor or light bulb, and back again. Moreover, an overload on one transmission segment can produce an instantaneous disconnection that cascades at the speed of light to related branches, causing more overloads and disconnections that can extend to several states. The transmission lines were built and owned by utilities for their private use, so it is understandable that they did not want to make them available to unregulated competing suppliers without just compensation. Try to imagine the federal highway system being owned by several hundred different companies, all with toll booths at their borders, and you may get the picture.

Since this is an interstate commerce issue, the solution came in the Energy Policy Act of 2005, which authorized the Federal Energy Regulatory Commission (FERC) to issue mandatory regulations for the reliable, economical operation of that system. FERC delegated this authority to the North American Electric Reliability Council (NERC) last month. NERC has submitted 17 reliability standards to the FERC for immediate approval.

As with all good intentions, this one comes with both benefits and burdens. A more reliable and versatile transmission system may evolve, but someone will have to pay for it. Guess who? The real question: How much it is going to cost you?

Conferences are being convened by consultants to help utility planners determine the best way to finance and price the future of a reliable and adequate interstate power transmission system. Questions being pondered include:

  • How much willingness will consumers muster to pay more for better service (what economists call “elasticity of demand”)?
  • Who will build and own the new system?

These are not merely rhetorical questions, because you will be facing some challenging options as an electricity consumer in the near future.

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