And just how important are fossil fuels relative to so-called renewable energies? Oil, gas, or coal generates the electricity needed to fill in for intermittent wind and solar power and ensure moment-to-moment reliability. So renewable energy, ironically, is codependent on nonrenewable energy short of (currently) prohibitively expensive battery technology firming the flow of electricity.

As a component of all products and services, energy needs to be affordable, convenient, and reliable. To this end, public policy should respect consumer preference and allow energy producers to meet the demands of the marketplace. This requires a respect for private property rights and voluntary exchange to facilitate the global exchange of energy and its innumerable subcomponents.

Global energy supplies are primarily the product of government, unfortunately, not the free market. In state-run economies political elites make the decisions that otherwise would be made by the multitude. Win-win exchanges are supplanted by government-dictated win-lose transactions. Wealth is redistributed. Pure waste results from the intervention of (political) third parties into what otherwise would be mutually advantageous self-interested exchange.

For example, electric utilities may be forced to buy wind power, solar power, or another politically correct energy under state law. A mandate is required because a free marketplace would not support such expensive, unreliable—noncompetitive—supply.

Oil and gas producers may be unable to access offshore properties because of government constraint. In such cases, supply is not produced and higher-cost substitutes elsewhere pick up some of the slack. Consumers are left with less supply and higher prices. Economists have a name for this: inefficiency.

Government intervention may also give life to uneconomic projects. Such ventures may include carbon capture and storage, a “smart” electricity grid, or even a nuclear plant that requires a federal loan guarantee. Resources that go to these projects do not go to other, more economical projects (which may or may not be in the energy sector) as judged by the marketplace. Resources are again misallocated.

Proponents of government intervention cite “market failure” as the reason for regulating or subsidizing energy projects. Negative externalities created by self-interested exchange require the government to modify transactions in ways ranging from a prohibition to a tax, they say.

Nonmarket Failures

But there are two other types of failure that also must be considered before rushing to policy judgment.

One is analytic failure, in which the outside evaluator’s prescription for intervention (such as a per-barrel “energy security” tax on oil imports or a per-ton “climate change” tax on carbon dioxide emissions) overcorrects or undercorrects for the “real” problem. The error might be purely intellectual—or it might reflect the personal prejudice of the analyst. Fallible self-interest in the marketplace has a counterpart in the ivory tower.

Second, there is government failure, whereby even the “correct” analytical blueprint is altered and violated in the political process. Special-interest tinkering adds to or subtracts from the core proposal, and political actors resort to “logrolling,” where extraneous issues are added to the legislation just to win votes.

House passage of a cap-and-trade energy bill last year and health insurance legislation enacted this year are stark evidence of sausage-making in Washington, D.C.—and something scarcely recognizable in “we the people” textbooks.

Thus “market failure” does not automatically require a government correction. This suggests a different approach. Knowing that political solutions are likely to be as bad as or worse than the problems, alleged market failures should be scrutinized to see if they are really serious problems. And if so, can the real problems be addressed by novel voluntary approaches and reforms rather than by government dictates?

Intellectual and political debates over energy have revolved around four “sustainability” issues: depletion, pollution, security, and climate change. Whole books address these issues, most from the market-failure viewpoint, concluding that mankind is on a perilous path and government-engineered energy transformation is necessary.

But students of energy history and energy policy must ask: Has a political makeover of any industry ever worked well for consumers and taxpayers? Or has it had the opposite effect? Creative destruction—a market makeover from shifting consumer demand—is one thing; having government pick winners with carrots and sticks is quite another.

Free-Market Sustainability

The arguments for allowing free markets, rather than government planning, to address the four sustainability issues can be summarized as follows:

1. Estimated quantities of recoverable oil, gas, and coal have been increasing over time, according to the statistical record. Human ingenuity in market settings has and will continue to overcome nature’s limits, leaving in its wake errant forecasts of resource exhaustion. The resource challenge is political: restricting access and perverting incentives prevents the ultimate resource—human innovation and entrepreneurship—from expanding energy supplies and multiplying energy’s productive utilization.
2. Statistics of air and water quality in the United States show dramatic environmental improvement and, in fact, indicate a positive correlation between energy usage and environmental improvement. While improvements have been achieved by politicized, command-and-control environmental regulation, the results could have been achieved at lower cost through market methods.
3. Energy security in the electricity market is assured by abundant domestic coal and the fact that almost all U.S. gas imports come from Canada. Most of the oil needed for transportation comes from domestic supplies supplemented by imports from a variety of countries led by Canada and Mexico. Oil imports from unstable or unfriendly nations, such as Venezuela and those in the Middle East, can be more effectively addressed by privatizing U.S. oil and gas resources than by government penalties against oil imports that cannot distinguish between “good” and “bad” barrels. Even if the United States were to use the powers of government to pare domestic oil consumption, the resulting drop in world oil prices would encourage non-U.S. demand and subsidize foreign industry. The world oil market will continue to exist and thrive even with reduced U.S. participation, and this will become more true over time.
4. The global warming scare is plagued by open scientific questions, economic tradeoffs, and the reality that carbon-based energy is necessary for economic growth. Carbon rationing (via the Kyoto Protocol) is a failed policy for the developed world and a nonstarter for the developing world. Not only have targeted reductions proved to be elusive, the economic costs of carbon rationing are not unlike those from (postulated) deleterious climate change.

The recent oil spill in the Gulf of Mexico raises an additional sustainability issue: unexpected setbacks that cause massive property damage and even fatalities. Short-run problems, however, can result in longer-term gains so long as the firm faces full liability and pays restitution to the victims. Accountability in private property settings encourages companies to square profits, people, and the environment—and avoid the financial losses that come from performance failure. Currently companies have their liability for damages capped by law at $75 million, though politics could potentially nullify the cap in any given case, as it apparently will in the BP Deepwater Horizon incident.

Rather than expand government, public policy should end preferential subsidies for politically favored energies and privatize such assets as public-land resources and the Strategic Petroleum Reserve. Multibillion-dollar energy programs at the U.S. Department of Energy should be eliminated. Such policy reform can simultaneously increase energy supply, improve energy security, reduce energy costs, and increase the size of the private sector relative to the public sector.

To Al Gore the “planetary emergency” is five billion to six billion people using oil, gas, or coal for most of their energy needs. But the real energy problem is that nearly one and a half billion people do not use modern forms of energy. Rampant statism in place of private property, voluntary exchange, and the rule of law is behind this problem.

Energy-impoverished people use dried dung and primitive biomass to stay warm and cook their meals, destroying their health and shortening their lives. Without electricity or machines, they do not have clean water, reliable lighting, or other means for comfortable, sanitary living. This here-and-now problem demands energy freedom and an end to debilitating energy statism.

The free-market vision stresses that these impoverished people should not be subject to energy rationing by government. Solar panels and industrial wind turbines can only generate a fraction of the energy produced by diesel generators or a conventional power plant—and are much less reliable. Energy brawn is needed, not inferior but politically correct energies that appeal to energy planners.

Property Rights vs. the Resource Curse

More fundamentally, these victims of statism need private property rights to in-ground minerals and ownership title to energy infrastructure. In this way, they can overcome the so-called resource curse whereby siphoned energy wealth underwrites government control and bad economic policy.

Countries worldwide should reject energy planning from a politically endowed elite. Government planners suffer from a “fatal conceit” that their knowledge and goals must override those of the masses. But on-the-spot energy consumers and energy producers, guided by prices and profit/loss, have much more collective wisdom than faceless bureaucrats commanding from on high. Top-down planning misdirects and destroys despite the best efforts of even well-educated, well-meaning bureaucrats.

Freedom—the use of reason and persuasion in place of coercion—is a worthy goal. In the U.S. energy sector, market reliance, though compromised by both pro-business and anti-business government intervention, has produced economic coordination, fostered economic growth, and democratized wealth. Government intervention, on the other hand, such as occurred in the 1970s with U.S. oil and gas price controls, has produced shortages, civil strife, and bureaucratic waste.

Markets are not perfect, inspiring some to devise and champion government intervention. But political solutions must contend with analytic failure, implementation problems, and public-sector (taxpayer) costs. Imperfect markets, in other words, may well be better than “perfect” regulation in the real world. The burden of proof, therefore, should be on government intervention, rather than on voluntary transactions premised on private property and governed by the rule of law.

Responding to the increased demand, private entrepreneurs funded the development of cracking technology. This method of transforming one set of hydrocarbons into another increased the proportion of the most-valuable products. On average 100 barrels of crude yielded 75.2 barrels of kerosene and 10.3 barrels of gasoline in 1880. By 1940 those same 100 barrels of crude produced an average of 5.5 barrels of kerosene and more than 40 barrels of gasoline. An equally dramatic example of technological progress occurred in the early 1930s and 1940s. The development of higher-performance engines prompted growing demand for higher octane gasoline, kicking off what came to be known as the “octane race” among refiners in the 1930s. Then World War II created demands for large quantities of high-performance 100-octane aviation fuel. Millions of gallons a year of this fuel, which had only been produced in tiny quantities as a reference chemical at a cost of $25 per gallon in the 1930s, became available at a cost of just over 25 cents per gallon in the early 1940s.

As a result, gasoline has been the subject of multiple regulatory efforts since the early twentieth century. (What? You thought they might produce public acclaim for an industry that had turned a waste stream into a valuable commodity and then upgraded the quality and reduced the price of its products to fuel the war effort?) These regulations have severely distorted the market for gasoline, increasing costs for consumers and diverting investment into political maneuvering. The government meddling produced a transportation-fuel network that is dangerously fragmented and at risk from natural disasters, accidents, terrorist attacks, and just plain old stupidity. Even worse, each time the fragile nature of the gasoline market is exposed, the reaction in Washington and state capitals is to layer on yet more bureaucracy and regulations, worsening the problem.

Aside from comparatively lightly regulated periods in the 1920s, 1950s, and 1980s, American governments have rarely left the oil business alone. Politicians use four different, and often mutually contradictory, rationales for their interventions.

• Antitrust. Since the Standard Oil litigation in the early twentieth century, politicians regularly invoke antitrust issues in support of claims that oil companies are conspiring against the public. When prices go up, you can be sure that politicians will call for antitrust investigations, windfall-profits taxes, and other measures to keep “greedy oil companies” from profiting “too much.”
• Destructive competition. When prices go down, however, domestic oil producers suffer reduced revenue, and less-efficient refiners and retailers lose market share. This spurs calls for investigations into measures to stop “destructive competition.” The governors of Texas and Oklahoma declared martial law in the oil fields during the Great Depression as part of their efforts to stop unregulated “excessive” pumping. Creating an oil “industry code” to reduce competition was a key element in the New Deal. Later regulatory programs have been filled with exemptions and special treatment for “small” players in the energy business in an attempt to protect inefficient firms from the ravages of competition.
• National security. From the time oil proved its worth as a naval fuel in World War I, the military has worried about adequate oil supplies. Domestically, national security concerns led to the creation of petroleum reserves after World War I (which later played a role in the Teapot Dome scandal) and these reserves have served as a fig leaf for import quotas and other restrictions on several occasions. You can count on the federal government to trot out national security as a justification almost every time it unveils a new subsidy or some other barrier to trade.
• Environmental protection. Governments at all levels take a keen interest in fuel formulation, inclusion of renewable fuels, and the location and operation of refineries, terminals, and filling stations. Since the appearance of the modern environmental statutes in the early 1970s, federal, state, and local governments have increasingly involved themselves in gasoline markets on environmental grounds. The actual regulations and laws enacted in pursuit of these goals often do not advance the stated purpose, which frequently serves as convenient window-dressing for interest groups looking for favors. (The definitive source on energy markets through the 1980s remains Robert Bradley’s monumental 1996 study, Oil, Gas, and Government.) To see how these interventions have disrupted gasoline markets, let us consider three of the largest regulatory programs: the Mandatory Oil Import Program (MOIP), the 1970s era of price and allocation controls, and the current mishmash of “boutique” fuel requirements.

MOIP

After World War II the refinery capacity built up to serve the military’s needs quickly refocused on producing gasoline for the booming domestic market. Freed from wartime scarcity and price controls, people bought cars and drove them, sending gasoline sales soaring. Many of the major oil companies invested heavily in developing new sources of crude oil in the Persian Gulf, Latin America, and elsewhere. These investments included construction of tanker fleets and oil terminals and acquisition of oil rights around the world. Production costs in the newly opened fields overseas were low enough that it was soon cheaper to import crude oil and refine it in U.S. refineries than it was to use domestic oil. As oil imports rose during the 1950s domestic producers and refiners who had not invested in access to the cheap foreign oil worried (correctly) that they were losing market share to foreign oil producers and the refiners who had made those investments.

Rather than playing catch-up in the marketplace, however, the disgruntled domestic oil producers and smaller and inland refiners headed to Washington, where they began a relentless lobbying campaign for restrictions on oil imports, citing the detrimental effects of competition from abroad and national-security concerns. At first the Eisenhower administration resisted the idea of quotas, then it experimented with “voluntary” quotas, but the administration ultimately gave in to the political pressure and created the Mandatory Oil Import Program. The program was in effect from 1959 to April 1973.

MOIP was simple in theory. Each refiner received a permit to import crude oil. The total number of barrels authorized was set below the amount that would have been imported in a free market. Refineries’ allocations of the permits started with a proportional share of this smaller total based on their prior level of imports, but these amounts were then adjusted in attempts to achieve various policy goals and reward particular interest groups. Crucially, every refinery got some permits, even if it had not imported any oil previously, and smaller refineries received a disproportionately large share of the permits. The permits were made tradable, making it possible for refiners that received permits, but did not need imported oil, to trade or sell them.

This system had five important effects. First, domestic oil producers got their reward as domestic crude prices were higher than they would have been in the absence of the quota system.

Second, because domestic prices were artificially above the world market price, the right to import the cheaper foreign crude granted by the permits became quite valuable.

Third, the major oil companies that had invested in tankers and terminals learned their lesson and shifted their investment dollars to lawyers and lobbyists who could find profits in the pages of the Federal Register. Within a few years they had learned to play the game well enough that they no longer opposed the MOIP.

Fourth, anyone who could slap together something that could pass as a refinery now had an incentive to do so, leading to a rapid expansion in the least expensive and least sophisticated refinery sector as new entrants built “teakettles” to get quotas. As a result U.S. refineries tended to lack the capacity to handle high-sulfur crudes, which have become an increasingly large proportion of the crude supply.

Finally, because independent ownership of refineries maximized quota allocations, consolidation in the industry was discouraged, leading to lower operating efficiency. (A group of refineries can often be operated more efficiently than an individual plant, because joint management allows operators to use equipment at one plant to prevent a bottleneck from developing at another.)

All that is bad enough, but the MOIP also proved to be a classic example of the unintended consequences of regulation. When the MOIP was enacted it allowed imports only under the permit system. Almost immediately, however, the Canadian government objected that limiting oil imports from Canadian oil fields through pipelines to refiners in the northern Great Plains was counterproductive. Not only would the limits hurt Canada, since the oil had no other export route, but the Canadians argued that it made no sense on national-security grounds to reduce imports from a loyal ally across a secure land pipeline. This argument proved persuasive and regulations exempted land imports.

When the exemption was granted, however, no one remembered to retract the permits that had been issued to the “Northern Tier” refiners. These refiners had no access to any other source of crude—there being no crude oil pipeline connection between Minnesota and the Dakotas and no port where tankers could unload Persian Gulf or Latin American oil. As a result, these refiners now found themselves with both access to the Canadian oil and valuable import permits that they physically could not use. So they sold and traded the permits to other refiners and pocketed the proceeds. On discovering the mistake, the federal government attempted to take back the permits. The “Northern Tier” refiners fought back with the aid of valuable allies like Minnesota Sen. Hubert Humphrey and succeeded in retaining what became known as the “double dip” for years.

That was just the first level of unintended consequences, however. Mexico soon came knocking on the State Department’s door, complaining of the special treatment Canadian oil was getting. True, Mexican oil was not imported via a land route, but wasn’t the Caribbean virtually as safe? And wasn’t Mexico vulnerable to communist subversion? Didn’t national security dictate that some accommodation be found for a key ally and neighbor?

To mollify Mexico, the State Department lawyers found what was termed a “crevice” in the MOIP regulations on overland imports launching the “Mexican Merry-Go-Round.” Tankers of Mexican crude sailed to Brownsville, Texas. The crude was unloaded into tank trucks, but remained outside the United States in the eyes of the law by being placed in customs bond, which prevented its transfer to Americans. The tank trucks were then driven across the border into Mexico, released from the customs bond, driven around a traffic circle, and then driven back into the United States, importing their cargo “by land.” The trucks returned to the port, and the oil was loaded into tankers headed to the east-coast refineries. Since the oil had entered the United States via a land route, it was eligible for exemption from the MOIP quotas. This strategy boosted Mexican exports to the United States from 7,000 barrels to 40,000 barrels per day.

The next complaint came from Venezuela, which pointed out that it too was an important Latin American ally and that there was a limited market for its heavy, sour crudes outside of U.S. refiners. An exemption for “resid,” or “residual fuel oil,” a minimally refined product, followed and industrial users in the northeastern United States began using Venezuelan resid largely because it was exempt from the quotas. The result was that the ratio of domestic resid production to resid imports fell from 1.42 before the MOIP to 0.46 during it, demonstrating a clear substitution of the foreign product for the domestic one. The exemption basis for the success of Venezuelan resid became clear when the end of the MOIP triggered a massive conversion to natural gas and distillate fuels by U.S. resid users.

Perhaps most ironically, it was the oil-rich countries’ concern over the impact of the MOIP on their ability to export to the United States that proved to be a key factor in spurring the formation of the organization now known as OPEC, surely one of the most counterproductive impacts of a policy in history.

Price and Allocation Controls

The proliferation of exemptions and special provisions by 1970 made the MOIP more of a sieve than an effective regulatory barrier, and the Nixon administration considered abolishing it. But Nixon was worried about energy prices as a factor in inflation, and the price controls imposed in August 1971 froze domestically produced and refined oil product prices. The price freeze had no impact on world prices, of course, and as these continued to rise, refiners dependent on crude imports were required to sell their products at a loss. The federal government continually modified the price controls, attempting to address the growing problems that this massive interference in the operation of the free market produced. Politics dictated the adjustments, however, with Nixon refusing to allow increases in politically sensitive commodities like home heating oil and gasoline. By 1973, when the Arab oil producers declared an embargo on shipments to the United States in retaliation for U.S. support for Israel in the Yom Kippur War, there had already been calls for a government allocation scheme to control crude supplies and distribution of refined products. A series of proposals created in response to these special-interest demands were cobbled together into a “response” to the oil embargo and passed as the Emergency Petroleum Allocation Act (EPAA) in 1973.

Not surprisingly the EPAA made the embargo’s impact worse. Mistaken assumptions that consumption patterns would not change and bad weather predictions, together with politically driven decisions about the appropriate product mix, left some regions awash in gasoline while shortages caused long lines elsewhere. But because the government dictated distribution patterns, the federal government ensured that areas with surplus gasoline could not send them to areas experiencing shortages and so exacerbated the initial misallocation problems.

Each misstep led to further expansions of controls—the Nixon administration even instituted a price freeze dubbed “Phase III1/2” to give the bureaucracy time to catch up on the flood of problems caused by Phases I to III.The crowning misstep in the program was Phase IV’s introduction of a distinction between new and old domestic oil supplies. Old supplies were price-controlled to prevent “windfall” profits; new ones were allowed higher prices to provide an incentive to expand supply. Of course, the distinction also meant that there was considerable money to be made if an oil well could be reclassified from “old” to “new,” and an industry sprang up doing exactly that.

The 1976 presidential campaign put pressure on both the new Ford administration and the Democratically controlled Congress to demonstrate that it had done something about energy issues. Desperate for a showpiece for voters, the administration and Congress produced the incoherent Energy Policy and Conservation Act (EPCA) of 1975, which managed to include both measures that would lead to price increases and others that would push prices down. Economic opinion of the EPCA was that it was “infinitely worse” than the prior programs because it left out the market-based quota-trading provisions of the MOIP and instead allowed transfers of quotas only at government-set prices.

The regulations issued under the EPCA granted entitlements to fuel to anyone with a refinery; energy analyst Daniel Yergin concluded in his massive history The Prize that “the result was the bringing out of mothballs any piece of ‘refining junk’ that could be found—leading to the return of hopelessly inefficient ‘tea kettle’ refineries of the kind that had not been seen since the flood of oil in the East Texas field in the early 1930s.” It also tilted allocations toward small refiners, ensuring that large refineries ran at less than maximum efficiency and so increased costs and rewarded the least efficient players in the market. Economists Kenneth Arrow and Joseph Kalt calculated in 1979 that the EPCA was worth $17 billion to special interests in 1979. The Carter administration began the move toward decontrol of oil prices, but these efforts were impeded by concerted special-interest pressures.

It took the election of Ronald Reagan to speed up the phase-out of energy price and allocation controls. The Reagan administration brought in a period of relatively relaxed regulation of energy markets, and the results confirmed what economists had predicted. The small, inefficient refineries set up to obtain quotas quickly closed (23 in 1981 alone), while refining technology improved as the more efficient refineries expanded capacity.

Boutique Fuels

When drivers fill up their tanks they rarely notice anything different about their gasoline whether they are in Denver or Detroit. But gasoline has evolved from the “straight run” distilled from crude by early refiners to a highly complex fuel whose characteristics vary widely from location to location. For example, fuels sold at higher altitudes (Denver) are less volatile than those sold in lower altitudes (Detroit). Many of these variations are the result of refiners adapting gasoline to optimize performance under different altitude and weather conditions. Gasoline retailers have also spent millions on advertising campaigns aimed at convincing drivers that there is a difference in the mixture of additives that should lead the buyer to prefer a “tiger in the tank” (Exxon) to “the detergent gasoline” (Mobil). (Of course, Exxon and Mobil then merged into ExxonMobil, presumably giving drivers a cleaner tiger in their tanks.)

Beginning with the mandate to remove octane-enhancing lead additives from gasoline in the 1970s, however, the federal, state, and local governments have exerted increasing control over the formulation of gasoline—in the name of improving environmental quality and increasing (you guessed it) national security by substituting locally produced ethanol for a portion of the gasoline. As the number of formulation requirements increased they came to be known as “boutique fuel requirements” because they made it impossible to sell gasoline formulated for Tucson in Phoenix.

There is no question that some measures can make gasolines burn cleaner. Removing lead octane enhancers from gasoline, for example, produced major environmental quality improvements, although the replacements for lead brought their own environmental problems. What is questionable is whether the particular mandates imposed by various regulators actually accomplish that goal and what the cost of splitting the gasoline market into an assortment of boutique markets is. And many of these mandates (particularly the use in the 1990s of MTBE and the current mania for ethanol) have little or no benefit and actually can be harmful to the environment.

Three things should make us worry about boutique-fuel mandates. First, by fragmenting markets, they are raising the cost of gasoline in the same ways as the 1970s allocation programs. The best statistical evidence suggests that they have increased prices in many instances, although EPA denies this. Second, limiting the sources for fuel for many regions to a small number of refineries set up to produce particular blends leaves those markets’ supplies vulnerable to refinery closures from accidents, natural disasters, and routine maintenance. Finally, boutique requirements reduce the availability of gasoline imports from foreign refineries. For example, European refineries produce more gasoline than is needed to satisfy European demand for gasoline (which is lower because of the much higher proportion of diesel-powered passenger cars in Europe). Because those refineries are primarily concerned with producing diesel for their home markets, however, the gasoline they make is not compatible with some U.S. fuel requirements. Since there are other buyers for this gasoline (like China), the refineries have little reason to make the large investments necessary to produce a U.S.-boutique fuel. But because U.S. refineries lack sufficient capacity to meet U.S. demand, any shift away from exports of European gasoline to the U.S. market will cause shortages and price hikes here.

Energy markets have demonstrated the power of private enterprise each time they have been permitted to function freely. A waste product, gasoline, became a valuable commodity, and production yields soared. Better engines required higher octane, and the quality of gasoline increased dramatically. But as this brief account describes, the American gasoline market has moved away from a national market and toward a series of fragmented regional markets. Further, domestic refining capacity is well below what a free market in gasoline would have produced in the absence of the pervasive government interference of the 1960s and 1970s. The combination leaves the market fragmented and vulnerable to price spikes caused by everything from hurricanes to refinery fires. If we want to fix gasoline markets, the first step is to take the bureaucrats out of the process.

He claims that the Enron bankruptcy was all “about doing away with regulation” of energy prices and of financial trading. Huh? The regulatory budgets of both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are at all-time highs, and they employ more regulatory bureaucrats than ever. If anything, the Enron debacle proves once again the ineffectiveness of SEC and CFTC regulation. Enron collapsed despite layers and layers of financial regulation.

Krugman’s claim that Enron used its “political clout” to create a “regulatory black hole” in energy markets is equally absurd. There has been very little, if any, deregulation of energy markets: oil, electric power, and natural gas remain among the most heavily regulated industries in the United States, as they have been for over a century. Radical environmentalists in and outside government continue to impose a regulatory blockade on energy development. What Krugman calls “deregulation” is really re-regulation, or a change in the form of regulation. A good example is California’s crazy electric power regulatory regime that blocks energy development while placing price controls on power, thereby guaranteeing periodic shortages and blackouts. He routinely misleads his readers by referring to this Byzantine regulatory morass as “deregulation.”

Like other anti–free-market commentators, Krugman also spreads the false tale that Enron’s chairman, Ken Lay, was a free-market disciple. This too is, well, baloney. Lay was a member of the group of extreme anti-capitalist ideologues known as the Union of Concerned Scientists. He was also a strong supporter of the Kyoto global-warming treaty. He supported this treaty (which the Bush administration refused to sign on to), because he wanted his company to profit from another Byzantine regulatory scheme concocted by the government: the trading of carbon dioxide emission permits. Lay wanted government-imposed restrictions on carbon dioxide emissions to create an artificial market for air pollution “credits” to be purchased to burn coal. A government-controlled and -supervised “market” is not a genuine market, of course, but more like the failed experiments in “market socialism” that occurred in some of the former communist countries.

Enron collapsed primarily because it made some bad business decisions. It reportedly invested billions in failed power plant, utility, pipeline, and waterworks companies in India, Brazil, and Great Britain. When the profits from these investments failed to materialize, investors got wise and dumped Enron stock. The energy-trading business is competitive and, as with all competitive industries, market leaders can expect their profits to be whittled away by new competitors.

If there was accounting fraud, that’s not a result of “deregulation” but the fact that there are sinners in all walks of life. Governments commit accounting fraud all the time; during the Clinton administration it was reported by Gene Epstein of Barron’s that the Social Security and Federal Highway Trust Funds were being plundered and the money placed into the current-year budget so that Clinton and Congress could take credit for balancing the budget. But don’t expect Krugman ever to call for smaller government whenever such fraud is uncovered.

In this respect Enron’s demise is an example of free-market success. The energy trading market in general is thriving; the fact that one firm that once had 25 percent of that market has left the industry is by no means an example of “market failure.”

Wrong on Argentina Too

Krugman is just as wrongheaded in his comments on Argentina. He blames the entire collapse of the Argentine economy on one thing: that country’s adoption of currency boards, as have been advocated by such free-market economists as Steve Hanke of Johns Hopkins University. Once again Krugman commits the post-hoc-ergo-propter-hoc fallacy (after this, therefore because of this). Yes, a currency board existed in Argentina, and yes, its economy has gone down the tubes. But Krugman never even attempts to prove causation. Anything that smells like a free-market institution must, in Krugman’s mind, be the culprit.

In reality, the fault lies with the International Monetary Fund (IMF) and the U.S. government, which have been subsidizing Argentina’s failed statist economic policies for many decades. The IMF promised to subsidize Argentina’s currency-board regime, which caused a flood of investment in Argentine bonds. The Argentine government was known to be hopelessly spendthrift and corrupt, but with the IMF’s guarantee, international investors began earning above-average returns on Argentine bonds with what they saw as virtually no risk. IMF funding created a massive moral-hazard problem.

The Argentine government used this massive influx of credit to enlarge an already bloated government sector, which always causes the private sector to shrink. Government spending doubled during the decade of the 1990s, far outstripping personal income growth. When a recession hit in the mid-1990s, the government responded in a prototypical Keynesian way by spending even more extravagantly and accumulating more debt. Private investors began shying away from Argentine bonds in 2000, at which time the IMF poured another $48 billion down the government rat hole.

The one good thing the IMF did finally was to refuse to continue to bail out Argentina’s politicians, and that is what caused the bottom to fall out of the Argentine economy.

For decades, Argentina has practiced the kind of economic statism that is championed by the likes of Paul Krugman. Its guiding philosophy has been that its economy should be centrally planned by domestic government elites with the help of the IMF bureaucracy. Its politicians were shielded from taking responsibility for the inevitable failures of these policies by IMF and U.S. government foreign aid. Now that the Argentine bubble of economic statism has burst, the Paul Krugmans of the world are frantically seeking to shift the blame to the free market. Sorry, Professor Krugman, it just ain’t so.

Thomas J. DiLorenzo – Department of Economics, Loyola College, Maryland

This highly readable book undermines both the economic and constitutional rationales for federal regulation of energy markets. The truly amazing thing is the sheer amount of information the author packs into 125 pages.

The economics of energy regulation take up just a little more than half of the book, but Paul Ballonoff, an attorney and president of a consulting firm that specializes in energy issues, covers a wide range of free-market scholarship that supports his position. For the past 100 years, U.S. energy firms have been regulated for two conflicting reasons: to prevent monopolists from charging too much, and to prevent excessive use of fossil fuels whose prices are supposedly too low. Ballonoff presents arguments and evidence that attack both assumptions.

In the petroleum industry, for example, there is virtually no evidence of monopoly by any measure. The industry does not fit the static model of perfect competition found in economics textbooks, because some firms do seem to enjoy superior profit margins. But such profits, Ballonoff argues, are a sign of dynamic competition; firms that are especially skillful at locating or producing oil tend to earn superior returns as a reward.

Nor do doomsayers’ common assertions that we are running out of fossil fuels hold up to scrutiny. The real, economic limit to fuel supplies is not the amount in the ground, but the human know-how employed in finding, producing, and using oil, gas, coal, and other fuels.

“Each advance in computer processing capability,” Ballonoff argues, “causes the supply curves for petroleum exploration, development, and production to fall by a noticeable percentage.” Productivity figures support this assertion. Between 1970 and 1990, for example, the number of barrels of oil found per foot of well drilled doubled! Even falling reserves are not evidence that we are running out of oil, because new technology makes it easier and cheaper to add to reserves when needed. In effect, oil companies are practicing something like “just in time” inventory management for their raw material, substituting better information technology for expensive drilling.

The author applies similar types of arguments to the gas and electric utilities. The traditional rationale for regulation in these industries is “natural monopoly”—because of high fixed and sunk costs, it is less expensive for one firm to serve the entire market, and so consumers get cheaper service when the government grants a monopoly to one firm and then regulates its rates.

Ballonoff grapples with the natural-monopoly dragon, but never quite slays it. He notes that annual depreciation accounts for less than 20 percent of the total costs of gas and electric transmission and distribution, implying that fixed costs are not nearly as high as most people assume. But the relevant measure of fixed costs is the total cost of fixed capital, not the annual amount that is charged off each year as depreciation.

Another, more original argument he offers is much more persuasive. A significant part of the fixed cost of providing utility service is the cost of the right of way, not the poles or wires or pipes. Natural monopoly or not, most homes are already served by as many as six different utility providers using their own rights of way—gas companies, electric companies, telephone companies, cable TV companies, and so forth. If indeed the right of way is the principal fixed cost, then competition would be quite feasible if government grants of monopoly were removed.

Even if some energy utilities are natural monopolies, Ballonoff presents ample evidence that regulation in practice actually leads to higher, not lower, prices.

The author offers three policy conclusions based on his analysis. First, all monopoly regulation of energy companies should be repealed. Second, if some degree of regulation must be retained, regulatory commissions should function solely as specialized antitrust courts with a duty to promote competition, not protect monopoly. And finally, policymakers should avoid “regulatory restructuring,” such as occurred in the natural-gas and telecom industries and is proposed for the electric industry.

No doubt these conclusions will be hotly debated. Even the staunchest supporters of free markets can honestly disagree over whether regulatory restructuring is a step toward deregulation. But such disagreements should not detract from the truth of Ballonoff’s central thesis, which is restated most forcefully in the book’s conclusion: “Many of the ideas that justify and govern traditional American energy regulation are simply wrong.” He’s right.