Natural Gas Hysteria?

“We need to declare a national crisis,” Andrew N. Liveris, the chief executive of the Dow Chemical Company, said in recent testimony before the Senate. Dow, the nation’s largest chemical maker, has shut 23 plants in the United States in the last three years in places like Somerset, N.J.; South Charleston, W.Va.; and Elizabethtown, Ky., as it shifted production to Kuwait, Argentina, Malaysia and Germany, where natural gas is cheaper.–Link to New York Times story

Whenever I read something like that from an industry exec my first instinct is to grab onto my wallet. The problem is, in my view an fundamental misunderstanding of economics and markets. For example, after looking at a litany of proposals to “deal with the problem”, the author of the article writes,

Some of these projects might eventually materialize, but none quickly enough to bring natural gas prices down substantially before this winter. Still, the proposals are part of a major push by the energy industry to raise imports and overturn decades of environmental limits on domestic exploration.

Brilliant, except for one small detail. To the extent that natural gas is a world wide market, these programs would have little impact on the world wide price for the most part. And even if the U.S. prices are higher, then the idea of subsidizing an industry whose prices are increasing is just nonsense. Profits are usually an increasing function of price. Hence, it would be like subsidizing a fat person’s potato chip consumption–i.e. stupid. However, getting the government out of the way to the extent of allowing for more drilling, more imports, and not building new import terminals on the coast of Louisiana and Texas for crying outloud would be a good place to start. Further, they’d be cheap in that we wouldn’t have to spend billions subsidizing companies that are already posting record profits.

One could argue that places like Canada and the Middle East could produce more natural gas. That’s fine, but the current prices are not just a function of what is out of the ground now, but how much can be produced, and how much is also estimated to be in the ground. And anything that reduces the price of natural gas will only reduce the incentive to produce natural gas.

And don’t be misled by statements such as this,

The hurricanes made a bad situation worse. The American Chemistry Council estimates that 100,000 jobs at companies that rely largely on natural gas have been lost since prices for the fuel began climbing in 2000. Chemical companies have been particularly outspoken in calls for the Bush administration and Congress to focus on curbing consumption and repairing energy infrastructure in the Gulf of Mexico.

Sure, 100,000 sounds like alot of jobs. However, that is not even a noticable blip when spread over several months in an economy with well over 1,500 times as many worker. Calling something like this an emergency requires that we re-define the word emergency to mean a rainy day or traffic congestion. And with prices already high and profits rising very fast, there is no need for the government to step in and do more to repair the energy infrastructure damaged in the Gulf. Those companies want that infrastructure repaired as soon as possible to take advantage of the high prices. And given that their competitors are thinking precisely the same thing, getting the government involved is just a way for these companies to get consumers to subsidize the repairs.

So what will the “national emergency” likely mean? More subsidies for energy companies and either higher taxes today or in the future. Personally, I say let the prices rise and let the alternatives become relatively more attractive in terms of price. For example, if the price of natural gas stays high, then generating plants like the one at Mohave may stay in operation. Sure, such a policy will be painful in that it will raise cost for electricity and heating homes, but one thing to keep in mind, in economics there is never a free lunch. The idea of lowering prices and increasing supply just tend not to work together.1 If there is one lesson that we should have learned from the oil crises is that when the government gets involved it usually screws things up royally.
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1The only thing that could result in increased supply and lower prices is if there is a downward shift in the cost function for all firms producing the good in question. One could argue that a subsidy would achieve this, but all we’d be doing is paying higher taxes (along with the deadweight loss inefficiency) to get the lower prices, probably not a good exchange.

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Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Peter Molinaro says:

    Full disclosure: I work for Dow. Your observation that the “natural gas market is a global one,” is incorrect. It is still a North American market, with world prices vastly different (~$4 in China, as low as $1 in the Mid-East). We’re not asking for subsidies for the producers, just to re-adjust the government policy that drives up demand while artificially constraining supply. Additional domestic production would be felt in the US market, given that the NYMEX is driving up the price in reaction to tight supplies and weather forecasts.

  2. odograph says:

    I was going to make a similar comment to Peter’s above, that the gas market isn’t really as fungible or as global as (naturally) liquid/solid fuels.

    Gas fields first developed close to population centers, so that they could be piped from field to gaslamp. Since then we’ve connected more and more fields on this continent to their users, but there are gaps, and the gaps matter. There is some question in Canada whether gas should be used to process tar sands or piped further to population centers.

    The hardest thing is to get natural gas across oceans. Compressing and liquifying are very expensive, and there are contstraints in the number of suitable ships and docks.

    Anyway, news out here in California is that our utilities are tapping their in-state reserves right now, to offset current prices. Which means of course they’ll have less reserve next year …

  3. Dale B says:

    There is at least one additional factor contributing to the lower supply of natural gas. There is an increase in demand. Many electrical power generation plants are converting to natural gas. The reason is, of course, that it burns cleaner. Three of the four non-nuclear power plants that supply the Minneapolis St Paul area have already converted from coal to natural gas. I don’t know if the fourth will convert or not.

    I always thought that this was shortsighted. It is true that coal is dirtier than just about any other fuel but it can be cleaned up. It costs money, a fair amount of money, but it can be done.

    Natural gas is used primarily for building heating and there are few alternatives. I think that fuel oil and propane are about it. We cannot realistically heat residential buildings with coal, at least not in its mineral form. I think that Propane is made from natural gas so that’s no help. Fuel oil comes from petroleum and subject to the same supply issues as the other petroleum fuels.

    Perhaps large commercial heating could be done with coal but it would be cost prohibitive to do it cleanly.

    We’ve got lots of coal. Coal requires a large application to make the cleanup costs reasonable.why not use it where it makes the most sense?

  4. TJIT says:

    Steve,

    I work in the oil business (drilling) so my comments are from someone who is in the industry for what its worth.

    1. I read the article and did not see any subsidies mentioned. What I saw was an effort to open more areas to drilling and working on approval of new LNG terminals to increase US natural gas import capacity.

    If I missed it would you please point out what subsidies are being proposed in the article.

    2. This month congress had hearings and demanded that oil companies do more to increase domestic oil supplies. After this demand congress actively prevented the to oil business from increasing domestic energy supplies by voting against allowing drilling in ANWR.

    I really don’t care if drilling ever occurs in ANWR. However, the rank hypocrisy of these actions is disgusting. Congress and the public has to understand if drilling is not allowed in ANWR, offshore and the Rockies the ability of the oil companies to increase domestic energy production is limited.

  5. Steve Verdon says:

    Peter,

    I understand, and that fits with quite a bit of what I wrote, but I see the typical resposne being to subsidize the natural gas producing companies, not things like allowing for more drilling, importation, and so forth. Remember who is sitting in the White House, a President who hasn’t been more happy to spend future tax revenues today on stupid policy.

    TJIT,

    Sure there subsidies, you just missed them. The part about the government helping more with rebuilding after Katrina? I can see that as nice juicey subsidies to help get rigs back online, pipelines back up and running, and so forth. It is at that point that we should recall that I also wrote,

    And even if the U.S. prices are higher, then the idea of subsidizing an industry whose prices are increasing is just nonsense. Profits are usually an increasing function of price. Hence, it would be like subsidizing a fat person’s potato chip consumption–i.e. stupid. However, getting the government out of the way to the extent of allowing for more drilling, more imports, and not building new import terminals on the coast of Louisiana and Texas for crying outloud would be a good place to start. Further, they’d be cheap in that we wouldn’t have to spend billions subsidizing companies that are already posting record profits.

    […]

    And with prices already high and profits rising very fast, there is no need for the government to step in and do more to repair the energy infrastructure damaged in the Gulf. Those companies want that infrastructure repaired as soon as possible to take advantage of the high prices. And given that their competitors are thinking precisely the same thing, getting the government involved is just a way for these companies to get consumers to subsidize the repairs.

  6. TJIT says:

    Steve,

    Let me be clear I don’t like subsidies and I think the energy bill was a pork laden disaster that should have never been passed. You are correct, the energy companies are doing everything they can to repair the infrastructure because having production is shut in is costing them massive amounts of money. Subsidies are not needed nor would they be helpful.

    Having said that I re read the article and the only thing I could find that even hinted of a subsidy was this sentence,

    “Chemical companies have been particularly outspoken in calls for the Bush administration and Congress to focus on curbing consumption and repairing energy infrastructure in the Gulf of Mexico” the meat of the sentence appears to be this “to focus on curbing consumption and repairing energy infrastructure in the Gulf of Mexico”

    One sentence out of a two page article does not seem to be a big push for subsidies. There could be a hint of subsidies in that sentence but I am not seeing an explicit call for them. In fact curbing consumption would seem to me to be the opposite of a subsidy. Furthermore, focusing on repairing infrastructure repair may mean something similar to the way the fuel blend standards were relaxed after the hurricanes to allow greater gasoline imports.

    Again, I agree with you on subsidies lets just focus on stepping on that cockroach where we know it exists.

    Thanks,
    TJIT