Friday, July 30, 2010

Energy in a Free Market

To say that energy is extremely important for our society is a truism. It is so important that, whenever there is anything from a hiccup to a coughing fit (such as the BP oil spill) in energy production or consumption, it reveals how many people presume that the energy market is rife with "market failure" and many feel anxious and call on the state to "do something." That is a plea the state is always eager to placate. It seems that very few realize how regulated and, hence, unfree the energy market actually is. In fact, the energy is so regulated it is likely we don't even know what a free market in energy would look like. 

Robert Bradley Jr., CEO and founder of the Institute for Energy Research, has done research on the energy market since 1980. His book, co-authored with Richard Fulmer, Energy: The Master Resource, is a very useful primer on energy economics. Bradley speculates on what a free market in energy might look like in his piece, "A Free Market Energy Vision."

Bradley identifies four sustainability issues around which energy market debates revolve:

  1. Future supply growth of carbon-based energy in light of "the fixity/depletion view of minerals."
  2. Air and water pollution from carbon-based energy production.
  3. Energy security, particularly oil imports to the U.S. from the Middle East.
  4. Global warming due to the use of carbon-based fuels.
Bradley then makes his case for a free market in energy, summarizes it in four points:
  1. Human ingenuity in market settings has and will continue to overcome nature's limits.
  2. Statistics of air and water quality in the U.S. show dramatic environmental improvement.
  3. Energy security in the electricity market is assured by abundant coal supplies and almost all U.S. gas imports are from Canada.
  4. Global warming is still an open scientific question and the reality is at the present time carbon-based energy is necessary for economic growth.
Because the future is uncertain, no one knows exactly what a free market in energy will look like. We don't know how energy demand will change and we don't know how entrepreneurial ingenuity will respond to demand. Still, Bradley suggests important reasons why we shouldn't be afraid of a free energy market after all. We know it will not be perfect. No human institution ever is. However, we have reason to believe that a free energy market will provide the most energy for the longest time in the most efficient manner possible.

We also know that private entrepreneurial provision of energy will be much more efficient than it is now in our severely hampered energy market. In a free market private entrepreneurs are able to use market prices for both energy and the factors used to produce that energy in calculating profit or loss.  This serves as the best guide for wisely using scarce resources. If producing a certain type of energy in a certain way is profitable, it will be done. If it is not, entrepreneurs will not sink scarce land, labor, and capital goods producing energy that is not worth the cost. Additionally, in a free market entrepreneurs are able to keep their profits and must eat their losses, so they have every incentive to make only profitable energy investments.

Things are exactly the opposite when the state intervenes. Price controls, subsidies, and taxes distort the price system, so energy producers are led to misallocate resources from the perspective of people in society. They also do not have the same incentive to reap profits and avoid losses, because their income is not tied to their success.  Therefore, we have every reason to expect that the more state intervention in the energy market, the less efficient and more wasteful it will be. This is why Bradley argues that the real sustainability problem is statism, not "market failure."

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