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Crony Capitalism and the Energy Sector

By MasterResource | Tue, 04 September 2012 22:24 | 1

America’s energy industries (oil, gas, electricity) have been a bastion of crony capitalism for much of their history. Leading gas and electricity firms sponsored state and then federal public-utility regulation during the Progressive Era and New Deal. Like other so-called public utilities, they welcomed the prospect of making commission-approved “reasonable” profits in an entry-restricted environment rather than taking their chances in open-entry markets.

The U.S. coal industry also longed for federal aid. “The bituminous coal industry has been one of the most chaotic industries in the United States in recent years,” an Ohio University professor wrote in 1940. “Because of this lack of order it has recommended itself to the Nation as an industry urgently in need of social control and, as a result, it has come to serve as a significant laboratory for experiments in certain types of government regulation.” The industry was too competitive, he posited, necessitating “minimum price regulation … to prevent excessive exploitation of the industry by its consumers in other industries which are in a better position to exercise a sabotage of production.” Coal producers could not have been happier with what at least one Ph.D. economist was saying.

On the other hand, integrated and independent oil companies were against public-utility regulation. Cost-based rate ceilings were not considered compensatory for the risk of exploration and production. And gasoline service stations could hardly be cost-and-entry regulated without regulating refiners, and, in turn, producers. Still, crony capitalism roared in with the oil gushers in the 1920s. The quest for stability began with state efforts to limit oil production to “market demand”—a regulatory regime called market-demand proration—to achieve a price of one dollar per barrel (about $12 per barrel today).

“Dollar oil,” a rallying cry among producers, also necessitated federal measures to limit imports. Preferential, industry-secured tax breaks for exploration and production was the third leg of what Alfred Kahn in the American Economic Review identified as a domestic oil-industry cartel.

Energy companies were a political force. John Ise in his 1946 textbook, Economics, noting that “big business is powerfully organized and integrated,” ranked 21 of the most powerful lobbying associations in Washington, out of nearly 400. The Edison Electrical Institute was first, the American Petroleum Institute fifth, and the National Coal Association eighth. Ise warned that “under pressure from special interests, the government itself has done much to foster monopoly and so to weaken our capitalist economy.”

Pro-oil-industry regulation, which continued through the 1960s, required ever more government intervention, which led Alfred Kahn to observe: “One interference with competition necessitates another and yet another, and an industry of ‘rugged individualists’ becomes more and more tightly enmeshed with the government to which they originally turned in hope of protecting themselves from competition.”

In 1971, fellow economist George Stigler, a future Nobel Laureate, identified the petroleum industry as a “political juggernaut” and “immense consumer of political benefits.” But political capitalism came to haunt the oil industry a short time later when growing demand, flat world supply, and the unintended consequences of government intervention sent oil prices to record levels. The age-old domestic programs to support prices—state-level wellhead proration and import restrictions—were no longer necessary in the new environment.

Oil politics reversed as “consumerist” politicians turned against the industry with price controls and tax increases. The first head of the U.S. Department of Energy, James Schlesinger, rationalized federal price ceilings by noting how the oil industry had politically raised prices for so long. An energy study by the Ford Foundation made the same point: the oil industry won with government policy during periods of low prices; consumers should now win relief from high prices. This price-control era would turn out to be as bad for consumers as it was for domestic producers, but that is another story.

Enron (1986–2001) had a business model predicated on regulatory advantage. The profit centers of Ken Lay’s company were aligned to special government favour, and his “smartest guys in the room” were adept at gaming complex regulatory structures (tax, accounting, energy trading). Enron-ex James Rogers (currently on the hot seat at Duke Energy)  imported Lay’s rent-seeking model to the electricity industry and persuaded the Edison Electric Institute to back cap-and-trade.

More recently, Chesapeake Energy’s Aubrey McClendon teamed up with the Sierra Club to try to banish coal from the electricity sector to favour natural gas (Chesapeake’s bread-and-butter).

When will energy rent-seeking end?

By. Robert Bradley Jr.

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  • Hans Nieder on September 07 2012 said:
    For an industry described as a “political juggernaut” it's net margins of 5 to 8% seem rather mundane...

    Rest assured, for every dollar earned by the oil companies, governmental units take in one to two bucks...

    Perhaps the title of this article should have read:
    Crony Government and the Subordinate Free Enterprise System

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