Feature

Energy and the Laws of Supply and Demand

by Jim Forbes

Kenneth Lay, the president of energy giant Enron, recently was in Los Angeles promoting the continued deregulation of California’s energy market. The audience made up mostly of Republicans included Michael Milkin, Arnold Schwarzenegger and Mayor Richard Riordan of Los Angeles. It was unclear if his pitch was to insure his recent cash flow or was it because he, like the choir he spoke to, truly believes that a free market is the only correct one? Or both?

To Lay and others like him, deregulation is almost a religion, if not an outright god. Given enough time in the overall scheme of things, I believe his approach, while severe, would result in the correct price for whatever product he sells. But like apartments in San Francisco, adjusting the price of energy comes with tremendous personal sacrifice from somebody.

It's That Supply Side Thing Again
Notwithstanding all the bonehead features in California’s electric deregulation, the most important fact that the parties failed to consider is that energy in California is of limited supply. Every year California must import about 50 billion kilowatt hours of electricity and another 70 billion kilowatt hours worth of natural gas used to produce electricity. All told, approximately 40% of our power is indirectly or directly imported into the state.

Until California’s supply of power equals demand, the cost is bound to go up or at least be vulnerable to manipulation by outside energy suppliers. Any landlord or tenant in San Francisco could have told them that.

No amount of new suppliers will change the imbalance in California’s energy market. Only actual supply will help. References to Pennsylvania or Great Britain are meaningless. Those municipalities have excess energy, in one form or another. If the goal of deregulation is to lower prices to consumers rather than achieve a principal, then deregulating a market with “excess capacity” will achieve that. But to deregulate in a market of “limited supply” will only cause higher prices. No wonder the Texan from Enron wants deregulation to continue.

San Francisco’s housing market is similar. As long as there is a constraint on the supply of new rental units, market rents will continue to rise because there is so much demand and there is like San Francisco.

What rent control does in San Francisco is limit the supply of market rate units, thus increasing the price. This process is synonymous to constraining the amount of pipeline capacity, just as El Paso Gas may have done to Californians.

Decontrolling 140,000 units in San Francisco most likely would cause market rents to drop significantly at first. Thousands of lower income residents would become displaced and their units made available to those with money. Chances are, however, that the rental numbers over time would regain their hold as the highest in the country because San Francisco itself, and everything within it, is still of limited supply.

The only way to drive rents down in San Francisco would be to build it into the ground. This would create such density (supply) that the infrastructure would buckle under the pressure, taking with it one of the reasons, besides plentiful jobs, that people move here—our quality of life.

Constrained
This will never happen. If construction costs, let alone land prices, don’t put the brakes on feasible new housing, existing residents will—as they do now, with moratoriums and zoning controls—further ensuring high prices. Even if we got to the point of a Manhattan-like city full of nothing but the well-heeled, they would probably have enough political clout in Sacramento to enact vacancy control, exasperating the “market” value of an apartment even more.

The same constraints hold true for the energy market in California. As long as Californians care about the environment, they will fight every obscene power plant or transmission line that is anywhere near anything they cherish. Whatever the NIMBYs fail to stop, natural gas prices will take care of the rest.

Ignoring for the moment the premium price California utilities have paid for imported natural gas from opportunistic suppliers, the price per million for this resource nationwide has settled in at about double what it was a year ago. When this cost is added to the mix of everything else that goes into producing electricity, no wonder electric costs have gone through the roof.

Also as long as we are dependent on natural gas to produce electricity (all new power plants in the construction pipeline will run on natural gas), the price of electricity will be a function of what outsiders want to charge us. To get out from under this stranglehold, at a minimum we would have to double the number of hydroelectric dams and nuclear generators. This would only make up for the deficiency of 1999, let alone all the new demand since then.

That Demand Thing Too
Obviously, demand is another part of the problem. California is suffering because of its successes. Thanks in part to all the neat gadgets we produce here and the extra money we spend, prices continue to rise. This increase is not necessarily because we use more. California actually has one of the lowest per capita consumption rates of power in the country. It’s all that money we have that creates demand.

San Francisco is one of the guiltiest. Even a population of a million in our city would not create the kind of demand we have seen for apartments and houses if all those people had the purchasing power of Pakistan. Instead, San Francisco County’s per capita income is second in the entire state and our immediate neighbors, Marin, San Mateo and Santa Clara (ranking 1, 3 and 4 respectively) offer no nearby relief unless one crosses the Bay Bridge.

The extra purchasing power San Francisco residents have is demonstrated by the fact that since 1967 (the first year records were kept for residential natural gas prices by state), rents in the city actually have exceeded the increase in natural gas prices by a margin of 150 percent. Incredible as it seems, since 1967, rents have climbed 1,350 percent while natural gas delivered to California residents has climbed a mere 1,200 percent. Of course, both are nuts. The cost of living increase during that time is up only 475 percent, and incomes in the State and city up about 700 percent.

What is the conclusion to this mess? A possible answer is—like rents in San Francisco—high-energy prices may be the new reality and we might as well get used to it. Only a substantial decrease in demand will change this and that will only come about from a substantial drop in income. This, too, is a possibility. If Governor Davis is right about anything, it is that these high-energy costs could drive California into a recession. Sucking billions of extra dollars from our wallets and delivering them into the hands of Kenneth Lay and his Texas buddies is not going to enhance California’s wealth. It’s also going to pump up inflation, as energy users pass on their increased costs to their customers.

Yet Lay’s plea to continue deregulation might bring prices down after all. Eventually we will run out of money to keep prices up or we will move to cheaper communities. After all, this is still a free country.

A Dysfunctional System
California’s inadequate infrastructure is anothercauseofhigh-energyprices. Confident that out-of-state suppliers would not try to do to natural gas and electric prices what the Hunt Brothers tried to do with silver, Californians got real laid back about constructing power lines, pipelines and storage facilities. It’s really dumb that if one section of the state is sitting on some extra supply, we can’t move it readily to a more needy part of California. If we can do it for water, why not do the same for electricity and natural gas?

Dumber still were the rules of the so-called deregulation plan that actually required utility companies to buy at the highest price possible. (I still can’t believe that insiders at PG&E and So. Cal Edison don’t have huge stock positions in their out-of-state suppliers.) To not see this coming is beyond belief. Meanwhile, billions of dollars are being siphoned out of California on their way to the Lone Star State, while we cringe or deny that something akin to an economic earthquake will rock our pocketbooks.

The amount of money this state has lost over the last year could have repaired all the damage caused by the Loma Prieta earthquake twice over. It’s a sad day in our state’s history, when Texan energy producers supplant Mother Nature as our biggest concern.

Meanwhile, we have to imitate our tenants when supply gets too tight or money too scarce—conserve. Take in roommates. Turn off the lights. Conservation will help because it reduces demand. However, we won’t get to the 40 percent reduction that we’ll need in order to no longer rely on Mr. Kenneth Lay and his pack of power mongers, but as far as I’m concerned, a kilowatt saved is a kilowatt earned.

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the SF Apartment Magazine. Jim Forbes is president of Urban Properties, a real estate investment and brokerage firm. He is a SFAA board member and the publisher of SF Property Report. He can be reached at 415-922-8998 or at his Web site at propnews.com. © Copyright 2001.