Corridors of Power

The Daily Reckoning PRESENTS: Have you ever really stopped to think about where the electricity that powers your home…your office…basically everything in your life comes from? Neither did we…good thing we have Byron King to enlighten us. Read on…

CORRIDORS OF POWER

If you are over a “certain age,” you probably grew up in a world in which you and your family had little or no choice of utility companies. Whether it was the local electric company, the local natural gas company or the local water utility, you simply paid your money and did not have a choice. It was a world that resembled Henry Ford’s famous comment about the Model T, that “The customer can have any color of car that he wants, as long as it is black.”

Let’s recall the olden days of electric power, for example. Your local utility company probably ran the whole show by virtue of a government-granted license. In other words, the utility company was a monopoly, but it also had the obligation to serve every entity that required its services. (At the consumer and customer end of things, the final demand for power is called the “load.”)

Under that arrangement, the local electric utility owned and operated the generating station just outside of town, or certainly within the region where you lived, and it owned and maintained the transmission towers that led from the powerhouses to the load. That utility company also owned the substations where the high-voltage power was stepped down into the street grid, of which it owned the poles and wires. And your friendly local electric utility company probably even owned the usage meter on the side of your house.

Things are certainly different now, aren’t they? If you live in or near a major urban market area, you probably receive frequent notices in the mail containing offers from companies of which you have never heard offering to sell you utility services such as “renewable” electricity. If you have read your local newspaper business section over the years, you have probably noticed that the utility company has sold its generating stations to some third party, again a firm of which you have never heard. And you may have seen that the utility company has sold the transmission towers to some other entity whose name you cannot recognize. The local utility may still maintain the street grid, but then again, maybe not. Every month, you may still receive a bill from the old utility company. But your bill probably contains all sorts of charges broken out for fuel or basic generating costs, plus transmission, and perhaps a “delivery” charge payable to companies with strange names, as well as a myriad of taxes and local fees. What is going on?

Welcome to the world of free market energy competition. This intellectual paradigm took root in U.S. public policy in a big way in the late 1970s. One of the leading lights of this movement was the economist Alfred Kahn of Cornell University, who earned his stripes as chairman of the New York Public Service Commission (New York’s PUC), and later as chairman of the federal Civil Aeronautics Board in 1977-1978 under President Jimmy Carter. It was Commissioner Kahn who set a national example with airline deregulation and increased competition with his efforts to deregulate airlines.

Deregulation is a political process in which the government removes or simplifies restrictions on businesses in order to encourage increased efficiency in the operation of market mechanisms. In other words, goes the rationale, deregulation means that fewer and simpler regulations will yield an increased level of competitiveness, with higher productivity, more efficiency and overall lower prices. Deregulation is not a uniquely American idea, by the way. During the past three decades, the concept has been applied, with varying degrees of success, in nations as diverse as Australia and Japan, the United Kingdom and Argentina, the European Union and even post-Soviet Russia.

Alfred Kahn’s initial focus on airline deregulation spread to other parts of the economy as well, particularly in the realm of transportation, such as railroads and motor freight trucking. The initial results were that under deregulation, literally hundreds of railroads and many thousands of trucking companies either went out of business or were forced by circumstances to combine with other firms via bankruptcy, asset sales and other forms of merger. And the results also included a large number of new entrants to the marketplace, to include companies like Federal Express (now FedEx), whose ubiquitous trucks would never have seen the light of day under the old, heavily regulated transportation system.

To make a long story short, by the 1990s, deregulation was occurring in the arenas of utility services, as well. This is when the old-time utility companies began to transform by selling off assets such as generating plants, transmission lines, wholesale distribution networks and even the “final mile” of distribution wires, if not the meter on the side of your house. If the name on your local utility bill looks like the familiar one with which you grew up, it may well be because some third party bought the right to use that name. From the standpoint of who owns what, you are now living in a different world.

I am using the story of deregulation in general, and what has happened to your old and faithful electric utility company in particular, to illustrate the point of how much and how dramatically things have changed on the other side of the light switch.

In the energy delivery industry, and certainly in the electricity and natural gas sectors, the transmission system has become a critical market-enabling mechanism. That is, transmission functions in much the same way as the interstate highway system, if not as those oceangoing freighter ships that bring foreign-made goods to U.S. shores.

Think about that last analogy of the oceangoing ships. What makes a factory in China truly competitive with a factory in the U.S. that can make a similar product? Does a Chinese injection mold operator have a better education than an American injection mold operator? Maybe not, but then again, consider how much TV the American worker has probably watched over the years. Or is it those proverbial “Every Day Low” sweatshop wages that they pay in China? OK, we are getting closer to an answer. Or perhaps it is because the Chinese factory spews a toxic brew into the adjacent air and water, in such a manner that would get the U.S. factory padlocked and its managers frog walked by the bunny cops down to the local jailhouse. Yes, of course, this matters in the broad scheme of things.

These Chinese competitive advantages, and many more that you could recite, do matter to one degree or another. But my view is that what truly makes Chinese factories competitive is the ability to transport the goods so cheaply across the Pacific Ocean, in containers that are then rapidly unloaded and shipped, via “deregulated” rail and truck, almost to the point of sale. Cheap transport effectively puts the factory in China right next to the factory in the United States.

It is the same thing with energy transmission as with oceangoing transportation. A well-managed transmission system is the key to enabling robust and competitive energy markets that offer customers choice, savings and related benefits.

But here’s a question – do you really know from where comes your electricity?

If you live in California, some of your electricity may come from New Mexico, if not British Columbia. If you live in Ohio, some of your electricity may come from Ontario, or even Quebec. If you live in New Jersey, some of your electricity may come from a plant in western Maryland. Or consider that one of the largest generators of wind-powered electricity in the U.S., for example, is Florida Power and Light, and many of its windmills are located in – are you ready? – North Dakota. Last time I looked, Florida is a long way from North Dakota.

What makes this all possible is the creation of long-distance transmission corridors, over which electric power is moved, or “wheeled,” from one region to another. No, the North Dakota electricity does not go all the way to Florida. But the North Dakota electricity might go to Illinois, and electricity from Illinois might go to Alabama, and electricity from Alabama might power homes in Florida. How do you calculate the electricity rates for Florida consumers, and who should get paid how much at each step of the way along the transmission corridor? It gets complicated in a hurry.

And why is FPL building windmills in North Dakota? For starters, it is just too hard to build new power plants in Florida, both despite and because of the fast-growing population, which adds more load and demands more and more electricity each year. Think about it. What community in Florida wants a new large power plant with a tall stack and thousands of rail cars passing by, hauling coal to the facility? And what electricity consumers in Florida want to pay what it costs to run a natural gas-fired power turbine just to generate base load electricity? “Not in my backyard,” goes the cry.

Or consider what happens to aging power plants, such as the pulverized coal units with the 600-foot-tall smokestacks of the old-fashioned utility company, when these industrial behemoths are ready for retirement. Can anyone, even the local electric utility company, consider replacing an older plant if it is located near an urban or near-suburban core? As a rule, many among the locals cannot wait to hear that some plant operator wants to decommission an old coal-burner near the city. “Goodbye and good riddance” is the typical sentiment. And nobody wants a new power plant to get built nearby, either, so the tendency is for power generators is to construct new generating facilities out in rural areas far from the urban NIMBYs and their lawsuits.

But developing energy facilities far from load centers requires construction of transmission lines over transmission corridors. Whether it is a new, higher-tech version of the old coal-burner or windmills out on the High Plains (or maybe even a new nuclear plant, one of these days), the problem of transmitting that power along a new transmission corridor from generation site to place of load is instantly presented. And just to add another layer of perplexity to the process, which comes first – building the generation or building the transmission? If you thought that building a new power plant in any one location was tough going, just try building a transmission line that crosses many jurisdictions, each filled with its local species of NIMBYs.

In the arena of renewable energy sources, one critical issue for wind farm construction is that installed capacity in some regions is outstripping producers’ ability to move the wind power from relatively remote areas to load centers in other areas. This affects market prices in a significant way, because the cost of installing and upgrading transmission lines to deliver the generation must be factored into the final consumer price.

Transmission constraints in West Texas, for example, have negatively impacted operations of numerous wind farms in that area. Thus, wind power generation in that region has been routinely curtailed to prevent overloading the local transmission system. This has resulted in losses of many millions of dollars per year of electric power sales. Texas generators and regulators are addressing the situation by upgrading existing facilities and constructing additional transmission facilities for high-voltage power.

New Mexico has similar problems and has recently adopted its own solution. That state-enacted legislation that will create the New Mexico Renewable Energy Transmission Authority, a quasi-governmental agency that will plan, finance, acquire and build power lines and energy storage projects. The Authority will have power to designate transmission corridors and to negotiate with other entities on the establishment of interstate corridors. It will be able to use eminent domain authority to help get projects built.

Another state, Wyoming, also has a transmission authority that likewise is intended to help transmit and export electricity produced by state’s energy resources.

Regards,

Byron King
for The Daily Reckoning
June 7, 2007

P.S. You can definitely feel the rising need for energy and basic materials in your own life.  You can feel it at the gas pump, you heating bills and even at the grocery store.  It’s very clear that the building blocks of life have gone up in price over the past few years.

I’ve also been working round the clock on my new stock research service – Energy & Scarcity Investor – that looks at these raw materials that are in high demand right now. Gold, oil, silver, corn, copper, water, alternative energy, farmland, uranium, tar sands, refineries, coal, oil services, steel…the list seems to go on forever…and the possibilities to profit from this resource boom are endless.

Editor’s Note: Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments, and frequent contributor to Whiskey and Gunpowder. Whiskey and Gunpowder is a free e-letter that covers resources, oil, geopolitics, military history, geology and personal freedom.

“But the glory has been the glory of pasteboard, and the wealth has been the wealth of tinsel.” – Anthony Trollope

The world seems to be taking a form of financial steroids…and maybe taking too much of it.

Yes, dear reader, love for old-fashioned values seems to have given way to price boffing…and the romance of real business ventures has been supplanted by the wham-bam-thank-you-ma’am of money-shuffling hustlers…

…Oh, dear, dear old reader…sigh…

But we pause this morning…to bring new dear readers into the conversation.

The Daily Reckoning began in the summer of 1999. We were convinced then that the tech bubble – centered in the U.S. NASDAQ market – was about to blow up.

Naturally, many readers were annoyed with us. They insisted that breakthroughs in communications technology were making us all smarter – for now we all had access to the worldwide web, and with it came an almost unlimited supply of INFORMATION.

Here at The Daily Reckoning we argued that more information was not necessarily a good thing. Like manure, information can be helpful. But pile too much of it up in one place, and it begins to stink.

“You just don’t get it,” they replied. To which we let the market respond. Six months later those who “got it” got it good and hard. The tech bubble collapsed…taking many earnest investors with it.

“You don’t get what you expect from the investment markets,” we remarked, with a superior air. “You get what you deserve.”

The stock market was then going down…and the economy was going down too. But it was not much later that a tiny group of fanatics scored what must be history’s most successful surprise attack: they brought down two of Manhattan’s greatest buildings and twisted America’s entire foreign policy – which had there-to-fore been clumsy, but not absurd – towards a preposterous ‘War Against Terrorism.’

Under pressure from the delusionary threat of terrorists under every Arab head wrap, and a recession that looked as though it could go the way of Japan’s then 12-year slump, the Feds responded with the biggest stimulus of cash and credit in history. Tax rates were cut. Spending was increased. The Fed’s key lending rate went down to less than half the rate of inflation and stayed there for two years.

Now, it is time for others to have the last laugh. We didn’t think it would work. Americans were already too far in debt, we said. You can’t solve that problem by lending them more money at better rates.

Professors of moral philosophy surely approved of our logic. We hope they didn’t bet money on it. Lower lending rates set off a new bubble – this one in residential real estate. Suddenly, houses were rising in price at the fastest rate ever. Homeowners were feeling rich and sassy. They wanted to borrow…and now they had something to borrow against. So, it was off to the races, with the biggest run-up in the housing market in 100 years (and the biggest increase in consumer debt, ever).

Meanwhile, the Bush Administration drew Tony Blair into its confidence and the two decided to attack Iraq. French president Jacques Chirac tried to warn them off their project; it was too risky, he said. We agreed with Chirac…and wrote a book, with Addison Wiggin, to describe what we saw as America’s imperial over-reaching, entitled “Empire of Debt.” In Paris at the time, U.S. readers responded by saying they hoped American bombers dropped a bomb or two on us, and Chirac too, on their way to blow up targets in Iraq.

The U.S. housing bubble began to lose air in 2006. Mortgage companies had lent billions to homebuyers who couldn’t pay them back. Suddenly, the lenders were in trouble…and the U.S. housing market was, too.

Again, our logic was unassailable: The U.S. economy…and by extension the world economy…depends on American consumer spending. Americans depend on rising house prices to give them the money to spend (there has been no real increase in average wages in the United States in 30 years). Therefore, stagnation or, god forbid, a slump in housing would cause a recession.

Not so far. But a housing market correction takes time. Sellers are reluctant to cut prices; while buyers take each small cut as an opportunity. They are all convinced that the correction will be slight, and quickly put behind us. But in the first quarter of this year, U.S. GDP growth slid to just 0.6%, annualized. That is well below the rate of population growth in the United States, meaning that if the country continues to prosper at that rate, Americans will eventually be as rich as Bengalis or Zimbabweans.

But today, comes news that the National Association of Realtors has pushed their recovery forecasts back a bit, on unemployment rates, inflationary fears, and rising mortgage rates. Looks like their certainty in a ‘soft landing’ for housing is being shaken – and it’s no wonder.

It is a cold and windy day here in London. But all over the world, the financial markets are hot and bubbly. No one seems to care about the weakness of the U.S. consumer. Asset prices are soaring almost everywhere; buyouts at record prices are in the news. Private equity firms are on the prowl and public companies on the run, spinning-off their assets as fast as they can to avoid being gobbled up. Fund managers are getting record bonuses. Living ‘artists’ are getting paydays that Monet and Rembrandt couldn’t have imagined. (More below…)

The rich are getting richer. And the poor? As Warren Buffett said when we interviewed him for the documentary, “As rising tide is lifting all boats…but it’s lifting yachts faster.”

It’s a worldwide Super Bubble – enjoy it while it lasts. Restaurants and bars in central London are full to overflowing – and now the city is the capital of the biggest, most successful industry of our time – modern finance.

People all over the world have come to believe something extraordinary…something that can’t be true, that they can all get rich without actually working or saving; instead they buy and sell financial assets.

Whom do they buy them from and sell them to, you ask? Why each other, of course! Then won’t they end up, on average, no richer than they began – or will they end up actually poorer, when you take out all the fees paid to financial middlemen?

Yes, of course. But the longer this amazing Super Bubble goes on, the more people come to think it is normal…the more investment positions depend on it…and the more people suffer when it ends.

Tomorrow…we explain the current worldwide Super Bubble in greater detail.

More news:

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Chris Gaffney, reporting from the EverBank world currency trading desk in St. Louis…

“In a move that surprised the markets, New Zealand raised interest rates to a record 8% due to increasing inflationary pressures. Housing demand and consumer spending continue to cause the central bank to keep a vigilant eye on inflation.”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig

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And more thoughts…

*** One man who does not seem to have gotten what he deserves is Fidel Castro. The man is still alive, alas. We read Huber Matos’s book; he was one of Castro’s original band of revolutionaries. The poor naïf thought he was fighting for democracy…and said so. Castro sent him to prison and let him rot there for 17 years.

So far, Castro has escaped justice. But at least there’s always the after life.

*** Oh…and here’s the brainless socialite of the art world, Damien Hirst, at it again. The show-off seems determined to prove that ‘art’ buyers are at least stupid as voters; there seems to be no limit to what either group will go along with.

Hirst’s latest work is a human skull encrusted with 8,601 diamonds. “For the Love of God,” he calls it. It is the most expensive bit of fluff the art world has ever seen. It cost Hirst $28 million to make. He expects to sell it for $100 million.

His next work is even more ambitious. He’s planning on a plaster cast of a human fetus, studded with even rarer blue diamonds, which is expected to sell for $200 million.

Is there no limit to man’s ability to make a jackass of himself?

*** One of the curiosities of the world economy, circa 2007, is the way the poor subsidize the spending habits of the rich. The Americans – supposedly the world’s richest people – save almost nothing. In fact, they spend more than they earn. Who makes up the difference? People who live on one tenth as much money. Indians’ savings, for example, equal 28% of GDP. The figure is similar for China.

According to IMF statistics, in 1996 the advanced countries of the developed world accounted for 78% of total global saving. By 2006, that share had fallen to 65%. Over the same decade, the developing world’s share of global saving rose from 22% in 1996 to 36% in 2006. Poor countries made up only 19% of world GDP in 1996 but still accounted for fully 58% of the cumulative increase in global saving over the 1996 to 2006 period, or approximately three times their weight in the world economy.

New reports show that last year foreign purchases of U.S. companies and foreign start-ups in the U.S. went up more than 75% over the previous year. The poor foreign boobs still see the United States as a good place to do business, despite the clamor for protectionism there.

The rich have borrowed trillions of dollars from the poor. As we watch them drive around in their air-conditioned SUVs this summer…and spend their holidays at the beach…and enjoy their tinsel wealth. We wouldn’t be at all surprised if they forgot to pay it back.

*** “Is this Mr. Bonner?” inquired a Frenchman on the phone the other day.

“Oui…”

“Well, this is the headmaster at your son, Henry’s school in Paris.”

“Oui…”

“I see you speak French very well. But, as I recalled from our meeting, you still have – if you will permit me to say so – a noticeable accent.”

“Oui.”

“Well, the man who called the school today, and said he was you, didn’t have any accent. In fact, he didn’t even sound like a man, but more like a boy. And he told us that he was Henry’s father…and that he was picking Henry up at school…and asked that Henry be excused. We gave him permission to leave the school, but when I heard about the call I was suspicious. You know, it’s the end of the school year and some of the boys are…well…feeling in high spirits. So I asked if the man had an accent and my secretary said no, he didn’t. So that’s why I am calling you.”

“Ooh…la la…”

“Yes, and so I must ask you, did you come to the school today and pick up Henry or give your instructions to let him out early?”

Ooh la la. Henry was in trouble. He had gotten another kid to call the school and pretend that he was Henry’s father. Now, with the headmaster on the line, we couldn’t lie to cover for Henry.

“No.”

“I’m afraid Henry is in a lot of trouble.”

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