The Markets Are Taming Energy Prices

Whatever happened to the energy crisis? It's summertime: Gasoline was supposed to be $3 a gallon, California was expected to be suffering through rolling brownouts, and the U.S. economy looked ripe for stagflation thanks to an undersupply of oil and gas. None of this is happening despite dire predictions from Washington. In fact, energy prices are falling dramatically, giving a boost to corporate profits and consumer spending. What gives? To the surprise of most policymakers and economists, the markets are working with spectacular efficiency. Before Washington embarks on a wholesale revamping of energy policy, it should take note of how the markets are already well on their way to boosting supply, cutting demand, and lowering prices. Drastic action doesn't appear to be needed.

Natural-gas prices are down 66% since their peak, thanks to a surge in drilling that has lifted production 3% from a year ago. And it's the fuel of choice, because it burns cleaner than coal and oil. Its price drop has cut the cost of electricity as well, since half the U.S.'s power generators are fueled by natural gas. In California, utilities were paying $300 a megawatt on the spot market a year ago. That's down to $100 a megawatt. Gasoline prices are tumbling, too. Regular is averaging about $1.54 a gallon. More imports and refinery capacity have sent inventories to a five-year high.

The markets are working to increase generating capacity as well. Three new power plants are coming onstream in California alone in coming months, and dozens more will open around the country this year. The real problem ahead may be too much generating capacity, not too little. Utilities that have locked themselves into high-priced long-term contracts may find themselves hurting once again.

Conservation is playing a major role in reducing electricity demand now that market forces are being allowed to work at the consumer level. It took California a year after its energy crisis began to uncap consumer rates, but once it did, power demand dropped sharply. In June, it was off 12% from last year. The sharp decline in the state's high-tech sector, of course, has also contributed to a drop in demand.

Not to be overlooked: The impact of energy prices on economic growth has been grossly underestimated over the years. Higher prices sent the U.S. into recession in the '70s. Lower prices helped sustain the boom of the '90s, and last year's surge added to the current slowdown. Now that market forces are lowering them again, the effect is like a tax cut.

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