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Crony Capitalism in the U.S. Energy Industry: A Brief Review

Editor note: This post follows those of Walter Donway, who authored Crony Capitalism: Principles (Part 1) and Crony Capitalism: Practice (Part 2).

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 favor, 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 favor natural gas (Chesapeake’s bread-and-butter).

When will energy rent-seeking end?

10 comments

1 Ed Reid { 09.04.12 at 9:34 am }

Only when “rent” is banned. That answer is the same for all rent seekers. I realize that is far easier to say than it would be to accomplish.

Any attempt by government to influence markets will always be accompanied by attempts by market participants to influence government, whether to minimize negative impacts or to maximize positive impacts. That might not be “enlightened”, but it is “self-interest”.

“A government big enough to give you everything you want is a government big enough to take from you everything you have.” Gerald Ford, Presidential address to a joint session of Congress (12 August 1974)

2 Jon Boone { 09.04.12 at 2:45 pm }

Thanks for this thumbnail excursion through electricity policy history, Rob. The rent seeking should be cut back significantly now, given the size of the national debt, the level of government spending at 25%% of GDP, incoming tax revenue at 15% of GDP, and a government that has become more about patronage than about providing necessary services.

However, I note with a mixture of alarm and sadness that neither Mitt Romney nor Paul Ryan has resurrected a call for eliminating or substantially reducing cabinet agencies like Education, Energy, Agriculture, which do little beyond exacerbating demand for higher tax revenues and increasing the national debt. Those agency employees, however, can bring their vote to bear actuarially, something not lost on the national political leadership.

One striking contemporary feature of our political structure/process is the percentage of Americans who today identify themselves as independents–over 40%, a rather sizable plurality. But the leadership of the minority Republican/Democrat Parties continues to effect political power. The disconnect between Republicrats and people at large continues to widen, a strong indication that the American people are alienated from their governing system–and can do little about gaining power, given the nature of that system, with its actuarial gerrymandering removing any force of the vote except in a few handfuls of districts across the nation. People are now very aware that, at the national and most state levels, their vote means little as a way to influence policy.

Energy policy rent seeking could be reduced substantially if Romney/Ryan adopted a Reaganesque insistence that electricity be made the abundant resource it should be, where any policy must stipulate that abundant electricity be extremely reliable and secure–and affordable by all. Any public incentives would go to producing firm capacity generation at all times.And virtually all of these would be tied to research and exploration–not to development. Otherwise, the rest of us could say… “There you go again….”

3 rbradley { 09.04.12 at 9:16 pm }

Jon:

Reagan, remember, started out with a pledge to abolish the Department of Energy. I think his energy secretary said something like ‘salt the earth’ so it would not come back again too). But what Milton Friedman calls ‘the tyranny of the status quo’ prevailed.

4 Jon Boone { 09.04.12 at 11:55 pm }

Yes, Rob–but Friedman was sloganeering. There is no tyrannical status quo oligarch; rather, as I stated earlier, there is the political leviathan of patronage, which feeds upon–more patronage. And is translated into more votes, which are wielded into actuarial manipulations to control the electoral process. With the coordinated aid of mass media, great wealth, and even more sophisticated social cum political manipulation, we ain’t seen nothing yet.

As many now lament, Republican Reagan did indeed back off thirty years ago on his pledge to eliminate both the Departments of Energy and Education. Instead he added a new one–Veteran’s Affairs, which delighted Democrats. Today, government by patronage has become like the image of Saturn devouring his child in the powerful painting by Goya: http://en.wikipedia.org/wiki/Saturn_Devouring_His_Son.

Until people begin acknowledging this in routine political discourse, rather than ducking it with such abstract sloganeering distractions–such as government is too big (what does this mean, really?)–the Republicrat monster will hold illimitable dominion over all….

5 Robert Bradley Jr.: Crony Capitalism in the U.S. Energy Industry: A Brief Review | JunkScience.com { 09.05.12 at 3:44 am }

[...] MasterResource Share this:PrintEmailMoreStumbleUponTwitterFacebookDiggRedditLike this:LikeBe the first to like this. This entry was posted in Crony capitalism, Economics. Bookmark the permalink. ← Subprime Bubble: Obama ‘Vampire Socialism’ Built It [...]

6 Kermit { 09.06.12 at 10:30 am }

Were not price controls on domestic crude placed during the Eisenhower Administration?

7 rbradley { 09.06.12 at 10:39 am }

Not oil but natural gas.

Oil was subject to import restrictions to support domestic oil-state ‘market demand proration.’ Oil price controls began with Nixon’s August 1971 freeze.

8 MarkB { 09.06.12 at 4:46 pm }

Given that the ability to grant rents is a fundamental power of government to which both major parties are equally adept, I seen no possibility of reform.

9 rbradley { 09.06.12 at 4:54 pm }

I am more optimistic. I think the Tea Party right and Occupy Wall Street left as having this issue in common. But we need to ‘shame’ corporations that are rent-seeking–and tell investors that such companies are not good bets.

10 » MasterResource on Crony Capitalism in the U.S. Energy Industry: A Brief Review Crony Chronicles { 09.07.12 at 6:00 am }

[...] industry, beginning with coal, then discussing oil, and ending with the Enron scandal. It is a quick read, but worth it if you want to see just how pervasive cronyism can be in certain industries: [...]

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