Editorial An EC energy half-step

The European Commission has taken a bold half-step into the world of market economics for energy. In markets, however, half-steps are not enough.

The EC proposes a directive that would encourage electricity utilities to base decisions about primary fuels solely on economic merit. So far, so good. But the directive also encourages consumers to reduce their energy use. Woops.

Faith in markets

Apparently, the well-meaning folks who govern Europeans want to believe in market economics. Why else would they deign to instruct power generators to use primary fuels that make the most commercial sense?

But their faith in markets has limits, yielding to the view that energy consumption is something governments ought to discourage. This view, grounded in environmentalism, has become a self-sustaining political force: No matter how much energy a country consumes today, less tomorrow would be better.

The view has two problems relevant here. The first is that it is simply wrong. Energy consumption is an economic activity that must be viewed in an economic context. The goal should be efficiency, which means reducing the energy use required for each increment of economic growth.

That's not what the EC has in mind. It is seldom what governments have in mind. The EC wants absolute reductions in energy consumption, which in the absence of efficiency gains can come about only through economic sacrifice.

This leads to the second big problem with the absolutist view of energy use reductions. Governments that adopt it logically sabotage other initiatives based on market economics, such as the EC's directive on utility fuel choice. Why should it be virtue for energy suppliers to make economic choices but vice for consumers to do likewise? Markets assume that consumers understand their economic interests, act accordingly, and need no help from governments.

The EC is far from alone in succumbing to the urge to dictate energy demand. Before stumbling over a half-step toward market economics, it should study a U.S. mess that developed because state utility regulators got carried away with something called demand side management (DSM).

DSM, which treats conservation as a source of supply, can be a useful correction to consumption incentives resulting from subsidies in old rate structures. Inevitably, however, it has fallen prey to regulatory pressures to consume less energy, no matter what. DSM thus has become a mechanism for requiring payment for energy not supplied or consumed. The resulting costs can be justified only in relation to subjective parameters such as environmental and societal values-often including fantasies about the value of reducing energy use solely for the sake of doing so.

As gas and electric utilities are learning, energy consumers do not approach the market wanting to buy environmental and societal values as defined by utility regulators. They come wanting to buy electricity or gas at the lowest possible price. Such prices are increasingly available from nonutility suppliers unburdened with costs of DSM and similar utility programs. Under deregulation, suppliers of this type are flourishing, which means competitive problems for utilities and growing rate questions for their regulators.

Seeking efficiency

If pressed, state utility regulators might contend that it is efficiency, not absolute reductions in energy consumption, that they really want. EC commissioners would probably say the same thing about their proposals to discourage energy use.

The oil and gas industry, which has an increasing interest in these matters as energy markets merge, should dispute this hypocrisy. As its history shows, government interventions in energy markets are inescapably inefficient. The direct path to energy efficiency is market freedom. Markets aren't free where governments manipulate demand.