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Winter 2005 CalBusiness  
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The Power of Ideas

The Politics of Energy
Professor Severin Borenstein on the future of energy markets

Severin Borenstein is the E.T. Grether Professor of Public Policy and Business Administration at the Haas School and director of UC Berkeley's Energy Institute. He spoke to CalBusiness about the lessons of the California energy crisis, and the governor's energy policy.

Q: What did you learn from the California Energy Crisis?
A: You have to design markets that are robust to players doing everything they can to make money because if there is a way to make money, and it's not explicitly outside the rules, somebody is going to do it. When we started getting a tighter electricity market, the sellers figured out they could make more money by making less electricity and driving the price up in the market. That's why you need to stress test a design like this before you put it into place. We also need to have much of the power bought on long-term contracts so that we aren't vulnerable to big fluctuations.

Q: You once said that all commodity markets require some level of regulation. How much should we regulate electricity markets?
A: There is still a strong argument for a regulated retail sector where you have a utility providing power to customers. But there is also a good argument for a less regulated wholesale sector. The utility companies would buy the power in a competitive market, instead of with the old model where the utility builds all its own power plants and self-provides the power.

Q: California pays 20 to 40 cents per gallon more for gasoline than other states. Will this change soon?
A: Up until about a year ago California averaged about 12 cents more per gallon than other states, before taxes. In the near future we are unlikely to see that 12-cent differential again for any sustained period of time. The reason is that from 1996 to last year California could produce enough gasoline for itself and still export to other states. That's over, by and large. We are now importing gasoline on the margin. We are in this position, if not permanently, for a long time to come, mainly because I do not see anyone building a refinery in California anytime soon.

Q: Will President Bush's second term influence the energy markets?
A: The simple prediction is that it's not going to make any substantial difference in the next five years. There's very little that can be done over the short run to change the energy situation. If we start drilling in the ANWAR (in Alaska) no oil will flow for another five years at least. If we did drill, it would be such a small share of the world market that it wouldn't make much difference to the price. If we upgraded the fuel efficiency standards for US cars, those upgrades wouldn't start to take effect for five years and, once they did, it would be at least another five years before they substantially affected fleet fuel economy because cars don't wear out that quickly.

Q: How do you view the steps Gov. Schwarzenegger is taking to address California's energy woes?
A: On the electricity side I'm in agreement with him on the need for wholesale competition. However, he believes there are strong arguments for retail choice or competition for large industrial consumers and I am completely unconvinced of that. I see a very serious downside if that is used to shift the costs to other customers. On the gasoline side there's not much a governor can do. We're stuck with some harsh realities: oil is going to cost a lot, California doesn't have the refining systems to support our gasoline needs, and no one wants to live near a refinery.

Q: Would energy independence solve the US energy crisis?
A: Energy independence is the wrong goal. We live in an integrated economy and we should continue to trade with the rest of the world. Reducing reliance on products that come from unstable or oppressive regimes should be our goal. We don't need to stop using oil, but reduction is critical. We can increase fuel economy in autos and trucks. On the electricity side we can continue to develop renewable alternatives, but with a real willingness to face reality about what works, what doesn't, and what costs a lot, and what doesn't. Wind power is something that we should be using now; solar power is something we should be putting money into for research and development to make it better.

Q: Do you see a worldwide energy crisis in the future?
A: We are in the middle of a worldwide, I'm not sure I'd call it crisis, but energy upheaval. People are focused on the spot price of oil and how it is above 50 dollars or below 50 dollars. That's the wrong focus to understand what's really happening. Since the early 1990s and before, if you looked at the futures market and looked at the farthest contract six years out, it was almost always between 18 and 23 dollars a barrel. At the start of 2005, it was more than 36 dollars a barrel. This is a much more dramatic change than what we've seen in the spot price. This is important. We aren't just seeing a short-term blip, we are seeing a long-term change in the supply and demand balance in oil. This change will have far-reaching implications for the world economy.

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<i>Severin Borenstein</i>

Severin Borenstein

E.T. Grether Professor of Business Administration and Public Policy

Director of the University of California Energy Institute

At Haas since 1996

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