Fundamental to the operation of any market economy is the relatively unfettered operation of supply and demand in finding an equilibrium price for the products in that market. That’s generally what most mean when they use the term “free market.”
Like us, many likely think about the subject in terms of a basic supply and demand curve.
At any given price, sellers will produce, and buyers will purchase a given quantity of products. The goal of any market is for buyers and sellers to find the “equilibrium price” at which sellers will produce the same amount of products that buyers are willing to purchase.
Setting a price lower than the equilibrium price – in the chart above, a price of $475 per widget – will result in a supply shortage. Buyers may be willing to purchase a lot of the product at that price level, but sellers are only willing to produce a relatively smaller amount.
Setting a price higher than the equilibrium price – in the chart above, a price of $525 per widget – will result in a supply surplus. Sellers may be willing to produce a lot of the product at that price, but buyers, given alternatives or other factors, are only willing to purchase a relatively smaller amount.
Either results in market inefficiencies. Producing less than the equilibrium level of products will cause buyers to incur costs to cover the shortfall in various ways that may well be higher than what they would have paid at the equilibrium price.
Producing more than the equilibrium level of products will cause sellers to incur unrecovered capital or other costs that may have been better deployed elsewhere.
Recently, we’ve been thinking about this curve a lot in the context of the Cook Inlet gas market.
Some say there is a “shortage” of gas, but most agree that doesn’t mean a physical shortage. As Governor Mike Dunleavy (R – Alaska) said in a recent press conference on the subject, “We got a lot of pools of gas out there [in the Cook Inlet], we got a lot of pockets of gas out there. There’s no doubt about it. That’s been confirmed by a number of different independent agencies.”
Instead, the “shortage” appears to be an economic one: the sellers and buyers in that market have not found the equilibrium price.
Put another way, in a claimed effort to maintain low costs to their customers – but more likely, out of significant fear of being second-guessed by regulators – Cook Inlet gas buyers have failed to offer a price that incentivizes producers to make the investments necessary to tap those “pockets of gas” to increase production to the equilibrium level.
In a true market economy, the government would let the situation play out. While it might encourage buyers and sellers to work toward finding the equilibrium price – in this case, for example, by ameliorating the concern about regulatory second-guessing – the government wouldn’t otherwise interfere.
But that’s not how the Dunleavy administration is reacting to it. Two weeks ago, Department of Natural Resources (DNR) Commissioner John Boyle announced that the state is changing its royalty approach for new Cook Inlet leases to reduce the fixed royalty rate to zero.
Then, late last week, Governor Dunleavy himself held a press conference to announce that his administration will be submitting legislation this coming session to also reduce the royalty rate on existing leases for areas outside of existing production.
And not to be left behind, following Governor Dunleavy’s press conference, the Alaska House Majority, composed mostly of Republicans, issued a statement “applaud[ing] the Governor’s … efforts” and pledging to focus on Cook Inlet gas.
In both steps, the government proposes directly intervening in the market to change its dynamics.
The administration’s effort appears to be directed at subsidizing the producers by reducing their production costs. The administration’s hope, presumably, is that the subsidy will shift the supply curve down so that producers are willing to accept a lower price within the range of what the buyers currently are willing to offer.
But that’s not a “costless” option. Like any government interference in the market, it has significant consequences.
One relates to who will bear the cost of the subsidy and the consequential effects of that.
It’s obvious from the “supply shortage” that the equilibrium price for Cook Inlet gas is higher than what the buyers thus far have been willing to pay. If the Dunleavy administration allowed the market to continue to operate and the sellers and buyers finally found that price, the higher price would increase the state’s royalty receipts. The higher revenues from those increased royalty receipts, in turn, would reduce the state’s need for alternative revenues, which, anymore, largely are coming from cuts in the Permanent Fund Dividend (PFD).
By intervening in the process and voluntarily lowering the state’s take and, thus, revenues, the state is increasing the need for PFD cuts or other alternative revenues from other sources. Yes, Southcentral gas and electric consumers may benefit from lower energy costs, but it likely will come at the expense of deeper PFD cuts – in other words, on the backs of middle and lower-income Alaska families statewide.
And what’s the consequence of that? As we’ve discussed before in these columns, not only are PFD cuts “by far the costliest [revenue] measure for Alaska families,” but they have the “largest adverse impact” of any of the revenue options on the overall Alaska economy. Like any government intervention, there is no free lunch. In this case, the Dunleavy administration is choosing to help out one sector of the economy – the Cook Inlet gas market – at the expense of both middle and lower-income Alaska families and other parts of the economy.
Another consequence of the intervention is its adverse impact on the development of alternative energy supplies, such as renewables.
Another of the benefits of a free market is that it helps identify and support lower-cost alternatives. If the price for Cook Inlet gas was allowed to rise to the equilibrium price in this situation, buyers might find that other alternatives – such as renewables in the case of the electric utilities – could provide the same energy at lower costs than a continued commitment to gas.
Sometimes, the Dunleavy administration claims a move to renewables is one of its priorities. But by subsidizing gas, its new leasing policies will undercut that objective. If, as the Dunleavy administration appears to hope, the subsidies result in the development of a significant amount of additional gas supplies, it might undercut its objective of increased renewables for a long time.
Another troubling aspect of the administration’s proposals is their open-ended nature. Going all the way back to Adam Smith – the “Father of Capitalism” – most advise that if the government feels compelled to intervene in a market, it does so at least in a limited way and for a limited time.
The Dunleavy administration already has existing statutory authority to do exactly that. Under AS 38.05.181(j), the DNR Commissioner “may provide for modification of royalty on individual leases” (or units) under various circumstances where the producer can demonstrate that, without the modification, production from the lease or unit “would not otherwise be economically feasible.
The statute contemplates royalty relief on a case-by-case basis, adding production increments as producers demonstrate a specific need.
The Dunleavy administration’s proposals, on the other hand, appear to contemplate blanket relief on all new leases and new production from existing leases without any requirement for an economic showing.
That’s not “limited intervention” in the market; it’s a wholesale invasion.
The consequences may be significant. What if, for example, a producer discovers on one of the leases covered by the Dunleavy reductions the “mother load” of gas many have speculated exists in the Cook Inlet, but none have ever found? Because of the agreement to reduce royalty, Alaskans would not share in the results, at least for an extended period, and, given the reduced cost of supply and, thus, price, renewables might be deferred for decades.
Contemplating such a situation, the existing statutory authority governing royalty reductions includes this condition. Under AS 38.05.181(j)(3), as part of any royalty reduction, the Commissioner:
… shall provide for an increase or decrease or other modification of the state’s royalty share by a sliding scale royalty or other mechanism that shall be based on a change in the price of oil or gas and may also be based on other relevant factors such as a change in production rate, projected ultimate recovery, development costs, and operating costs.
Dunleavy’s proposed blanket change does not appear to contain any such condition, however. Such a windfall to the producer – and cost to Alaska families – would simply be another distortion created by the government’s wholesale intervention in the market.
We understand that governments often are tempted to interfere in a market economy to redirect the outcome to favored constituencies. That certainly seems to be the situation in this case. The Dunleavy administration and Alaska House Republicans appear intent on bailing out the Cook Inlet gas market regardless of its effect on Alaska families and other parts of the economy.
Given their previous rhetoric about the perils of government intervention in markets, however, we are surprised that Governor Dunleavy and the Alaska House Republicans have become major advocates of doing so. They appear to have given up on one of the very things they claim to prioritize.
Brad Keithley is the Managing Director of Alaskans for Sustainable Budgets, a project focused on developing and advocating for economically robust and durable state fiscal policies. You can follow the work of the project on its website, at @AK4SB on Twitter, on its Facebook page or by subscribing to its weekly podcast on Substack.