December 2004

Dis-Extrapolationism

by Roger Feldman  --   Bingham, Dana L.L.P.
(originally published by PMA OnLine Magazine: 2005/01/08)
 

It is the time of year when forecasts are made for the coming year. This is particularly appropriate for the energy industry which is all about markets and forecasts about markets: betting on them or hedging against them. In the world of the hockey stick projections, the man with the facemask is king. Also, the energy industry is a source of convenient aphorisms, the most convenient of which (most recently cited when natural gas prices soared way above projections, destroying the IPP market) was “Our projections were based on the best available data.”)

Unfortunately, energy projections, like most projections in the producer world, may not be assumed to take place in a vacuum. Some of the most obvious “exogenous variables” are the impacts of the economy on commodity and money costs, the swings prompted by geopolitical developments, the uncertainties of energy audited corporate accounting data. (Enron books, Shell anyone?), and (most recently acknowledged to the trumpets of Nobel prizes) the fact that “actual man” (whether consumer or speculator or investor) does not, when taken as a herd, behave the same as “individual economic man” is supposed to, depending on what actual man believes future economic reality will in fact, be).

To these caveats in evaluating forecasts - are three discovered in the otherwise eventless year of 2004:

• the Law of Election Interpretation (“winner takes all” on policies not even discussed in elections)
   
• the “Law of Statistical Blasé,” (all things will return to some prior mean at some prior time, like the legendary momentary accuracy of stopped clocks)
   
• the “Law of Accelerated Disintegration,” (the unforeseen by policymakers rapid logarithmic disappearance of policies found to have been placebos or at least non-instantaneous solutions

So the guiding principle apparently should be “disextrapolate”  -

Here’s how some key forecasts can duly disextrapolate by the foregoing Laws:

ITEM
“Bernard Kerik, former New York City Police Commissioner named head of Homeland Security.” Surely this reflects the Bush administration’s renewed get-tough intention to get to the real root of American insecurity - energy dependence - color it - NYPD Blue and create an integrated technology review and development program (the moon landing project of the ‘00s.

However, this assumption would conflict with the aforementioned Law of “Election Mandates”: Dick Cheney is the Minister Plenipotentiary of Energy, and the plan the USA will follow is already written (subject to the realities of the law of supply and demand). First ANWR, then LNG, some coal gasification maybe a little wind power - or maybe that’s just the dry wind over Mosul.

ITEM
“Oil prices take Another Deep Drop: Higher Heating Fuel Inventories, Mild Winter Prod. Decline” (Washington Post December 2, 2004). How did this happen? Well, forget all of that stuff about tight supplies, fear of disruption, impact of hurricanes -- that's so - well October! The new news is that the Energy Department has mistakenly underestimated the amount of natural gas in storage; that OPEC is likely to keep production levels (at its next meetings) and that milder weather has leveled requirements. In response to which news a noted financial analyst blandly was quoted “It does not surprise me, to be honest.” This contretemps highlights that any extrapolation of this headline should be ignored: it is subject to the Law of Statistical Blasé in energy industry evaluation.

. . . Which leads us to the power industry.

ITEM
“Others Watch Ohio’s Power Bill” (Wall Street Journal), Nov. 19, 2004. It now seems that “Despite Deregulation, States’ Electricity Rates May Rise”. Among other little observations: while deregulation proponents had counted on supplier-switchers to drive rates down, in the case of First Energy the largest potential source of change, more than half the customers moved to First Energy Solutions, its unregulated unit Ohio utilities received surcharges to pay down the cost of investment on assets potentially stranded by competition. Meanwhile, even though the (Ohio) utilities haven’t built new plants in many years; they desire to be free to raise their power prices in step with those in neighboring states where expensive new gas-fired plants have been built. Or as a utility spokesman put it. “If the market hasn’t developed, then now can you test the reasonableness of power prices charged by a utility going to market.”

Don’t bank on headline extrapolation to the effect that a mild winter in the Midwest, coupled with a summit meeting of M150 will result in downward movement of electric prices (or a surge of new IPPs, either, for that matter). Not for help from the Cheney Plan.

So then, one forecast (which I may be able to markup and use next year as well): There will be a progression toward concentrated production or importation of all types of energy, by a more concentrated group of players to accommodate the current perceived market status quo; unless and until and to the extent the cage of that status quo is so rattled by futures market price speculation that seams appear (or are created by regulators) where opportunities are created for new players not subject to the current system of traditional regulations. In other words, there’s plenty of hope for 2005. Be anti-disextrapolationist and have a great new year!

ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.