Another Example of Government's Respect for Contracts

When you or I sign a bad contract, we have to live with it.  Did you sign up for a mortgage you can't afford anymore?  Sorry, you can find a way to suck it up financially, you can have the bank take your home, or you can declare bankruptcy and try to sort things out.  As a farmer, did you pre-sell your crops for what now looks like too low of a price?  Sorry, better luck next year.  What you and I don't get to do (and with good reason) in these situations is call for a mulligan and arbitrarily rewrite the terms of the contract the way we would like them today.

But the government, apparently, gets to do just that.  A while back I wrote about a series of court cases regarding wholesale electricity contracts in California:

Mike Gibberson
links a pair of court decisions that may set back any progress made in
deregulating at least the wholesale electricity markets.  In a series
of suits, the State of California is seeking a mulligan, asking the
court to rule that wholesale electricity contracts it entered into in
2000-2001 should be voided because the price was too high and FERC did
not have the authority to allow blanket market-based rather than
cost-based electricity pricing.  And the judges seem to agree:

The panel held that prices set in those bilateral transactions pursuant
to FERC's market-based program enjoyed no presumption of legality.

don't think there is anything more depressing to a good
anarcho-capitalist like myself than seeing the government rule that a
price negotiated at arms length by the free will of consenting, and in
this case well-informed adults enjoys "no presumption of legality."  If
not, then what does?  Is that where we are heading, to a world where no
voluntary actions enjoy a presumption of legality?

By the way, one has to remember that this is not a case of an
impoverished high school drop-out in East St. Louis signing a high
interest rate loan he didn't understand.  This is the case of highly
paid electricity executives and government electricity officials
signing electricity contracts.  It is as ridiculous to argue that they
were somehow duped in buying the one and only item they ever buy for
resale as to argue that Frito-Lay somehow shouldn't be held responsible
for the price it negotiates for potatoes.  These electricity companies
knew they had obligations to supply power at retail at certain rates
and failed to lock up enough supply in advance.  Whether Jeff Skilling
gamed the short-term spot market is irrelevant - the utility executives
were at fault for finding themselves beholden to the spot market for so
great a volume of electricity, and doubly at fault for taking this
power at insane rates when other lower cost options were available to
them (such as cutting off customers on interruptible contracts).

Apparently, Congress is doing it again, this time with offshore oil royalty rates.   They WSJ($) picks up the story:

The Democrats also insist that the big five oil
companies have received sweetheart deals from the government that have
ripped off taxpayers. So let's take a closer look. The most
controversial issue involves $6 billion in royalty payments that oil
companies are said to owe the government for oil pumped from federal
waters. The facts suggest otherwise.

These were leases for drilling rights in the Gulf of
Mexico signed between oil companies and the Clinton Administration's
Interior Department in 1998-99. At that time the world oil price had
fallen to as low as $10 a barrel and the contracts were signed without
a requirement of royalty payments if the price of oil rose above $35 a

Interior's Inspector General investigated and found
that this standard royalty clause was omitted not because of any
conspiracy by big oil, but rather because of bureaucratic bungling in
the Clinton Administration. The same report found that a year after
these contracts were signed Chevron and other oil companies alerted
Interior to the absence of royalty fees, and that Interior replied that
the contracts should go forward nonetheless.

The companies have since invested billions of dollars
in the Gulf on the basis of those lease agreements, and only when the
price of oil surged to $70 a barrel did anyone start expressing outrage
that Big Oil was "cheating" taxpayers out of royalties. Some oil
companies have voluntarily offered to renegotiate these contracts. The
Democrats are now demanding that all these firms do so -- even though
the government signed binding contracts.

The Democratic bill strong-arms oil companies into
renegotiating the contracts or pay a $9 per barrel royalty fee from
these leases. If the companies refuse, they lose their rights to bid
for any future leases on federal property. So at the same time that the
U.S. is trying to persuade Venezuela and other nations to honor
property rights, Congress does its own Hugo Chávez imitation.

Note: This is an update of this post, where I got these royalty issues both wrong and right.

  • You've got a bit about the California Electric "Deregulation" wrong.

    The primary blunder for California was letting companies like Enron write the rules for the market.

    From my understanding of the California "deregulation" rules, there was never an option for the Electricity Distribution Companies (Dists) to sign long-term supply contracts with Electricity Generating Companies (Gens). All of the Dists had to buy their electricity on the daily spot market, while at the same time they were locked into selling at a set rate. This wasn't a problem at the beginning because the wholesale prices on the spot market were so low that the Dists made a handy profit.

    But when Jeff Skilling gamed the market, the Dists were legally unable have a safety net of long-term contracts. The gaming of the system drove up wholesale prices on the spot market. The gaming also led to the rolling black-outs across California.

    An indication that the deregulation framework itself was broken was what happened in Los Angeles. Los Angeles's municipal power company was exempt from the Deregulation plan. LA had no problems getting electricity, had no rolling black-outs, and no spike in wholesale prices. When a giant government bureaucracy performs better than the market, something is wrong with the market.

    I wish I could find some documenation about this. I've got two passing references from PBS web sites.

    No Long Term Contracts:

    LA power:

  • I had a web site trauma and had to rebuild, so the link to Mike's post has actually changed number: