“Farmer Johnson, plant more corn”

Michael Giberson

If you haven’t had your fill of ethanol-and-the-high-price-of-food-everywhere stories, today the Washington Post takes a look from the point of view of an Iowa farmer.

Johnson is a one-person summary of how high corn prices are washing through the world of agriculture and climate change. Normally, he plants half of his 900 acres with corn and half with soybeans. He alternates crops on each field because it is better for the soil.

But last year he planted 500 acres of corn and 400 of soybeans, and this year he will do the same. “The market was screaming, ‘Farmer Johnson, plant more corn, plant more corn,’ ” Johnson says.

Well, the market may be screaming for more corn, but much of it is due to the hard, swift kick in the bushel-basket delivered by Congress:

In 2005, the Republican-led Congress and President Bush backed a bill that required widespread ethanol use in motor fuels. Just four months ago, the Democratic-led Congress passed and Bush signed energy legislation that boosted the mandate for minimum corn-based ethanol use to 15 billion gallons, about 10 percent of motor fuel, by 2015. It was one of the most popular parts of the bill, appealing to farm-state lawmakers and to those worried about energy security and eager to substitute a home-grown energy source for a portion of U.S. petroleum imports. To help things along, motor-fuel blenders receive a 51 cent subsidy for every gallon of corn-based ethanol used through the end of 2010; this year, production could reach 8 billion gallons.

The article is part four in a series on high food costs around the world.

Piling on the criticism of a summer gas tax holiday

Lynne Kiesling

By now you all have probably heard that Hillary Clinton and John McCain are proposing gasoline tax holidays this summer to take some budget pressure off of voters who drive a lot (c’mon, let’s be honest about the true audience of these proposals). Barack Obama does not support such a proposal.

Criticizing this proposal is truly like shooting fish in a barrel, and others have done it more thoroughly and eloquently than I can (thanks to the WSJ’s Environmental Capital for the link).

So will the populist impetus take the day on this issue, or will there be room for reasoned economic analysis to convince voters that this is a stupid policy? Depends on who they are and how much they drive, probably.

Thrills! Chills! High Oil Prices! A Roller-Coaster Ride of Excitement!

Michael Giberson

Wow, this article on international oil supply and demand from the New York Times is fascinating, and not in a good way. Did they fire the editors? It is like a bad action movie – fast-paced, a few colorful characters, far too many plot twists, and if you stop to think you spoil the effect. It just doesn’t add up.

Here is one thread of an idea, followed through the article:

But as prices flirt with $120 a barrel, many energy specialists are becoming worried … Higher prices have done little to attract new production or to suppress global demand, and the resulting mismatch has sent oil prices spiraling upward.

Have you ever actually seen a price spiral upwards? Not me. Nor downwards either. Later in the article:

“It’s a crunch,” said J. Robinson West, chairman of PFC Energy, an energy consulting firm in Washington. “The world is not running out of oil, but rather it’s running out of oil production capacity.”

I think the reporter didn’t understand what “running out of oil production capacity” meant to the story.

Still later:

In fact, high prices have sparked a global dash for oil. … In some cases, the hunt has been successful. … To make up the shortfall, the world is increasingly turning to fuels made from unconventional sources, like biofuels or heavy oil.

The world is running out of oil production capacity because there is a global dash for oil. This dash is the oil supply response, and it is probably not too soon to conclude the world oil production will be higher this year than last, even as we are short on oil production capacity.

Oil production capacity is expandable, of course, as more tools can be built, more geologists trained, more wells drilled, more reservoirs analyzed, and so on. But just like a new oil discovery doesn’t show up in your gas tank the next day, it takes time.

(HT to The General)

“There’s no such thing as a free carbon cap”

Lynne Kiesling

I’m taking a little time this morning to catch up on the reading I’ve missed over the past month, while I’ve been focused elsewhere. One worthwhile observation, with which I agree, comes from Virginia Postrel’s note about carbon policy positions of Presidential candidates, among other things:

It’s infuriating how all three presidential candidates prattle on about the need to fight global warming while also complaining about the high price of gasoline. … The last thing you’d want to do is reduce gas taxes during the summer, as John McCain has proposed. That would just encourage people to burn more gas on extra vacation trips–as any straight talker would admit.

No gouging or other manipulation found in study of Washington state gasoline prices

Michael Giberson

Leffler-Washington-gas price study 2008 cover.pngAccording to a year-long study of gasoline prices in the state of Washington, variations in prices across the state “are due to the cost of obtaining and transporting fuel to stations and local competition – not illegal price manipulation.”

The state’s Attorney General commissioned the study, which was conducted by University of Washington economist Keith Leffler.

“West Coast refineries are running at capacity,” [Washington Attorney General Rob] McKenna said. “We’re importing higher-priced refined gasoline to meet consumer demand, which raises average prices at the pump. Any glitches in the supply system can cause significant price spikes. Meanwhile, crude oil costs nearly four times as much as it did five years ago.”

In general, the report observed that retail gasoline prices were higher because the cost of crude oil was higher, regional variations in wholesale prices were closely related to variations in the cost of supplying fuels to terminals (though exceptions are noted), and competition within city areas is the most important factor behind remaining differences in regional retail prices.

Current average retail Washington prices were reported to be the sixth highest in the nation, in part because, as the report explains, Washington state gasoline taxes are highest in the nation.

Perhaps unlike Vermont*, gasoline consumption per person is going down in the Pacific Northwest. The Seattle Post-Intelligencer reported:

Washington, Oregon and Idaho residents are guzzling less gas per person, according to a report released Thursday by Sightline Institute, a Seattle-based think tank.

Motorists used on average nearly a gallon less each week in 2007 (7.8 gallons) than they did in 1999 (8.7 gallons), the lowest per-capita level since 1966.

Despite growth in population, overall gas consumption has been relatively flat in the region in the last nine years, the report said.

“The biggest single impetus is higher prices,” said Clark Williams-Derry, research director of Sightline. “When prices rise, people start to make different kinds of choices. … We’re traveling a little less. We’re making shorter trips and fewer trips.”

*Or maybe Vermont, too, is using less gasoline, despite the note yesterday saying that vehicle miles traveled in the state is up since 2000 even with higher prices. The Kansas City Star reports that gasoline consumption is falling nationwide:

Kansas City Star_gas_by_region_042208.jpg

A longer view of the retail gasoline experience in Vermont

Michael Giberson

Free Press columnist Ed Shamy offers “a stroll through The Burlington Free Press archives about gasoline prices,” beginning January 16, 1974, continuing to today:

Jan. 16, 1974: Gasoline in short supply in Vermont. Entire communities without a single open filling station. And gasoline is obscenely expensive, an average of 48.7 cents per gallon for regular.

Jan. 19, 1974: AAA poll of 113 Vermont service stations shows most are open 7 a.m. to 7 p.m., most closed Sundays, all limiting sales to $3, and charging an average of 49.6 cents per gallon.

April 2, 1974. Some Vermont vendors are selling gasoline for as high as 53 cents per gallon for regular. Rampant speculation that oil companies may be gouging consumers.

Oct. 1980: “People will drive five miles to get 2 cents off on a gallon,” says the manager of a Berlin gas station during a price war.

May 1981: Three gas station owners in Londonderry predict a painfully slow summer tourist season because gas has reached an eye-popping $1.399 per gallon. Rampant speculation that oil companies may be gouging consumers.

May 1989: President of the Vermont Chamber of Commerce says, “When it breaks that $1.50 a gallon figure, that’s when it starts to affect people.”

August 1999: Burlington man: “Terrible! It was $1.19 the other day. Today it was $1.21. They’ve got you where they want you, and they are going to keep you there until they bleed you to death.” Rampant speculation that oil companies may be gouging consumers.

September 2005: “I didn’t know until yesterday that my pumps wouldn’t go over $2.99,” says a gas station owner in Elmore.

November 2007, with gasoline prices averaging $3.02 per gallon in Vermont: “Everybody keeps wanting to see what’s that point of impact where people start to cut back. We keep setting the benchmark, and people continue to travel,” a AAA spokesman says.

Today: $3.50 per gallon and rising with no end in sight.

Shamy adds a footnote: “In 2000, each Vermonter traveled 11,167 miles in a motor vehicle, according to the U.S. Transportation Department. By 2005, there were more of us and still each of us traveled more — 12,379 miles.”

More on ethanol policy and food prices

Michael Giberson

In an op-ed in the Washington Post, Lester Brown and Jonathan Lewis seem overly generous in their interpretation of the motivations for the now-obvious-failure of ethanol policy in the United States:

Food-to-fuel mandates were created for the right reasons. The hope of using American-grown crops to fuel our cars seemed like a win-win-win scenario: Our farmers would enjoy the benefit of crop-price stability. Our national security would be enhanced by having a new domestic energy source. Our environment would be protected by a cleaner fuel. But the likelihood of these outcomes was never seriously tested, and new evidence has shown that the justifications for these mandates were inaccurate.

I must have missed the analysis indicating that ethanol was intended to create crop price stability. I thought the hope was always that the policy would push food prices up. Isn’t that how increases in demand work?

Also, the national security argument for ethanol always struck me as false. We import most of our oil from Canada and Mexico, and with oil a fungible product in an international market, it is hard to see just how some other nation might wield oil-withholding as an offensive threat.

Possibly the move to increased ethanol could have lead to environmental improvements, but biofuel mandates are a bad way to implement policy even if it were true that they produced benefits. As a practical matter, the environmental arguments for ethanol have always been mostly a smokescreen. Ethanol policies were never popular in Iowa because of their potential for improving air quality in Los Angeles or New York City. “Food-to-fuel mandates” always smelled like political pork to me, so I guess I’ve never had a generous opinion of the motives of its political supporters.

(In fact, there is some danger that all ethanol technologies will be unfairly tainted by an association with current failed policies mostly intended to drive up corn prices. Supporters of non-corn-based alternatives for making ethanol may want to distance themselves from the pork-barrel politicking of the agribusiness lobby.)

Of course, Brown and Lewis are promoting a change in policy, for which the support of politicians is needed. I suppose, purely as a rhetorical device, it is useful to not describe the targets of your appeal as a bunch of …. Well, it is probably useful not to finish that sentence.

The Brown and Lewis editorial does bother me in parts. Does most of the energy used to make ethanol actually come from coal? I would have guessed oil for fuel and natural gas for fertilizer. Also, like many people (myself included), Brown and Lewis are eager to blame world-wide high food prices on ethanol policy, but most of the analysis I’ve seen in the newspapers is thin. The argument makes a lot of sense, but there are other obvious factors (high fuel costs, increasing world demand for meat consumption, increasing world demand for food generally), so it would be nice to see a careful sorting out of the contributing factors.

The conclusion, however, is good:

[I]t is impossible to avoid the conclusion that food-to-fuel mandates have failed. Congress took a big chance on biofuels that, unfortunately, has not worked out. Now, in the spirit of progress, let us learn the appropriate lessons from this setback, and let us act quickly to mitigate the damage and set upon a new course that holds greater promise for meeting the challenges ahead.

(HT to Tim Haab at Environmental Economics)

The crescendo of the biofuels/food interaction

Lynne Kiesling

We’ve been talking about the interaction of biofuels subsidies and food markets here at KP for at least the past year. The interaction is reaching a crescendo, as seen in the increased media coverage of the increased food prices, riots in poor communities, and impending increased hunger and starvation. See, for example, the lead in this week’s Economist. Their recommendation: stop the policy distortions.

In general, governments ought to liberalise markets, not intervene in them further. Food is riddled with state intervention at every turn, from subsidies to millers for cheap bread to bribes for farmers to leave land fallow. The upshot of such quotas, subsidies and controls is to dump all the imbalances that in another business might be smoothed out through small adjustments onto the one unregulated part of the food chain: the international market.

For decades, this produced low world prices and disincentives to poor farmers. Now, the opposite is happening. As a result of yet another government distortion–this time subsidies to biofuels in the rich world–prices have gone through the roof. Governments have further exaggerated the problem by imposing export quotas and trade restrictions, raising prices again. In the past, the main argument for liberalising farming was that it would raise food prices and boost returns to farmers. Now that prices have massively overshot, the argument stands for the opposite reason: liberalisation would reduce prices, while leaving farmers with a decent living.

There is an occasional exception to the rule that governments should keep out of agriculture. They can provide basic technology: executing capital-intensive irrigation projects too large for poor individual farmers to undertake, or paying for basic science that helps produce higher-yielding seeds. But be careful. Too often–as in Europe, where superstitious distrust of genetic modification is slowing take-up of the technology–governments hinder rather than help such advances. Since the way to feed the world is not to bring more land under cultivation, but to increase yields, science is crucial.

Who would you back: the market consensus or book-writing pundits?

Michael Giberson

Tyler Cowen picks the market consensus over book-writing pundits:

Either the current market estimate of inflation is the best estimate available, or you know that it is wrong and you will be a very rich man. I find the former scenario more plausible.

Cowen is commenting on the Kevin Phillips book, Bad Money, recently out.

Of course book authors may be wary of going directly into the financial markets to wager their hard earned cash, which is why I have advocated prediction markets for pundits in which authors would have a chance to back their book-selling punditry with real money. See my post: Separating cheap talk from truly held beliefs.

“Decade of deregulation felt in climbing bills”: Costs by category

Michael Giberson

As I mentioned yesterday, I thought the Washington Post‘s story (“Decade of deregulation felt in climbing bills“) on various costs embedded in electric power bills was reasonably good. But the article covers several aspects of the overall picture without always being clear about the role played by the charges. From the economics point of view, the vital element of any charge included in the consumer’s bill is whether it tends to contribute more or less to efficiency in the production and consumption of electric power. One step toward sorting out the issues here is to sort out the different charges depending on whether they arose under the old or new regulatory regime.

Re-reading the article, I counted about nine overlapping categories of costs or charges that feed into a consumer’s bill. Below I identify the nine types of costs and assign them to one of three categories: (1) Costs left over from the old regime, (2) Costs arising in the new regime, and (3) Continuing cost types. Each of the categories is illustrated by a quote from the article.

Of course the biggest factor of influence over the bill — fuel costs — is mostly ignored in the article by design. The focus was explicitly on elements of a consumer’s bill “that have nothing to do with the rising price of fuel.”

Costs left over from the old regime/Transitional costs:

  • Stranded costs – “Virginians are paying Dominion Power tens of millions of dollars a year for a nuclear plant the company planned in the 1980s but never built.”
  • Rate freezes (aka Performance-based ratemaking) - “The charges include $238 million for a new nuclear reactor at its plant outside Richmond. Dominion canceled plans to build the plant 26 years ago amid safety concerns about nuclear power. The last of the charges was set to expire in 1999. But when rates were frozen during the transition to deregulation, the charges stayed. They’ll continue until at least next year.

Costs associated with the new regime:

  • Congestion pricing – “Federal rules that accompanied deregulation also increase costs to consumers. Because of them, customers pay a premium for living in a congested region thirsty for power.”
  • Uniform marginal price – “Now, on hot summer days, for example, when the demand for electricity is high, the price is set by the last, most expensive plant that is needed to supply power. These are typically natural gas plants. But the rising price of natural gas has produced a windfall for owners of older nuclear and coal plants.”
  • Capacity market payments – “And although they began paying surcharges last year so power companies will invest in new plants, the charges have resulted in relatively few additional megawatts. These charges account for about 25 percent of the price of electricity in the District and Maryland and less in Virginia.”
  • Structural impediments to competition – “Critics say the supply has increased so little because the existing system not only benefits the companies in the region, it gives them an incentive to constrain the supply of electricity to keep prices high…”

Same as it ever was:

  • Funds for eventual decommissioning of nuclear plant – “More than 1 million residents of the Washington-Baltimore area paid $920 million to take the Calvert Cliffs nuclear … off-line in 2034….”
  • Continued political influence over rates – “The deal reached between Constellation and Maryland Gov. Martin O’Malley (D) this month blunted two years of recrimination over a 72 percent rate increase for 1.1 million Baltimore Gas and Electric customers. They will get a $170 one-time credit and relief from future decommissioning costs.
  • Flawed consumer incentives to use power economically – “PJM spokesman Ray Dotter said the Aug. 1 price reflected the cost to produce electricity that day. But customers pay a flat rate, giving them little reason to use less power, he said. “A more ideal situation would be that the price sends a signal that people conserve more.””
  • Hmmmm… – “Electric bills in Virginia are expected to climb when the state returns to regulation next year, although it’s unclear by how much.”

This is just sort of a rough draft approach at a sorting. I know we have some expert readers and I’d be happy to receive comments from them. Each of these topics could bear individual attention. I’ll post on some of them over the next several days.

You may have noticed I referred above to “the old or new regulatory regime,” and not to “the regulated or deregulated regime.” Yep. I am one of those wackos that prefers the ugly word “restructuring” to the apparently more catchy term “deregulation” when talking about the changes in public policy toward certain elements of the electric power industry over the last ten to twenty years.